Bay Area real estate prices have been rapidly appreciating since 2012. Over the last seven years, median property values have more than doubled, and some areas of the Bay Area have more than tripled!
The rapidly escalating prices are great for those that have already bought into the market. For potential homebuyers, these escalating prices result in getting less home for your dollar (and/or having to increase your budget), and gives pause as to not wanting to buy at the peak of the market.
A lot of buyers ask us our thoughts on when the market will cool and prices start to come down. The short-answer is we don’t think this will happen anytime in the next 24 months, and prices will continue to appreciate for the next few years. So long as the technology stock market remains hot, and technology start-ups continue to go public, we believe the Bay Area housing market will continue to appreciate.
The longer, and more detailed, answer is that Bay Area housing has radical supply and demand imbalance, with the demand for housing dramatically outstripping the supply of housing. This will likely continue for the next few years, short of an unexpected jolt to the economy (or a major earthquake).
On the supply side, the Bay Area is not increasing the amount of housing stock at anywhere near the rate to keep up with demand. Geographically, a lot of the Bay Area is surrounded by water, and thus new land for development is not readily available. The Bay Area could increase the amount of housing by increasing density on the available land (“building up”), however most communities are opposed to increasing density due to quality-of-life and economic reasons. Thus the Bay Area is largely stuck with a fixed quantity of housing stock.
On the demand side, the local economy is booming largely due to the Bay Area’s place at the center of the technology world. The number of high-paid technology jobs is increasing rapidly as large companies like Google, Facebook, Salesforce, Genetech, among others, grow their businesses, as well as the increase in workforces at larger “start-ups” like Uber, AirBnB and Lyft. This influx of high-paying jobs is increasing the number of buyers willing to pay top-dollar for their home.
In addition to the high-paying jobs, a lot of Bay Area companies are going public, giving a substantial amount liquidity to hundreds of early employees. Each time a Bay Area company goes public, many early employees are able to sell their stock options and have hundreds of thousands, or even millions, of dollars available from the sale. Many of these employ this newly-available wealth to purchase a home or condo to live. These IPOs are minting hundreds of additional buyers, who are oftentimes able to make all-cash offers to acquire a Bay Area property.
Looking forward, it would be reasonable to expect the number of high-paying technology jobs to increase, and for a number of large IPOs of Bay Area headquartered companies (Uber, Lyft and Pinterest have already gone public, and AirBnB, Palantir and Slack are rumored to go public in the next 12 months). This will result in more buyers looking to buy Bay Area real estate, and consequently that Bay Area prices will continue to increase.
What would it take for the Bay Area real estate market to cool?
So if a cooling off in Bay Area prices doesn’t look imminent, what would have to change for real estate prices to come down (or even to stay flat)?
Firstly, let’s cover why we don’t think either a change in taxes or rising interest rates will slow down Bay Area prices.
In late 2017, we saw new national tax legislation passed which detrimentally affected Bay Area homeowners through a lower Mortgage Interest Deduction and a cap on State and Local Tax deductibility (affecting property tax deductibility). This big change to tax policy (which would not come into affect until 2018 tax returns, but should have been factored in for new buyers) has not slowed Bay Area real estate prices since the announcement of the new tax laws.
Mortgage interest rates have been creeping up since October 2016 (average rate: 3.47%) to June 2018 (average rate: 4.54%). Yet, again, we have seen Bay Area real estate prices continue to increase even as the cost of borrowing has increased 25%+.
If changes in taxes or rising interest rates won’t change the trajectory of Bay Area real estate prices, then what would it take? We think it would take something pretty major for prices to come down.
A major economic crisis could certainly reverse Bay Area real estate price trends. This was the catalyst for the last Bay Area real estate downturn (2008 through 2011). This financial crisis was very intertwined with the real estate industry (due to lax mortgage lending practices and rampant speculation), and saw a near total freeze on new mortgages and foreclosure rates increase 3.5x their 2006 rates. This caused a 25% decrease in Bay Area real estate prices from their 2007 highs.
The prior Bay Area downturn was after the dotcom-crash in 2001. Bay Area prices dropped 10% during this downturn, although the market had recovered by 2003.
The other possibility, although more unlikely, would be if Bay Area zoning regulations were to change allowing substantially more properties to be built. In 2017, ~32,000 new housing units were authorized to be built. This compares to the Bay Area population increasing ~70,000. If zoning laws were to change, allowing substantially more new development, we may see an equalization between supply and demand. However, changes in Bay Area zoning laws haven’t happened historically, and are very unlikely to happen in the future.
Conclusion
If you’re waiting for the Bay Area to cool before buying a property, you will need some patience and to be prepared to wait on the sidelines. During this wait, you may see Bay Area real estate prices continue to increase 5-10% per year. It may even be so many years before the next market correction, and the magnitude of the downturn may be so mild, that prices never drop below their current levels. As with every market, timing the market to buy at exactly the right moment (and importantly avoiding buying at exactly the wrong moment) is a very tricky timing exercise, and may result in you missing a window if the market continues to rise.
If you believe that Bay Area real estate prices will continue to increase over the coming decades (they have increased 6x over the last 30 years), and you have a long enough hold window, trying to time the market becomes less consequential. Yes, the market may suddenly drop right after you buy your property, but if the current trends continue, your property will be worth several multiples of its current price in the future when you sell it.
Looking at the 2008-2011 downturn, those that bought right at the top of the last peak in 2007 were, on average, back at their initial purchase price by 2013, and the value of their properties are now 35% higher than their purchase price. Yes, those buyers would have been better off if they had waited another couple of years and bought when prices were 25% cheaper. But conversely, those potential buyers who waited on the sidelines in 2013, are now looking at prices that are 50% higher, and prices may never dip back at the 2013 levels, even if the next downturn is severe.
The rapidly escalating prices are great for those that have already bought into the market. For potential homebuyers, these escalating prices result in getting less home for your dollar (and/or having to increase your budget), and gives pause as to not wanting to buy at the peak of the market.
A lot of buyers ask us our thoughts on when the market will cool and prices start to come down. The short-answer is we don’t think this will happen anytime in the next 24 months, and prices will continue to appreciate for the next few years. So long as the technology stock market remains hot, and technology start-ups continue to go public, we believe the Bay Area housing market will continue to appreciate.
The longer, and more detailed, answer is that Bay Area housing has radical supply and demand imbalance, with the demand for housing dramatically outstripping the supply of housing. This will likely continue for the next few years, short of an unexpected jolt to the economy (or a major earthquake).
On the supply side, the Bay Area is not increasing the amount of housing stock at anywhere near the rate to keep up with demand. Geographically, a lot of the Bay Area is surrounded by water, and thus new land for development is not readily available. The Bay Area could increase the amount of housing by increasing density on the available land (“building up”), however most communities are opposed to increasing density due to quality-of-life and economic reasons. Thus the Bay Area is largely stuck with a fixed quantity of housing stock.
On the demand side, the local economy is booming largely due to the Bay Area’s place at the center of the technology world. The number of high-paid technology jobs is increasing rapidly as large companies like Google, Facebook, Salesforce, Genetech, among others, grow their businesses, as well as the increase in workforces at larger “start-ups” like Uber, AirBnB and Lyft. This influx of high-paying jobs is increasing the number of buyers willing to pay top-dollar for their home.
In addition to the high-paying jobs, a lot of Bay Area companies are going public, giving a substantial amount liquidity to hundreds of early employees. Each time a Bay Area company goes public, many early employees are able to sell their stock options and have hundreds of thousands, or even millions, of dollars available from the sale. Many of these employ this newly-available wealth to purchase a home or condo to live. These IPOs are minting hundreds of additional buyers, who are oftentimes able to make all-cash offers to acquire a Bay Area property.
Looking forward, it would be reasonable to expect the number of high-paying technology jobs to increase, and for a number of large IPOs of Bay Area headquartered companies (Uber, Lyft and Pinterest have already gone public, and AirBnB, Palantir and Slack are rumored to go public in the next 12 months). This will result in more buyers looking to buy Bay Area real estate, and consequently that Bay Area prices will continue to increase.
What would it take for the Bay Area real estate market to cool?
So if a cooling off in Bay Area prices doesn’t look imminent, what would have to change for real estate prices to come down (or even to stay flat)?
Firstly, let’s cover why we don’t think either a change in taxes or rising interest rates will slow down Bay Area prices.
In late 2017, we saw new national tax legislation passed which detrimentally affected Bay Area homeowners through a lower Mortgage Interest Deduction and a cap on State and Local Tax deductibility (affecting property tax deductibility). This big change to tax policy (which would not come into affect until 2018 tax returns, but should have been factored in for new buyers) has not slowed Bay Area real estate prices since the announcement of the new tax laws.
Mortgage interest rates have been creeping up since October 2016 (average rate: 3.47%) to June 2018 (average rate: 4.54%). Yet, again, we have seen Bay Area real estate prices continue to increase even as the cost of borrowing has increased 25%+.
If changes in taxes or rising interest rates won’t change the trajectory of Bay Area real estate prices, then what would it take? We think it would take something pretty major for prices to come down.
A major economic crisis could certainly reverse Bay Area real estate price trends. This was the catalyst for the last Bay Area real estate downturn (2008 through 2011). This financial crisis was very intertwined with the real estate industry (due to lax mortgage lending practices and rampant speculation), and saw a near total freeze on new mortgages and foreclosure rates increase 3.5x their 2006 rates. This caused a 25% decrease in Bay Area real estate prices from their 2007 highs.
The prior Bay Area downturn was after the dotcom-crash in 2001. Bay Area prices dropped 10% during this downturn, although the market had recovered by 2003.
The other possibility, although more unlikely, would be if Bay Area zoning regulations were to change allowing substantially more properties to be built. In 2017, ~32,000 new housing units were authorized to be built. This compares to the Bay Area population increasing ~70,000. If zoning laws were to change, allowing substantially more new development, we may see an equalization between supply and demand. However, changes in Bay Area zoning laws haven’t happened historically, and are very unlikely to happen in the future.
Conclusion
If you’re waiting for the Bay Area to cool before buying a property, you will need some patience and to be prepared to wait on the sidelines. During this wait, you may see Bay Area real estate prices continue to increase 5-10% per year. It may even be so many years before the next market correction, and the magnitude of the downturn may be so mild, that prices never drop below their current levels. As with every market, timing the market to buy at exactly the right moment (and importantly avoiding buying at exactly the wrong moment) is a very tricky timing exercise, and may result in you missing a window if the market continues to rise.
If you believe that Bay Area real estate prices will continue to increase over the coming decades (they have increased 6x over the last 30 years), and you have a long enough hold window, trying to time the market becomes less consequential. Yes, the market may suddenly drop right after you buy your property, but if the current trends continue, your property will be worth several multiples of its current price in the future when you sell it.
Looking at the 2008-2011 downturn, those that bought right at the top of the last peak in 2007 were, on average, back at their initial purchase price by 2013, and the value of their properties are now 35% higher than their purchase price. Yes, those buyers would have been better off if they had waited another couple of years and bought when prices were 25% cheaper. But conversely, those potential buyers who waited on the sidelines in 2013, are now looking at prices that are 50% higher, and prices may never dip back at the 2013 levels, even if the next downturn is severe.