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The Great Cooling Off

 After four years of utter madness, our housing market might be turning. But how much, how fast, is a matter of debate.


Read more from the Real Estate Issue here.

Near Mayor Ed Lee’s
desk sits a roughly 150-page report spelling out exactly what to do if the Big One hits. It’s a break-glass-in-case-of-emergency guide, if you will, in the event that a major disaster like the 1906 earthquake and fire or 1989’s Loma Prieta quake strikes the city. Joining it at the beginning of next year will be a similarly wonkish report on what to do when the next economic or tech crash jolts the city’s economy from its Icarian heights. It’s titled the Economic Resiliency Plan, and its timing is telling.

Though hordes of panicked homeowners aren’t hitting the sell button yet, a mood of quiet apprehension is beginning to settle in from City Hall to Sand Hill Road to real estate offices across the Bay Area. In San Francisco, the price index for new condos had declined for three consecutive months as of September, and the number of houses and condos for sale is up by 26 percent over last year—both indicators that the city could be transitioning to a buyer’s market for the first time in years. Nationally, venture investment, which partially fuels the rate of job growth at private companies and also induces spikes in certain regions’ rental prices, was down by about 12 percent in the second quarter of 2016 from the year before. The amount that VCs raised in the first quarter of 2016 was down even further—37 percent from the previous year—as many firms have started squirreling away capital for a potentially long economic winter. These are all classic signs of a boom market letting out some air.

At 89 months, the nation’s current economic recovery is the fourth longest since World War II. We are, many economists believe, in the late stages of an up cycle and possibly due for a correction, though how violent or prolonged it could be, nobody knows. Not wanting to take any chances, the mayor’s geeks have assembled their step-by-step financial crisis handbook—one that takes the lessons of previous downturns and dives and tries to apply them to the current economic moment. “The goal is to ensure we have systems, policies, and plans in place when the downturn comes,” says Todd Rufo, who oversees the city’s Office of Economic and Workforce Development. 

But what should those looking to buy or upsize a home do when the next crash, dip, or dive comes? How will they know when to leap, and where to leap to? While no one can say with absolute certainty where the Bay Area is in the economic cycle, and recognizing that real estate experts often tell house hunters not to try to game the market, the facts are worth your attention: There are starting to be signs of a softening, and the window to capture value in the real estate market could soon be nudging open. “If you’re using baseball analogies, we’re definitely entering the seventh or eighth inning,” says Eric Tao, a real estate developer at AGI Avant, which receives investment from the California Public Employees’ Retirement System to build multifamily housing in San Francisco. “Land costs have not come down, but the market is cooling—2008 was a steep crash, but we’re doing a slow kind of burn or downward cycle.”

This isn’t a dramatic slowdown. After all, employment levels are near all-time highs, as are rents and median housing prices. And inventory is still distressingly low: There are currently only about 400 single-family homes and 540 condos for sale in San Francisco, and both categories of housing spend an average of 49 days on the Bay Area market, according to Zillow—the lowest in the nation. But there’s an air of uncertainty over job production in the tech sector, which has for the past several years fueled much of the outlandish growth in housing prices in the Bay Area. “We’re thinking there will be a correction in the next couple of years, but we think it starts with the high end turning, and then it spreads [to slowing] job creation,” says UC Berkeley economist Kenneth Rosen, who has been studying Bay Area real estate markets for 37 years. “The key to the Bay Area depends on capital markets. The question is, will unicorns succeed and go public or have to cut back?”

That’s the proverbial $1.1 million question (the median price for a home in San Francisco, per Zillow). The city’s home values have nearly doubled since the Facebook IPO of spring 2012. Behind that explosion are roughly 50 or so Bay Area–based unicorns, companies that are privately worth more than $1 billion and affect rental markets through an increase in hiring and a corresponding uptick in employee wages. But most of these pre-IPO companies have yet to provide any large-scale liquidity to workers, who might enter the real estate market as buyers if their companies successfully go public—or, conversely, might fail to enter it if their companies stagger. The most important of these unicorns, Uber and Airbnb, are both headquartered in San Francisco and have yet to debut on the stock market. But when they eventually do IPO, their newly enriched employees could leave the city’s real estate market awash in another tsunami of cash.

Until that time, though, we may be settling into a lull—if a fleeting one. Aileen Lee, a venture capitalist who started her firm, Cowboy Ventures, after leaving one of the industry’s more venerable names, Kleiner Perkins, is the woman who coined the term unicorn in a 2013 blog post on TechCrunch. That phrase has since been twisted into a more cynical portmanteau, the unicorpse (see former billion-dollar babies like Theranos, Evernote, or Mode Media). But like any early-stage VC, Lee has an occupational proclivity toward optimism. Despite a general softening in angel investment activity, she’s heartened by the success of post-IPO companies like Twilio, which has doubled its share price since going public over the summer. 

“Everyone feels like we went to a great party for the last five years, and now it’s time to stay home and not go out so much. There’s been a sobering, for sure,” Lee says. But she argues that the long-term movement of software pervading all kinds of industries—the trend Silicon Valley is at the red-hot center of—is one that will last beyond any downturn. “In the long run, we will see more and more unicorns,” she says. “Tech is going to drive and address more industries in healthcare, education, and real estate.”

And how does this resiliency translate to the Bay Area real estate market? It means, essentially, that downturns will come and downturns will go, but that in the end, everything will soar again. “Even if there is a correction,” Lee says, “I don’t know if it is going to loosen up enough office and housing space. There’s just such limited real estate up and down the entire Bay Area.”

The key, then, is to know when the market is at its ripest for buyers and to take a large bite out of it before everything goes sour again. That moment might soon be upon us.

Taking a long-term view,
there’s nothing exceptional about the pricing action of the most recent upswing in the Bay Area real estate market. Bay Area housing is doing exactly what it’s been doing for the last 30 years. In the last four bull cycles since the mid-1980s, the region’s home prices have jumped by anywhere from 60 to 100 percent, according to Paragon Real Estate. In this current cycle, home values have risen by 65 to 70 percent—exactly in line with previous booms.

Paragon’s chief market analyst, Patrick Carlisle, has been analyzing the regional real estate market for three decades. He says that the Bay Area typically sees bursts of appreciation in five-to-seven-year spans and then a cooldown that lasts one to four years. The most recent upswing started over four years ago, in early 2012—perfectly timed with Facebook’s IPO. In the last three economic downturns, Bay Area housing prices went down by 11 percent, 10 percent, and 27 percent. “We’ve had an incredible run of appreciation in San Francisco, and I believe that buyers have become resistant to the prices that they’re now required to pay in the city,” Carlisle says. “So they’re now looking at other options, which has put pressure on other counties and made Oakland the craziest market in the country right now.” 

Indeed, San Francisco’s space constraints and overheated prices have had deep ripple effects throughout the East Bay real estate market. Adrian Sanders, who founded the Y Combinator–backed company Beacon before starting up another business called Chargehound, has been looking for a home in the East Bay on and off for four years. Recently, a house in his North Oakland neighborhood started out at an opening price of $650,000 and closed at more than $1.1 million, all cash. “We knew we weren’t going to get it,” says Sanders, who rents a one-bedroom and is expecting his first child with his wife. Later they looked at a property in El Sobrante for $450,000 that closed at $650,000, also all cash.

Sanders blames the expansion of tech bus shuttles throughout the East Bay and the high prices in San Francisco for driving workers into Oakland and beyond. “What we’re starting to see is 30-year-olds from Google, Facebook, Apple, or Twitter saying there’s no way they can afford to have a family in San Francisco or the Peninsula, so they’re looking in the East Bay,” Sanders says. “If the Google bus goes through Oakland and stops in San Leandro, you can buy anything along that strip for $700,000 and you’re probably going to be fine, because you can afford that mortgage.” 

The informal and largely unregulated fleet of tech shuttles undergirding all of this job creation has also grown into one of the largest transportation providers in the Bay Area, with tentacles stretching out as far as Sacramento and Santa Cruz Counties. If tech buses—which carry about 34,000 passengers per day—were operated by a single public transit agency, it would be the seventh largest in the region, just behind services like Caltrain and Samtrans. Homeowners want transit accessibility, so with each additional tech shuttle traversing a residential corridor, you see rising land costs: bad news for all of those hoping to nab a deal in the once-cheap suburbs.

The silver lining to this spillover effect (at least for San Franciscans): It relieves a little pressure on the city’s real estate market. Of course, this is all relative. The only housing segment that’s flattened is condos: The median condo sale for the third quarter of 2016 was $1.05 million, according to Paragon, virtually identical to the year before. By comparison, the entry-level tier for starter homes—or whatever passes for a “starter home” these days in San Francisco—was up by 10.9 percent in August compared with the same month in 2015, according to the Case-Shiller Index. “Prices are starting to fall in the condo market in San Francisco because that’s where all the new construction is,” Carlisle says. “But houses have become the rare commodity, and people are fighting over this rare commodity instead of waiting to buy.”

Part of the issue is a pure shortage of supply: There’s just not very much inventory in the category (except among luxury homes—defined by Paragon as houses priced at $2.5 million and up—which saw their largest spike of new listings ever this September). Even if the overall number of houses for sale is up by more than 19 percent compared with last year, that number is still only one-third of 1 percent of San Francisco’s total housing inventory. By comparison, the percentage of homes for sale in New York City is more than three times higher.

When the Mayor’s Office
commissioned the resiliency report earlier this year, the very first area its economic team suggested the city should study was how the tech industry (or “the tail that wags the dog of our entire local economy,” in the words of San Francisco’s chief economist, Ted Egan) is similar to or different from the dot-com boom of the ’90s. Tech was responsible for one-third of the city’s new jobs during the economic recovery of 2010 through 2014, boosting median rents to the highest in the United States.

From teeny early-stage startups to publicly traded corporations, every step of the tech industry’s corporate pipeline affects the local real estate market. Early-stage companies recruit and attract workers who come to the Bay Area and lease housing throughout the region, pushing up rents. Later-stage or post-IPO companies—or the lucky startup guppies that are acquired by bigger, richer fish—produce liquidity that workers use to buy up charming fixer-uppers in Noe Valley and Bernal Heights. Needless to say, the Bay Area’s tech job base is big and getting bigger. The San Jose Mercury News counted 746,000 tech workers in 2016, 21,000 more than during the first dot-com peak in 2000. In the latest boom cycle, venture capital has centralized in Northern California, rather than dispersed geographically, as one might expect as the tech industry matures. The Bay Area’s share of venture capital invested nationally has risen to almost 50 percent, with $27 billion of last year’s $59.1 billion put into the San Jose and San Francisco metropolitan regions. Back in the mid-1990s, the Bay Area’s share of dollars invested hovered in the mid–20 percent range. 

But all of this youthful exuberance may be dissipating—or at least settling into a quieter middle age. In early 2015, when venture capital investment was humming along at the fastest pace since the dot-com bubble, the emphasis among investors was on company growth. This year, the focus has tilted back toward more financial conservatism and caution, says Bill Gurley, a venture capitalist at Benchmark Capital, one of the industry’s top-tier firms. Gurley has been famously vocal for years about outlandish spending by pre-IPO tech companies. “We’ve seen a change of behavior. There are lists [of companies] where you can find layoffs. You can find companies that have shut down. You’ve seen companies that have reined in perks,” he says.

Gurley saw signs of an industry downturn last year when he started seeing companies being offered commercial leases with clauses that ratchet up rental rates over each year of the contract. “Those were going down in 2000. They were the number-one types of leases that ended up shutting companies down, because liabilities were so long into the future,” he says. “When a landlord starts asking for a piece of paper like that, it’s like a bomb that blows up on itself.”

A newfound caution is visible all the way from fledgling startups to late-stage companies. All of this is manifesting in slower employment growth, which is stabilizing the double-digit percentage rent increases that were commonplace in San Francisco in 2014 and 2015. “It’s more like a healthy correction than a big pull-back,” says Naval Ravikant, who runs Angellist, the industry’s best-known platform for early-stage investing. He says seed and angel funding is down by about 20 percent to 2013 or 2014 levels. However, he doesn’t anticipate a corresponding drop in tech workers looking for housing: “I don’t see the demand for San Francisco Bay Area real estate letting down significantly from this industry. If it does drop, it’s more due to macro factors or pricing.”

Barring a black swan event—a Trump victory, say, or a market crash in China—the industry’s biggest privately held companies seem content to keep away from the public markets. Although Gurley has been a vocal proponent of companies going public, two of his most notable investments of the last wave—WeWork, based in New York, and Uber—have shied away from IPOs. But if or when an Uber or Airbnb does decide to go public, it could have dramatic effects on local housing markets in San Francisco, Oakland, and beyond. On the Peninsula, Google’s IPO led to 22 and 15 percent bumps in Palo Alto home prices in 2004 and 2005, while Facebook’s 2012 IPO led to 14 and 24 percent bumps in Menlo Park housing prices in the two years that followed.

For now, both Uber and Airbnb continue to be able to raise capital through private markets even if regulatory uncertainty or competitors give them pause about going public. Airbnb recently raised more than half a billion dollars in a round led by Google Capital, a later-stage corporate venture firm from the search giant, while Uber turned to Saudi Arabia for a $3.5 billion infusion earlier this year. In the short term, this is good news for San Francisco home buyers, if possibly bad news for Uber and Airbnb employees waiting to cash in their hard-earned equity (although Airbnb did strike a deal with employees in July that would let them sell a percentage of their stock). While hundreds of future millionaires wait around for their grand exit, the rest of the Bay Area’s home-buying public can at least try to get ahead of them.

Of course, this
 isn’t just about your possible next house. If Bay Area housing continues to do the same predictable thing it’s done for the last 30 to 40 years, nearly doubling in value every economic cycle, the whole region has a very serious problem on its hands. Most people will never be able to afford to buy a home here—not even during the one-to-four-year-long lull that some analysts predict. That is, unless the region can come up with the major governance, land-use, and tax reforms necessary to grapple with the consequences of economic success over the last generation.

Most wages are not keeping up with the cost of housing. In the late 1970s, Bay Area homes generally cost 3 to 4 times the median household income. Today they’re 9 to 10 times the median household income, according to Zillow. This is worsening an affordability crisis that first manifested in California with the appearance of wide-scale urban homelessness in the early 1980s; it has since expanded into the service industry and is now worming into the middle class and beyond. According to Redfin, exactly zero percent of houses are affordable for public schoolteachers in Silicon Valley. 

Bay Area cities keep adding jobs at a rate that vastly outpaces the region’s willingness and ability to construct housing units. According to Plan Bay Area, a regional blueprint meant to guide transit and housing decisions over the next several decades, the suburbs ringing the bay have added 15 jobs for every housing unit since 2011. The three major cities of San Jose, Oakland, and San Francisco did twice as well as the suburbs on that measure, but the results are still piddling—a rate of one housing unit for every seven new jobs. 

San Francisco, which has added 12,000 new residents per year since 2010, has built a rough average of 1,900 units a year over the last 20 years. Even though the number of housing units the city produced hit a two-decade high of 3,514 in 2014, the figure fell by 16 percent last year. Meanwhile, the Bay Area’s affluent Silicon Valley suburbs, which have property-owner majorities that are financially incentivized to sustain or worsen a housing shortage, are even less successful by this measure. When Apple’s $5 billion Campus 2 opens, it will eventually have a capacity of 14,200 employees on a site where 9,800 once worked. Yet the city is being asked to produce only 1,064 units over seven years under California’s residential housing production recommendations.

At the state level, a proposal from Governor Jerry Brown to fast-track development plans died earlier this summer at the hands of the building trades and affordable housing advocates, who argued that it relied too much on market-rate approaches to solving affordability. All of this is having an effect on the job mix in the Bay Area by further redistributing middle-income workers to other parts of the state and the nation as a whole. Growth-stage tech companies are sending sales jobs to cities in other regions while keeping higher-compensated managerial and engineering jobs in the Bay. Companies like Weebly and Gusto have opened satellite offices in Phoenix and Denver, while Lyft moved its customer service team to Nashville. 

“We have reached a tipping point, and it is obvious to everyone that the current situation is not sustainable,” says Carol Galante, who recently arrived at UC Berkeley as a professor researching affordable housing after serving as an Obama appointee in the Federal Housing Administration. In September the White House published a zoning tool kit that was not so subtly aimed at the Bay Area, encouraging the region to make reforms like taxing vacant land, building granny units, and streamlining permitting processes. Galante hopes that the administration’s policy proposals, as well as the governor’s stalled effort at getting housing approvals streamlined, will eventually lead to stronger state power over local land-use issues. “While the governor’s proposal didn’t pass, it added a level of urgency and energy to the dialogue,” she says. 

That’s all cold comfort for Bay Areans looking to buy a house right now. But that doesn’t mean buyers should lose all hope. Though the region’s housing will stay expensive and inventory will remain tight for a good, long while—heck, maybe forever—small windows of opportunity beckon. And the next could be just around the corner.


Originally published in the November issue of San Francisco

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