Supply, Demand, Money and Demographics

What’s Behind San Francisco’s Real Estate Market?

July 2014

This chart is a simplified, smoothed-out and approximate look at the last few real estate cycles in San Francisco, illustrating estimated percentage changes in home prices from successive peaks and bottoms of the market. The years between these high/low points are simply depicted here as straight lines (which does not reflect reality). Different market segments have experienced varying appreciation and depreciation rates over the years and how this chart applies to any specific property is unknown without a tailored analysis.


Why is San Francisco’s housing market so hot, so competitive? It’s worthwhile to take a step back and consider some of the main factors at play, some of which reflect general macro-economic trends and some of which are specific to the city itself:

  • Population growth: San Francisco has recently been adding approximately 10,000 new residents per year and new home construction has not come close to adding enough additional housing units to meet increase demand. (And more would move here if they could find a place to live.) New construction is booming again in the city, but it will be a while before enough new units arrive (to rent or to buy) to substantially change the existing high-demand/low-supply dynamic.
  • Employment growth: San Francisco now has the highest number of employed residents in its history and job numbers continue to grow as new companies start up and existing ones expand. Many of these new jobs are very well paid.
  • Surging stock market: The S&P 500 is up over 50% since 2011 began. The affluent have benefited most from the recent, large increase in the value of financial assets, and San Francisco has one of the most affluent populations in the country. When people feel wealthier, they spend more on homes, second homes and real estate investment properties.
  • Brand new wealth: Thousands of newly affluent residents – including significant numbers of millionaires and even billionaires – have been created in the Bay Area in recent years from stock options, IPOs and company sales. This is super-charging the “wealth effect” on the market.
  • High rents: Purchasing a home in San Francisco, with the attendant tax benefits and equity accrual (as well as the possibility of future appreciation), often makes compelling financial sense if the alternative is to pay an extraordinarily high rent.
  • Low interest rates: from 1996 to 2006, the average interest rate on a 30-year fixed rate loan was approximately 6.3%. As of early July 2014, it was 4.1%. That 35% reduction in the cost of financing makes an enormous difference in affordability and the ongoing cost of housing.
  • Work there, live here: A relatively recent development, many of the people working or taking new jobs in Silicon Valley high-tech and bio-tech now insist on living in the city. The “Google bus” phenomenon is just one illustration of a trend which puts considerable additional pressure on our housing market.
  • Magnet effect: San Francisco, a small city of 7 by 7 miles, is now the capital of perhaps the fastest growing, most lucrative, highest-prestige business segment. It is also in one of the most beautiful, best educated, most tolerant and culturally rich metropolitan areas in the world. That makes the city a magnet for smart, creative, ambitious people from all over the planet and they are willing to pay a premium to live here.
  • Limited supply: Almost two thirds of the city’s housing is in rental units, much of it under rent control. The number of homes suitable for owner-occupancy and available to purchase each year is relatively small: As an example, the SF homes market is less than half the size of the markets in either Alameda or Contra Costa counties.

Huge demand + surging wealth + severely inadequate supply =
today’s San Francisco real estate market.

None of this implies justification for an ever-appreciating real estate market: Almost all these factors can stall or even go into reverse. Real estate and financial markets are prone to a wide variety of extremely complex and hard-to-predict economic and political factors – and they typically go in cycles: up, down, flat, up again (repeat). And economic and market fluctuations are not uncommon within cycle phases. Still, these are, we believe, the fundamental realities underpinning the city’s homes market now.

San Francisco’s real estate market is now about 2 ½ years into its latest recovery. In the last few cycles, recoveries have typically lasted 5 to 7 years before a significant market adjustment, but, of course, the past is no guarantee of the future.