Supply, Demand, Money & Demographics:
10 Factors Behind San Francisco’s Real Estate Market
Updated December 2015
A consideration of the main factors at play behind the current San Francisco real estate market, some of which reflect general macro-economic trends and some of which are specific to the city itself. As we've seen in 1989, 2001 and 2008, many of these factors can stall or go into reverse very quickly in the event of a large, negative, economic, political or even ecological event.
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 increased demand. New construction is booming again in the city, and tens of thousands of new housing units are now somewhere in the planning and construction pipeline, but, for the time being, 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.
Approximately 12,000 units of housing have been built in San Francisco since 2010. Over the same 6 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.
Stock market upswing: Though there was some major volatility this past autumn, the S&P 500 is still up approximately 60% from 2011. 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, being able to take advantage of low interest rates, 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 (with none of those benefits).
Low interest rates: from 1996 to 2006, the average interest rate on a 30-year fixed rate loan was approximately 6.3%. As of December 31, 2015, it was running at about 4%. That 37% reduction in the cost of financing makes an enormous difference in affordability and the ongoing cost of housing. With recent indications from the Fed, many expect interest rates to rise significantly in 2016, though expectations have been confounded so many times in the past 6 years, it's impossible to be sure what will happen. If rates do rise appreciably, it will definitely affect housing affordability.
Renting instead of selling: Very high rents and very low interest rates have
convinced some owners who would have sold
their homes to rent them out instead, and the Airbnb rent-to-tourists option is probably adding to this (even if in many instances, it violates city statutes.) As an adjunct to the financial calculation for renting instead of selling, we are also hearing from some owners that they are afraid that if they sell now, they or their children will never be able to afford to move back. All this further
depresses the supply of new listings coming on market, exacerbating the
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.
There has clearly 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, usually 6000 to 7000 units. 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 two. But also 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 accommodate 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 they are a big factor underlying the housing market. 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.
Huge demand + surging wealth + severely inadequate supply =
today's San Francisco real estate market.
We want to reiterate that 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 4 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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