Archive for February 2018 | Monthly archive page
There are plenty of fun things to enjoy in the city this Spring. Take a peek at these events in our Spring 2018 events guide.
The California Association of Realtors recently released its Housing Affordability Index (HAI) for the 4th quarter of 2017, which measures the percentage of households that can afford to buy the median priced single family dwelling (house).
In this analysis, affordability is affected by 3 major factors: county median house price, mortgage interest rates, and the distribution of household incomes within the county. (Housing Affordability Index Methodology). The HAI uses house prices exclusively and if condos were included in the calculation, median home prices would decline, affordability would increase and income requirements and PITI costs would be reduced as well. (SF now has more condo sales than house sales, but that is not the case in other Bay Area counties.)
If the HAI Index incorporates changes to the federal tax code (effective 1/1/18) limiting the deductibility of interest expenses and property taxes, it will presumably have a negative effect on affordability percentages in 2018. By definition, half the homes sold in any given county were at prices below the median sales price, i.e. there were numerous homes that were more affordable than the median prices used in this analysis. However, any way one slices it, the Bay Area has one of the most expensive – if not the most expensive – and least affordable housing markets in the country. That impacts our society and economy in a number of important ways.
Since many of the figures don’t change that much quarter to quarter, we’ve only updated some of the charts in this report with Q4 2017 data.
Affordability Percentage by Bay Area County
Note that extremely low affordability readings converged across Bay Area counties at the top of the bubble in 2006-2007. So far, there has not been a similar convergence in our current market, though affordability is generally dropping as prices increase.
Having dropped approximately 40% from 2007 to mid-2016, extremely low interest rates have subsidized increasing home prices to a large degree in recent years – but they’ve begun to rise in early 2018.
San Francisco is still 4 percentage points above its all-time affordability low of 8%, last reached in Q3 2007 (even though its median house price has increased about 50% during that period). Other Bay Area counties (except for Silicon Valley) have appreciably higher affordability percentages, for the time being. Generally speaking, as one moves farther away from the heart of the high-tech boom, San Francisco and Silicon Valley, affordability increases.
Minimum Qualifying Income to Buy Median Priced House
Assumes 20% downpayment and including principal, interest,
property tax and insurance costs.
Bay Area Median House Prices
San Francisco-Only Median House Price Appreciation
by Quarter since 2012
Before the high-tech boom, Marin, a famously affluent county for long time, had the highest median house price. But the high-tech boom accelerated median home prices in San Francisco and San Mateo faster and higher.
San Francisco has a much larger and more expensive condo market than other local counties, and is the only county with a very substantial luxury condo market – one that is growing significantly with recent new-condo project construction.
by the National Association of Realtors
Mortgage Interest Rates since 1981
Short-Term Changes in Mortgage Interest Rates
Interest rates play an enormous role in affordability via ongoing monthly housing costs, and interest rates, after their recent post-election jump are about 35% lower than in 2007. To a large degree this has subsidized the increase in home prices for many home buyers. It is famously difficult to predict interest rate movements, though there is general agreement. Any substantial increase in interest rates would severely negatively impact already low housing affordability rates.
Santa Clara, San Mateo and Marin Counties have the highest median household (HH) income in the Bay Area. Though the median HH income figures of these 3 counties are almost double the national figure, their median house prices are 4 to 5 times higher, an indication that income dollars can go a lot farther in other parts of the country than they do here. Indeed an income that in other places puts you close to the top of the local register of affluence, living grandly in a 6-bedroom mansion, in the Bay Area might qualify you as perhaps slightly-upper-middle class, living in an attractive but unostentatious, moderate-sized home that costs twice what the mansion did (though, this being the Bay Area, you are probably still driving a very expensive car).
On the other hand, you live in one of the most beautiful, highly educated, culturally rich, economically dynamic, and open-minded metropolitan areas in the world.
Behind median HH incomes, each county also has enclaves of both extreme wealth and poverty within its borders.
Very generally speaking, in the Bay Area counties, renters typically have a median household income about half that of homeowners. In San Francisco, where the majority of residents are in tenant households, that significantly reduces the overall median HH income figure. The picture of housing affordability for renters in the city is ameliorated or complicated by its strong rent control laws (which, however, don’t impact extremely high market rents for someone newly renting an apartment) .
San Francisco has the lowest percentage of residents under 18 of any major city in the U.S. (It is famously said that there are more dogs in the city than there are children.) It also has an extremely high percentage of residents who live in single-person households – 39% – which is a further factor depressing median household income below markets with similar housing costs.
It should be noted that besides high incomes per se, another factor in the Bay Area housing boom of recent years has been the stupendous generation of trillions of dollars in brand new wealth from soaring high-tech stock market values, stock options and IPOs. Thousands of sudden new millionaires, as well as many more who didn’t quite hit that level, supercharged real estate markets (especially those in the heart of the high-tech boom) as these newly affluent residents looked to buy their first homes, perhaps with all cash, or upgrade from existing ones. That is something not seen in most other areas of the country, certainly not to the degree experienced locally, and is a dynamic outside typical affordability calculations. This increase in new wealth has slowed or even declined in the past 12 months as the high-tech boom has cooled (temporarily or not, as time will tell). Still, there are dozens of local private companies, usually start-ups, some of them very large – such as Uber, Airbnb and Palantir – which are considered to be in the possible-IPO pipeline. If the IPO climate improves and successful IPOs follow, a new surge of newly affluent home buyers may follow.
pressure on both home prices and apartment rents.
Bay Area Median House Prices since 1990
If one looks at charts graphing affordability percentages, home prices, market rents, hiring/employment trends and to some degree even stock market trends, one sees how often major economic indicators move up or down in parallel.
Monthly Rental Housing Costs
The recent economic boom has added approximately 600,000 new jobs in the Bay Area over the past 6 years, with about 100,000 in San Francisco alone – with a corresponding surge in county populations. Most new arrivals look to rent before considering the possibility of buying. The affordability challenges for renters (unless ameliorated by rent control or subsidized rates) has probably been even greater than that for buyers, since renters don’t benefit from any significant tax benefits, from the extremely low, long-term interest rates, or by home-price appreciation trends increasing the value of their homes (and their net worth). In fact, housing-price appreciation usually only increases rents without any corresponding financial advantage to the tenant. Rents in the city have been plateauing in recent quarters and may even be beginning to decline as the hiring frenzy has slowed and an influx of new apartment buildings have come onto the market – but they are still the highest in the country.
There may be no bigger political and social issue in San Francisco right now than the supply (or lack) of affordable housing: Battles are being fought, continuously and furiously, in the Board of Supervisors, at the ballot box and the Planning Department by a wide variety of highly-committed interests, from tenants’ rights and neighborhood groups to anti-growth factions and developers (to name a few). It is an extremely complicated and difficult-to-resolve issue, especially exacerbated by nimby-ism and the high cost of construction in the city. SPUR, a local non-profit dedicated to Bay Area civic planning policy, estimated in 2014 that the cost to build an 800 square foot, below-market-rate unit in a 100-unit project in San Francisco was $469,800 – and we have seen higher estimates as well.
This fascinating graphic above, based on SF Controller’s Office estimates from late 2013, breaks down SF housing supply by rental and ownership units, and further divides rental by those under rent control. All the units labeled supportive, deed restricted and public housing could be considered affordable housing to one degree or another, i.e. by their fundamental nature their residents are not paying and will never pay market-rate housing costs. (Units under rent control will typically go to market rate upon vacancy and re-rental, though rent increases will then be limited going forward.) Adjusted for recent construction, there are roughly 34,500 of these units out of the city total of about 382,500, or a little over 9% of housing stock. Section 8 subsidized housing would add another 9,000 units.
There are currently many thousands of affordable housing units, of all kinds, somewhere in the long-term SF Planning Department pipeline of new construction, though many of them are in giant projects like Treasure Island and Candlestick Park/Hunter’s Point, which may be decades in the building. But it is generally agreed that new supply will never come close to meeting the massive demand for affordable housing, further complicated by the question of what exactly affordable means in a city with a median home price 5 times the national median, typically well beyond the means of people such as teachers and members of the police force. One corollary of increasing affordable housing contribution requirements for developers and extremely high building costs is that developers are concentrating on building very expensive market-rate units – luxury and ultra-luxury condos and apartments – to make up the difference.
Other reports you might find interesting:
All our analyses can be found here: Paragon Market Reports
Our sincere gratitude to Leslie Appleton-Young, VP & Chief Economist, Oscar Wei, Senior Economist, and Azad Amir-Ghassemi, research analyst, of the California Association of Realtors, for their gracious assistance in supplying underlying data for the CAR Housing Affordability Index calculations.
These analyses were made in good faith with data from sources deemed reliable, but they may contain errors and are subject to revision. All numbers should be considered general estimates and approximations.
I am often asked how one development or another might affect SF and Bay Area real estate markets – tax law changes, interest rates, soaring stock markets, foreign buyers, migration trends, housing affordability, climate change, new home construction, and so on – but trying to evaluate one factor in isolation is often misleading because multiple factors often gang up to trigger a change, or 1 factor counteracts or ameliorates the effect of another. Or a single development has both positive and negative influences. I created this analysis in an attempt to organize my own thoughts on the possible impact of various factors on the market, and it is very much a work in progress.
I do not know how these factors will ultimately play out, which factors will become dominant and which will fade into irrelevance, or what new factors will arise. Circumstances will change, requiring re-evaluation of the thoughts below. As to market cycles, I have learned over the past 30+ years that booms can go on much longer than one would expect, or get second winds, and negative adjustments can arrive suddenly from unexpected directions. These adjustments can be of varying scale, in the nature of a dramatic crash (or bubble popping), the slow deflation of an over-pumped football, or a combination of the two. In periods of irrational exuberance – and I am not saying we are in one (though a review of history implies its inevitable arrival someday) – there are always many who insist it is not irrational (this time). One thing is clear from multiple studies on forecasting: Most predictions made by analysts, economists and other “experts” turn out to be off the mark, get the timing wrong, or are fundamentally mistaken. There are just too many moving parts in the world today – economic, political, social, technological and ecological, many of which are not even on our radar screens – for any reasonable claims to certainty.
The order in which these factors are discussed do not necessarily reflect an opinion of their importance.
– by Patrick Carlisle, Chief Market Analyst
The Bay Area Economy
Positive angles: The Bay Area economy is probably stronger than it has ever been, and is possibly the most innovative and dynamic economy in the world. It is the high-tech (bio-tech, fin-tech) capital of the world, as well as being a major financial center. It is home to some of the biggest and most fabulously profitable companies on the planet. Employment and affluence have soared stupendously in past 7 years. In many Bay Area counties, unemployment rates hit historic lows at the end of 2017.
Negative: Not all Bay Area residents have participated in the benefits of the economic boom; income inequality is increasing; and over-exuberance in the local economy could be subject to correction – this could reverse employment gains, as occurred 2001 – 2005, during which SF employment declined by 70,000. I am not implying the situation today is parallel: There are material differences between the dotcom boom and the current high-tech boom, but, of course, there are also similarities. (There is nothing like sudden, spectacular wealth to generate hubris of similar proportions.)
Start-Ups & Possible Future IPOs
Positive: New start-up companies seem to open every week and start-ups add fantastic dynamism to the local economy. The potential for dozens of large, local companies to go public could inject enormous amounts of new wealth into the economy and housing markets. New wealth creation over the past 6-7 years has been one of the decisive factors in the Bay Area economy.
Negative: If investor and venture capitalist confidence suddenly collapses due to national or international events, as has occurred in the past, it will have adverse effects on currently unprofitable start-ups with negative cash flows and insufficient reserves.
Positive angles: Soaring stock markets have been substantially increasing wealth and the sense of affluence, which fuels consumer confidence and housing markets.
Negative: Some analysts see dangerous signs of rational confidence tipping into irrational exuberance, which can have severely negative economic and social ramifications.* Even financial market volatility can have a chilling effect on real estate markets, especially at the high-end since the affluent are generally much more invested in, and sensitive to, financial markets.
* Note: It can be very challenging to determine the point at which rational confidence shifts into irrational exuberance. And in retrospect, the duration of the period of irrational market exuberance, when gains often accelerate into the stratosphere, typically seems utterly incomprehensible: “How could anyone have thought that this made sense?” Such are the pleasures of hindsight.
Positive: Rates dropped 40% to 45% from 2007 to mid-2016, and remain very low today when compared to historical norms over the past 40 years. Interest rates play a critical role in the ongoing cost of housing and housing-purchase affordability, and lower rates have subsidized much of the home price increases since 2011.
Negative: As of early February, rates have been recently increasing and may be poised for further increases – potentially, a major impact on housing affordability at a time when affordability is already flirting with historic lows. (Fear of impending increases can motivate buyers to act now, which played a role in early 2017 market dynamics.) Per Freddie Mac, as of 2/1/18, the average rate for conforming 30-year loans was 4.22%, and it currently forecasts that interest rates for 2018 shall average 4.5%. This would be almost 30% higher than in mid-2016 and about 15% higher than in mid-2017. As points of reference, rates averaged 6.3% in 2007, 8% in 2000, and 10% in 1990.
Note that interest rate changes are extremely hard to predict, and forecasts have been more frequently wrong than right over the past 10 years.
Low & Diminishing Housing Affordability
Negative: A huge social and economic problem that increases poverty levels, puts terrible stress on many normal working people and families, and encourages resident and business relocation. It also discourages relocation into the area by job seekers evaluating options in other locations, and puts local business at a competitive disadvantage when recruiting talent. It can also discourage start-ups from starting up here. There are many other areas of North America, with less expensive housing costs, actively soliciting both start-ups and established businesses to locate there, or relocate there from the Bay Area.
Positive: The Bay Area has become a magnet for the best and the brightest from all over the world. Local employment growth in the past 7 years (600,000+), generally of high-skill, high-pay jobs, has been nothing short of staggering. This has played a definitive role in the economy and in home price appreciation experienced since the recovery began in 2012.
Negative: More people are now moving out of California to other states than moving into CA from other states, per U.S. census data for 2016 (which is before new federal tax law changes discussed further below). The scale of foreignimmigration into the state and Bay Area in recent years has far exceeded the state-to-state deficit – but that was before federal policy turned distinctly hostile to immigration in 2017. As much of the Bay Area’s population growth, and economic and cultural dynamism has been fueled by immigration – currently about a third of Bay Area residents are foreign born – a reversal would certainly be an adverse factor.
New Federal Income Tax Law
Positive: Residents who have not itemized mortgage interest or state income and local property tax deductions in the past, will probably see reductions in their federal income taxes. New corporate tax law may make local businesses more profitable and more valuable, which might lead to income and/or wealth gains for their employees – which would then feed into the local economy. Heightened corporate profitability might also fuel further technological innovation and increase investment in local communities, both business related and in charitable and social improvement efforts.
The new tax law also has substantial benefits for some real estate investors, depending on their legal structure.
Negative: New federal tax law limiting the deductibility of mortgage interest and state and local taxes appreciably reduces some of the financial incentives of homeownership, and for for many Bay Area residents will raise the cost of living, and specifically the cost of housing. Making the most expensive U.S. metro area to live in more expensive – and specifically, more expensive in comparison to other places – discourages immigration into the area and encourages resident and business relocation to more affordable metro areas. Note: the CA legislature is looking for ways to blunt the effect of these federal income tax changes, however it is unknown to what degree they will succeed in light of the antagonism of the political party in power in Washington.
The new tax law will reduce the financial incentive to make charitable donations for many residents, which may reduce social services to those in need. It is uncertain how this will play out.
New Construction Boom
Positive: Accelerating residential and commercial construction in the Bay Area adds employment, investment, and business expansion potential, and, if it continues at the current pace, should improve housing affordability: Indeed, the recent boom in apartment construction in the city has already led to an 8-10% drop in rental rates since they peaked in 2015 (though our rents are still the highest in the nation).
Negative: There continue to be high hurdles for developers to get approvals to build, and already high construction costs are increasing: A recent report, by the UC Berkeley Terner Center, said SF had the 2nd highest building costs in the world (after NYC), much of that due to local resistance to and governmental regulation of development, as well as to labor and land costs. New construction is also historically subject to very dramatic boom and bust cycles. Last but not least, some residents believe that further development itself is a negative factor in quality of living.
Negative: Upgrades in infrastructure have not kept up with the considerable growth in population. This is especially apparent in transportation and the subsequent increase in the time and aggravation related to commuting.
Positive: Interest rates remain historically low, making debt service less onerous to individuals and businesses.
Negative: In an environment of low interest rates, swelling consumer and business confidence and surging asset values, household debt (mortgage, car, credit card, educational), corporate debt, governmental debt and stock market margin-loan debt are all increasing, while economic optimism and a search for yield has weakened underwriting (risk assessment) standards. Sudden asset-price declines or economic turbulence wreak much greater havoc amid high debt levels. Debt played either a significant or dominant role In the last 3 financial crises: 1989-1990 – junk bonds, S&L crisis, bad commercial-loan underwriting; 2001-2002 – high rates of margin lending coupled with extreme, irrational financial-market exuberance; 2007-2008 – a total abrogation of underwriting standards, debt securitized and widely sold under defective ratings, widespread predatory lending and loan fraud, extreme use of leverage in financial institution investments.
Note that debt and debt levels, and when they reach dangerous levels, are a complex subject on which the writer is very much a layman analyst. Debt levels that seem tenable can abruptly become untenable if asset values suddenly plunge or interest rates jump. Federal governments (or an organization of federal governments like the EU) will sometimes step in to relieve or guarantee corporate or local government debt if default risks destabilizing the general economy.
General International Factors
Positive: The world economy and international financial markets are probably their strongest since 2007 and appear to be improving – with generally positive ramifications for the Bay Area economy.
Negative: International economic and political factors have an increasing impact on national and local conditions, and such factors appear to be becoming more volatile and, recently, antagonistic. Examples of recent negative, but manageable, international events before the new presidency, include the Chinese stock market drop in summer-autumn 2015, the oil-price crash of early 2016, and the Brexit vote in spring 2016, all of which caused significant, though temporary, drops in U.S. financial markets – and led to the SF luxury home market abruptly cooling, venture capitalist confidence and funding dropping, the number of local IPOs plunging, and a decline in local hiring during that period.
Examples of possible future international influences are virtually limitless, from political, social or financial instability in other major economies, to trade wars; technological attacks against our financial, communications, infrastructure and political/election systems; and, worst of all, real wars.
Negative: Impossible to predict speed or scale of effects from climate change, but increasing state and local potential for drought, fires and sea level change offers only unhappy longer-term ramifications. Current federal administration maintains policies that will almost certainly exacerbate the problem. And, of course, earthquakes are always a wild-card factor in the state and Bay Area.
Diminishing Frequency of Home Selling
Positive: For existing homeowners: limited supply encourages price appreciation and increases their net worth.
Negative: The considerably reduced supply of homes available to purchase has undesirable ramifications for housing affordability and also dramatically adds to the stress of home buying.
General Local Conditions
Positive: The Bay Area is one of the great economic, social and cultural metro areas of the world, located in a gorgeous setting surrounded by water and park lands, with generally moderate weather, a low nasty-insect ratio, and home to the world-champion Warriors basketball franchise. A great proportion of residents and businesses feel its benefits far outweigh its negatives, and they’re not moving to Texas despite the allure of lower home prices, no state income taxes, a world-class fossil-fuels industry, the right to carry assault rifles in public, and the pleasure of being represented by Senator Ted Cruz in Congress (a lighthearted jab in a longstanding interstate rivalry).
Negative: Significant social and economic changes, including the cost of housing, have, according to several recent polls, increased the percentage of Bay Area residents and businesses considering or willing to consider relocation (though not necessarily in the immediate future). It would be arrogant to argue that other states, and other metro areas such as Seattle, Denver, Portland and Austin, don’t have their own legitimate appeal to businesses, working people, and retirees. (As a matter of fact, according to census figures, more Californians and Bay Area residents are moving to Texas than vice versa – a wake-up call against complacency.)
Other articles or reports you might find interesting:
Economic Context to the SF Real Estate Market – Illustrated
30+ Years of San Francisco Real Estate Cycles
San Francisco & Bay Area Demographics
Is Now a Good Time to Buy?
Paragon Main Market Reports Page
The writer of this analysis is not an economist and some readers may believe him unqualified to comment on some of these topics. This report reflects the opinions of its author, and does not necessarily reflect the opinions of the agents, other managers or principals at Paragon. These analyses were made in good faith with data from sources deemed reliable, but may contain errors and are subject to revision. It is not our intent to convince you of a particular position, but to attempt to provide straightforward data and analysis, so you can make your own informed decisions.