SF Housing Bubble Soon to Pop

Prediction: San Francisco Housing Prices Will Plummet 50% by 2023

A crisis is a terrible thing to waste. Had I not heard this phrase more than a dozen times in the last two months, I might still be eager to learn who first coined the phrase, and what next opportunity might be wasted if I don’t take advantage of the new way of life under quarantine. In fact, however, it was not too long ago there were multiple “crises” competing for our attention, from teen vaping to the opioid epidemic, to the impeachment trial of President Trump (I know, feels FOREVER ago). While none of these crises were actually solved, the relentless and all-consuming coronavirus pandemic has certainly starved them of attention. However, while out of the limelight, there is one long-standing crisis which may indeed be turning the corner — the San Francisco housing crisis.

To start with full disclosures, I count myself among the thousands of SF residents who have repeatedly said for years “I’ll never be able to afford a house in the city…unless there’s a major recession.” Therefore, there is indeed a tangible amount of desire for this prediction to come to fruition. However, the purpose of this essay is neither to over promise nor enrage, but instead to put into writing what I’ve found myself debating with friends and family in recent weeks, and to invite readers to share their feedback and poke holes in an admittedly imperfect thesis.

That thesis is simple: a long-term effect of the coronavirus pandemic will be a reversal in the decades long appreciation of urban housing prices, as people and businesses globally retreat from dense metro areas. The shift will not be abrupt nor immediate, but by the summer of 2023, we predict median real estate sales in SF will have fallen by 50%.

To arrive at this prediction, we’ll step through three stages of argument. First, we’ll seek to understand the problem at its root — why SF real estate is so expensive to begin with? Second, we’ll review the first-order effects of the coronavirus on San Francisco, and lay the foundation for our prediction. Third, we’ll dive deep into the real estate industry and the actual dynamics of how housing prices change, why we think the upcoming shift will be slow. We’ll conclude with a few practical recommendations, and a request for thoughtful comments and criticisms from readers like you.

1. Why is SF real estate so expensive today?
2. Why the world will never be the same post-COVID
3. Why real estate values change slowly

Why is San Francisco housing so expensive today?

We begin with a question that’s been asked countless times over the last 10+ years. Why is the rent so damn expensive? To get to a useful answer, let us start with some fundamental economic principles. In a theoretical market economy, the price of any good is a function of both supply and demand. When existing supply is not enough to satisfy the aggregate demand, prices go up. Higher prices incentivize the production of those goods, causing supply to increase. Increased supply relieves the demand-side pressure, and we expect prices to then fall. All things being equal, increases in demand, as well as reductions in supply, cause the market price to go up, and the inverse pressures cause prices to go down. This push and pull of supply & demand is what Adam Smith first described as the “invisible hand” of free-market capitalism, which (again in theory) causes the market price to settle into a stable equilibrium.

Turning back to the real estate market, let us consider the relevant supply & demand forces at work. The more straight-forward part of the supply and demand equation is supply. Houses must be built, and to do so requires there be available land, materials, and labor. For anyone who’s never actually looked at San Francisco on a map, it’s literally a roughly 7x7 mile square of land surrounded by water on three sides. So even without considering the cost of labor and materials, the city is actually just physically constrained to its 49 square miles, and thus there has always been a finite supply of housing available. To make matters worse, the city decided long ago to implement zoning and height restrictions to no more than four stories across most of the city (source). As such, when it comes to whether there will ever be meaningfully more housing created in San Francisco, the short answer no.

On the demand side, however, is where it gets more interesting. Every person in the world needs a place to live, and is thus required to pay for housing. But not every person wants to live in the same place. Many many more people want to live in the Bay Area and New York City than want to live in Montana or Alaska. Certainly that fact by itself is not surprising, but let us ask why exactly that is the case. On the one hand, there are personal preferences for weather, geographic terrain, and proximity to friends and family. Those factors certainly matter, but the largest factor affecting demand for housing is simple — jobs. Four of the most profitable and fastest growing US companies in the last two decades are based in the Bay Area — Apple, Google, Facebook, and Netflix. And in the past decade’s more recent tech boom, we added Uber, Lyft, Airbnb, and Stripe to the list, among dozens of others. As a result, the 2018 median household income in San Francisco clocked in at $112,376 per year, nearly double the U.S. overall median of just $63,179 per year (source).

When we combine a fixed supply of housing with an insatiable demand, driven by seemingly ever higher wages and job growth, we get a massive increase in price. And the data confirms that is exactly what has happened. In the past seven years, the median home price in San Francisco has more than doubled from $600,000 to $1.4 million (source).

Why the world will never be the same after COVID

For better and for worse, a few things have become very clear since shelters-in-place began across the world just a few months ago. Among them are the fact that big tech is not slowing down. Google, Apple, Facebook and Netflix were already a huge part of our lives. They’re now even more so. All of their employees are now working from home. And it’s working. We may not love it, but it’s working. We may complain on social media and joke about never wearing pants anymore, but not a single big tech company has had layoffs, nor echoed even a modicum of concern about the need to reopen offices immediately. And so in the post-COVID era, it is becoming increasingly clear that big tech offices will never look the same.

Offices will reopen eventually, but working from an office will no longer be mandatory. People who work from a central office Monday to Friday will be the exception, rather than the norm. It’s worth noting that tech employees have actually been capable of working remotely for quite a while. The pandemic did not create video-conferencing, nor broadband internet access, nor the need to coordinate global work across multiple time zones. But in forcing everyone to do so at once, the pandemic has exposed how viable remote work is today, at least for those whose primary definition of work entails sitting in front of a computer.

As a personal example, I’ve spent the majority of the past two months based in a second home in Tahoe. During “normal times,” because my favorite leisure activity is skiing, I’d commute every weekend in the winter from San Francisco to Tahoe, and felt privileged to often be able to “work from Tahoe” on Fridays so that I could leave on a Thursday and avoid the bay area traffic from thousands of other “weekend warriors” who do the same. Nowadays, I simply don’t commute, leaving me more time for both work and leisure. And as I’ve thought about the future and going “back to normal”, I’ve mostly wondered why I hadn’t moved to Tahoe sooner. Beyond the implicit assumption that my job required me to live in the Bay Area, few other reasons come to mind. And those that do come to mind (dense, walkable neighborhoods with lively bars and restaurants on every corner) are certainly less attractive within the context of social distancing.

While my personal experience is certainly not ubiquitous, neither is it particularly unique. Some people like surfing more than skiing. Others love San Francisco for its close proximity to wine country, or hiking in the Marin headlands. But in the aggregate, when the requirement to live in San Francisco for work is no longer present, overall demand for housing in San Francisco will fall.

Why real estate prices change slowly

“Change is uncomfortable.” I won’t pretend to know the original source of this phrase, but the fear of change is recognizable across all walks of life. In matters big and small, we’re always much more likely to do the same thing today as we did yesterday. Where we choose to live is no different. As such, if you’re hoping to buy a home at fire sale prices next month, don’t hold your breath.

In stark contrast to the volatility of the stock market, the real estate market moves at a snail’s pace. A few factors explain why this is the case, such as the relatively low “liquid” supply at any given time, and the simple fact that moving one’s entire life and belongings is a big deal. According to the U.S. Census, the typical American moves homes only 11 times in their lifetime, and that includes moves across town.

As such, while demand for housing in San Francisco will drop quickly (in the next year), the mechanics of the real estate market dictate that prices will slowly tick down over the next few years, if not longer. There will be no “exodus” of tech workers moving out in July. Those that already own multi-million dollar estates in Pac Heights have no need to leave, nor will they feel any pressure to sell in a down market. But when hiring resumes and prospective employees have the option to choose where to live, they’ll be increasingly likely to choose to live somewhere “nearby” (e.g. in the same time zone) where they can afford to have twice as much space at half the cost. And when tech companies know that all new hires have this option to pay less for more, offer packages will slowly tick lower. No longer will “I need at least 100k to afford my 3k per month 1-bedroom apartment” be a reasonable expectation for the 22-year-old computer science graduate. But these changes will take time. Big tech companies still compete over talent, and remain highly profitable, and so there will be no overnight across-the-board pay cuts. Instead, compensation growth will stagnate, and slowly diversify further and further away from the bay.

Conclusion

In conclusion, the SF housing crisis is not going to get better overnight. But it will get better slowly. The reduction in aggregate demand to live in cities will align with a widespread increased demand to live in other beautiful places. Beach towns, ski towns, lake towns, and really any other towns close to friends and family will prosper. So if you’re reading this as a Bay Area native and want to own property close to loved ones, you may eventually be able to do so. Just don’t hold your breath.