It is hard to believe but home values in San Francisco have doubled in a matter of four years. Since 2012 the typical San Francisco home went from $600,000 to $1,200,000. The Bay Area is under a tech based hypnotic spell and foreign money just can’t get enough of million dollar crap shacks in San Francisco. As we all know trees do not grow to the sky with unlimited potential and at a certain point the laws of reality have to hit. Only 11 percent of households in San Francisco can actually afford to purchase the typical $1.2 million crap shack. And that is why home prices in San Francisco have been waffling for the past year. It looks like an interim peak has been reached. Of course this also has to do with the stock market moving sideways and people digging deeper into all the venture capital money chasing unicorn tech companies. It seems like people are denying a bubble because we just had a bubble. The bubble was in real estate. The bubble hit California. So of course it can’t happen twice in the same place. But this definitely feels like an echo bubble brought on by foreign money, investors, tech money, and a stock market that has only gone up for 7 years now.
“Capitulation: the action of surrendering or ceasing to resist an opponent or demand.” There seems to be an air of capitulation floating around the air. No, not the toxic fumes floating over Porter Ranch but something akin to giving up. It is actually a weak form of giving up since you are talking about hipsters and house humping adults looking to overpay for a crap shack. Forget about the fact that last month the median price on your typical California home fell. No, it is time to buy now or be priced out forever. You get the selection bias going: I bought at X time and now I’m X times richer. Let us ignore the 7,000,000+ households that recently lost their homes to foreclosure. At least some are willing to admit their “investment” was basically blind luck. At a few open houses, you can see people as if they were entering a cult with their eyes dilating like the cat in Shrek. “Can you please let me buy this place and take on a massive mortgage? Pretty please?!” To be honest, it is rather shocking to see people waiving contingencies and throwing caution into the wind. In many cases, people are buying old crap shacks that actually have a ton of deferred maintenance. One open house, a standard SoCal stucco box, looked like it hadn’t been touched since the 1970s and the aroma of cat urine and dog poop whiffed around the room as people elbowed each other to “examine” the place. The only sense you had was of panic of missing out. In other words, mania.
There were two housing stories that stood out to me today. One shows the pure absurdity of housing in California, in particular Northern California. As we’ve discussed before a home is expensive or affordable only as measured by incomes in the local area. Well for Palo Alto, it looks like having a salary of $250,000 per year could qualify you for subsidized housing. Of course having this income puts you in the top 2 percent of all U.S. households but in Palo Alto you might as well be eating Purina Dog Chow with a nice class of Manischewitz. The Bay Area is running on hot money from the tech industry. Another story focuses on the continuing rental revolution we are undergoing. In Q3 of 2015 100,000 apartments came online, the most since the late 1980s. And most were rented within 12 months. I think these stories really highlight the larger theme in housing – extreme money for hot enclaves and renting for the vast majority. The middle is being cleaned out like using a melon baller on a cantaloupe.
People are surprised to hear that Los Angeles County is the most unaffordable location in the entire United States when it comes to renting. Isn’t San Francisco or New York more expensive? Of course they are but affordability is based on income and Los Angeles has a much lower household income base to draw from. Unlike creative mortgage financing, you actually need to pay your rent out of your net income each month. What has happened since the housing bubble popped is that more families in Los Angeles are now renters and rents have soared causing a rental Armageddon in the area. Families are being squeezed in what I would like to call housing purgatory. They have no way of buying an inflated crap shack but at the same time are unable to do anything about rising rents. For those with Taco Tuesday baby boomer parents, many Millennials are opting to move back home. And builders realize this trend is only going to continue and that is why builders are going after multi-unit permits at a much higher rate than single family permits. Los Angeles County is now becoming a renter’s paradise assuming you like cramped living areas, high traffic, and sky high rents. I don’t see permits for new freeways coming online at the rate of multi-unit permits.
You want to know why homebuilders are still reluctant to build even though real estate prices are up? The first reason is the demand in housing is coming for rental properties and building in multi-unit housing is up. Good assessment on that one builders. The other reason is that high priced metro areas are seeing Millennials move in with mom and dad. What is interesting is that the group leading the charge in new household formation is seniors. Yes, older folks are driving the creation of new households but this may not be what will sustain a long-term healthy market. After all, it is unlikely that a 75-year old is going to be buying a crap shack with a 30-year mortgage. What was interesting is that in 2015 net household formation came in at the lowest rate in a generation only behind the epic disaster year of 2008. So what does this mean for housing overall?