(To read more on the multifamily market, click here.)

SAN FRANCISCO-Banc of America Securities is predicting high single-digit NOI growth for Bay Area apartment properties through 2007 due to the inaffordability of the single-family home and a lack of new apartment development. The report follows a tour of several Bay Area apartment properties owned by REITs such as Equity Residential, Archstone-Smith, United Dominion, Essex Property Trust and AvalonBay.

Average occupancy in the Bay Area has been rising steadily and now stands at 97.4% from its 2001 low of 94.4% following the telecom/dot.com bust, according to the report. Part of the reason for the improvement is supply. While there have been lots of apartment units converted to condominiums, the report found that no rental market rate apartments have been delivered for the past four quarters and that expected deliveries in 2006 will total only 480 units, only slightly better than the 406 units delivered in 2005. If construction completion expectations hold true, the Bay Area will have posted the two lowest annual totals since 1996, according to the report.

Two key fundamentals, population and employment growth, are expected to stay relatively tepid at 0.5% and 1% per year, respectively, through 2010, below the national average of 0.9% and 1.3%, respectively. However, the relative lack of job growth and low net migration has been more than offset by continued strong demand from investors and tenants along with the lack of new supply.

As a result, cap rates in San Francisco have fallen over the last three years. According to Real Capital Analytics, average cap rates on apartments have dropped 190 basis points from 8% to 6.1%. The spread between cap rates in San Francisco versus the rest of the nation has widened slightly over the past few quarters and is currently 200 basis points, which the report suspects is due to capital chasing product located in coastal markets that are hard to enter.

In conclusion, the report promotes companies like Archstone-Smith, Avalon Bay, BRE Properties and Essex Property Trust, which have assets “in high barrier-to-entry coastal markets where the wide spread between the monthly costs of owning versus renting gives landlords pricing power.” The report is more cautious regarding company like Apartment & Investment Management, Equity Residential, Post Properties and United Dominion, “which generate condo income and have exposure to markets where housing affordability is not as stretched.”

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