Monday, May 19, 2014

San Francisco Valuation Update

All real estate is local…

Good, got to get the aphorism out of the way first.  

Now one more: Numbers lie, numbers lie, numbers tend to…well…stretch the truth.

Let me merely highlight some of the complexity at hand by detailing two separate pieces of contrary fundamental evidence that come to two alternating conclusions. Beginning with the arguments then the evidence below each:

1.      Housing prices will cool down in SF:

·         Relative to national metrics, SF is an over-achiever. The 10-City and 20-City Case-Schiller index was up 13.6% and 13.4% over the past year. Pretty good year for housing at large (granted SF makes up 11% and 8% of those indices). SF, on the other hand was up over 20%! No denying that SF continues to outpace the national metrics.
·         The “Price-to-Rent” ratio for SF is now at 32x. The P/R ratio is a less-than-robust indicator of how much of an “earnings power” a home potentially has if one chose the landlord route. The reason 32x is considered high is that it is 14% higher than the ratio of 28x, which was the average spanning from 1989 through 2003. See blog(s) on Cap Rates for an analysis on evaluating rental success.
·         The “Price-to-Income” ratio for SF is at 4.8: meaning a home is nearly 5x an annual salary, which is about 20% higher than it was in the pre-boom era. National averages are not relevant to compare because the local marketplaces are desperately heterogeneous.

2.      Housing prices are supported and will continue to rise in SF:

·         Interest rates remain low and the Federal Reserve remains accommodative. The Credit spigot is still open and the 30-year fixed is high-fiving with 4.31%, as of the end of last week (source: Bloomberg).
·         According to the Brookings Institute, between 2007 and 2012 San Francisco had the widest spread growth of income divergence between the rich and poor. One has to step back and chuckle at the irony: in one of the most tolerance-promoted cities of America, home prices have reflected nearly the opposite outcome.
·         But it is not the fault of the people. The Elasticity Score of SF is among the lowest in the States. Translated: it continues to be extremely difficult for developers to build! With supply absolutely unable to meet the level of demand, only the wealthy continue to justify housing prices. The matter really is deeper—more sociological than purely economic.

The numbers by themselves do not give the whole story. Paying attention to fundamental trends is how to resound one’s self with the confidence needed to get a good price with the right justification.