Supply, Demand, Money & Demographics:
10 Factors Behind San Francisco’s Real Estate Market
Updated September 2015
Why is San Francisco’s housing market the way it is now? What's behind the often intense competition among buyers and the surge in appreciation since 2012? It’s worthwhile to take a step back and consider the main factors at play, some of which reflect general macro-economic trends and some of which are specific to the city itself:
Population growth: San Francisco has recently been adding approximately 10,000 new residents per year and new home construction has not come close to adding enough additional housing units to meet increase demand. (And more would move here if they could find a place to live.) New construction is booming again in the city, but much of it is in very expensive, luxury projects (selling 1 and 2-bedroom units) and a large percentage of buyers for such real estate - maybe as much as 40 to 50% - are wealthy people with primary residences elsewhere, buying second or third homes or units as investments. They are "sopping up" much of the added inventory being constructed without relieving population pressures. All in all, it appears that it will still be a while before enough new units arrive (to rent or to buy) to substantially change the existing high-demand/low-supply market dynamic.
Employment growth: San Francisco now has the highest number of employed residents in its history and job numbers continue to grow as new companies start up and existing ones expand. They're not just in high-tech - though that is certainly leading in job creation - but in science, medicine, construction, retail and financial services as well. Many of these new jobs are very well paid.
Speaking of just high-tech jobs, according to the San Francisco Business Times (3/6/15), "The city's tech workforce has more than doubled in the last 3 years, and Indeed.com, a recruitment site, still lists 8600 unfilled software engineer positions in the city."
The net net: Approximately 12,000 units of housing have been built in San Francisco since 2010. Over the same 5.5 years, the number of employed residents has increased by over 100,000. In light of the mismatch between supply and demand, the pressure on housing prices is not surprising.
Surging stock market: The S&P 500 is up approximately 60% from January 2011 to autumn 2015. The affluent have benefited most from the recent, large increase in the value of financial assets, and San Francisco has one of the most affluent populations in the country. When people feel wealthier, they spend more on homes, second homes and real estate investment properties.
Brand new wealth: Thousands of newly affluent residents – including significant numbers of millionaires and even billionaires – have been created in the Bay Area in recent years from stock options, IPOs and company sales. This is super-charging the “wealth effect” on the market. According to Wealth-X, San Francisco ranks 3rd in the nation for number of "ultra-high-net-worth" residents.
It's also interesting to note that: "San Francisco ranks first among U.S. cities in income mobility — the opportunity to rise upward on the income scale — thanks to its schools, its growing economy and its compact physical size that doesn’t produce walled-off divisions." (San Francisco: a city pushed to new limits and opportunities)
High rents: Purchasing a home in San Francisco, with the attendant multiple tax benefits and equity accrual (as well as the possibility of future appreciation), often makes compelling financial sense if the alternative is to pay an extraordinarily high rent.
Low interest rates: from 1996 to 2006, the average interest rate on a 30-year fixed rate loan was approximately 6.3%. As of September 2015, it was running below 4%. That 37% reduction in the cost of financing makes an enormous difference in affordability and the ongoing cost of housing.
Renting instead of selling: High rents and low interest rates have
convinced some owners who would have sold
their homes to rent them out instead.
The Airbnb rent-to-tourists option is probably adding to this. This further
depresses the supply of new listings coming on market, exacerbating the
inventory shortage: 2013 to 2015, the number of new
MLS listings is down significantly, when higher prices would typically be expected to increase supply. (If considering this option, see Renting vs. Selling in San Francisco.)
Work there, live here: A relatively recent development, many of the people working or taking new jobs in Silicon Valley high-tech and bio-tech now insist on living in the city, creating what might be called a "reverse commute" from past patterns. The “Google bus” phenomenon is just one illustration of a trend which puts considerable additional pressure on our housing market.
Magnet effect: San Francisco, a small city of 7 by 7 miles, is now the capital of perhaps the fastest growing, most lucrative, highest-prestige business segment. It is also in one of the most beautiful, best educated, most tolerant and culturally rich metropolitan areas in the world. That makes the city a magnet for smart, creative, ambitious people from all over the planet and they are willing to pay a premium to live here.
Last but not least, there has been a general demographic trend for post-college adults, aged 24 - 39, to move back into urban core areas - and that certainly is dramatically occurring in San Francisco. (See the books, "The Great Inversion & the Future of the American City" and "Who's Your City? How the Creative Economy Is Making Where to Live the Most Important Decision of Your Life.")
Limited supply: Almost two thirds of the city’s housing is in rental units, much of it under rent control. The number of homes suitable for owner-occupancy and available to purchase each year is relatively small: As an example, the SF homes market is less than half the size of the markets in either Alameda or Contra Costa counties.
Furthermore, new housing construction simply has not been adequate to the city's needs over the past 35 years. 49% of San Francisco’s housing stock was
built prior to 1940. As seen in the chart below, the surge in
population during WW II led to a burst of building, which then steadily
declined to clearly insufficient levels until the big increase in condo
construction at the end of the 1990’s. The 2008 market crash ended that cycle,
and the current boom in home construction has been quickly gathering steam only
in the last year or so. But note that ever since the mid-1990's the units being built are typically 1 or 2-bedroom condos or apartments, instead of 2 and 3-bedroom houses, i.e. the new housing units being added house much fewer people per unit.
: We won't count this as one of the 10 factors behind the current market, because the enormous tax benefits of homeownership in the U.S. are always present, boom or bust (until Congress legislates large, unexpected changes to U.S. tax law), but still it is a big factor underlying the country's housing market generally. Being able to deduct interest costs and property taxes allows homes to cost (much) more and yet remain affordable to buyers. And there is also the $250,000/ $500,000 exclusion of gains realized upon sale of a primary residence from capital gains taxes: There is not another financial investment we can think of that allows one to reap profits of this magnitude without any tax liability. It's interesting to note that the tax benefits of homeownership in this country are rarely found anyplace else in the world.
This chart below is a simplified, smoothed-out and approximate look at the last few real estate cycles in the San Francisco Bay Area, illustrating estimated percentage changes
in home prices from successive peaks and bottoms of the market. The years between these high/low points are simply depicted here as straight lines (which does not reflect reality). Different market segments - areas, property types, price segments - have experienced varying appreciation and depreciation rates over the years and how this chart applies to any specific property is unknown without a tailored analysis. (The city of San Francisco's market has been outperforming the overall Bay Area in its rate of appreciation.)
Huge demand + surging wealth + severely inadequate supply =
today's San Francisco real estate market.
None of this implies justification for an ever-appreciating
real estate market: Almost all these factors can stall or even go into reverse. Real estate and financial markets are prone to a wide variety of extremely complex and hard-to-predict economic and political factors – and they typically go in cycles: up, down, flat, up again (repeat). And economic and market fluctuations are not uncommon within
cycle phases. Still, these are, we believe, the fundamental realities underpinning the city’s homes market now.
San Francisco’s real estate market is now about 3.5 years into its latest recovery. In the last few cycles, recoveries have typically lasted 5 to 7 years before a significant market adjustment, but, of course, the past is no guarantee of the future. Much depends on how strong and sustained the current high-tech boom turns out to be.
All data from sources deemed reliable, but may contain errors and is subject to revision.
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