Five Reason to Be Bullish on San Francisco Real Estate

I like to consider myself an "optimistic skeptic." Healthy skepticism layered on top of a more general optimistic outlook on the world keeps me mindful of growing trends while avoiding the overly pessimistic views that result in perma-bears missing out on far too many good investment opportunities.

Trying to assess the state of the current real estate market in San Francisco is a perfect example of needing to question how long our current boom may (or may not) last, while embracing the dramatic changes in our economy and business landscape, and how companies -- many of which call the Bay Area home -- may benefit in the years to come.

And since I have found more skeptical than optimistic of late, it seems like a good exercise in "seeing the other side of the trade" to look for reasons why now is a time for optimism, rather than skepticism.

1) Demographics

We've long been harping on the global urbanization movement and its implications for San Francisco real estate. Millennials, as the story goes, are shunning suburbs and flocking to urban areas where they can walk or ride, rather than get behind the wheel of their own car, to get where they need to go.. Ryan and I even launched an entire investment fund in 2012 based on that premise.

Now as demographic data start to come in from the past few years, some interesting trends are emerging. In a report last year, Trulia's chief economist Jed Kolko observed that the fastest growing cities aren't necessarily the ones with the highest high rises and the densest neighborhoods. Places like Austin, Texas with relatively low density, are actually growing at a faster clip than larger, denser metropolitan areas like New York and Chicago. 

In a way, this makes sense. Shifts in demographic are slow-moving, spanning decades not years, so its no surprise that young families settling down in urban areas rather than traditional suburbs are flocking to cities that have the best of both worlds. In San Francisco, the emergence of Bernal Heights and Potrero Hill as two of the most popular neighborhoods among young families illustrate that trend. In fact, online brokerage Redfin named Bernal Heights the country's hottest neighborhood in 2014. SOMA is booming, to be sure, but the majority of its new residents are young, unmarried professionals looking for a bustling urban vibe.


All this bodes well for continued population growth and demand for housing in San Francisco, the inevitable correction from our current boom notwithstanding. Good weather (in the eastern neighborhoods at least) and an abundance vibrant walkable commercial districts near suburban-type neighborhoods, not to mention a robust market for jobs should only make San Francisco more desirable as these demographic trends plod on.


2) Supply

With cranes littering the skyline and traffic snarling from construction everywhere, we who live here may guess that San Francisco ranks as one of the fastest growing cities in the country. But according to the US Census estimates for 2013-2014, San Francisco doesn't even crack the top 20 (hat tip: Slate).

So why can't we house the droves of young professionals flocking to the city by the bay? That's a loaded question, but for now let's focus on supply. Or the lack thereof.

Mayor Ed Lee's initiative to build 30,000 new housing units by 2020 makes for nice political print and is a good start, but even if the number is achieved (at last tally, we're a bit behind) the status quo is the best we can hope for. And the status quo is widely described as an affordability crisis. 

With 850,000 people at last count, San Francisco's 1.3% growth rate equates to about 11,000 new residents each year and about 70,000 between time the mayor launched his initiative in 2014 and 2020. If you assume that each new housing unit will house on average two people (healthy unit mix of studios, 1-bedrooms, etc), that's roughly space for 60,000 new residents. And if we stay on our current building pace, each new unit would have to house three people to keep up with demand.

One would think new projects would be sailIng through the Planning Department, but politics has a nasty way of getting in the way of rationality. Voters in November get to decide whether to enact a moratorium on new construction in the Mission district. We even have to go to the pools to approve a huge new housing development near AT&T park on what is now the Giants' main parking lot ... which displaces exactly zero people.

Anecdotally, I am hearing developers pull back from new projects not just because building costs are skyrocketing, but because the political climate is so terrible that its hard to know whether the moratorium movement in the Mission will gain steam in other parts of the city.

In other words, we already weren't building enough and the prospects for even getting the units already in the pipeline is looking sketchy, at best.


3) Here Come the (really) Rich

In certain circles, it's hard to imagine a San Francisco that isn't a destination for the rich and famous. But in the broader world of the rich and influential, San Francisco as a real estate destination is still in its infancy.

London, Paris, New York, Hong Kong -- the list goes on for a while before you get to San Francisco when it comes to "must have" locations for those fortunate enough to collect real estate around the world.

But we're getting there. 

I remember talking to a high school friend a few years ago who was looking to move back to San Francisco and open an office for the New-York based luxury condo developer he worked for. I asked who else was here developing super high end condos like the ones they built along Central Park South.

"No one." He said. And we both decided that sounded about right. That the demand just wasn't there. 

We're about to find out if we were right (looks like we weren't). The Lumina at 201 Folsom is already cracking the $2,000 per square foot mark and the city's first truly luxury development built during this cycle, The Pacific, a retrofit of the University of Pacific Dental School in Pacific Heights, is supposed to hit the market later this year.


4) Schools.

Looking at the demographic trends above, a logical follow up question would be, "Sure, but aren't San Francisco public schools a mess?" Well, yes. And no.

There are plenty of great schools -- public and private -- but the trick is how to get your kids into the one you want. Historically, the process was one part lottery, one part nepotism and three parts black magic. The result, partially due to the uncertainty surrounding where kids would actually end up, was that young San Franciscan families have historically moved out to surrounding suburbs when their kids reached school age.

But parents are now more inclined to stick it out in the city past their kids' toddler years. And while we don't have nearly enough space here to dive into whether its a good or bad thing, the system got tweaked last year to try and give priority to kids who live hear the school of their choice. This seemingly logical notion alone is encouraging more families to forgo the suburbs for the chance to stay close to the urban amenities they have grown to love.

That, and the fact that our ongoing real estate boom has made moving to the burbs a financially untenable option for many.


5) Rent Control

Another topic too controversial and too complex to fully address here, rent control is perhaps the single feature that makes San Francisco real estate (residential at least) one of the trickiest assets in the country to own.

With 65% of the city renting and roughly 3/4 of all rental units under rent control, don't expect rent control to go anywhere any time soon. Rent control may be many things to many people, but most academics and economists agree that it decreases the availability and quality of housing. This makes sense: landlords have little incentive to maintain buildings where there's a ceiling on what rent they can charge.

Rent control is a moral and social issue with dramatic economic consequences: how much are we as a society willing to pay to protect certain groups who, although they may not be able to afford to live somewhere, should receive a subsidy to do so? Like I said, too complex an issue to address here.

But the bottom line is that rent control itself, plus the morass of bureaucratic and procedural red tape accompanying it, will keep housing supply in San Francisco low for the foreseeable future. 



Rereading this list, I almost have myself convinced that the good times will roll on and that my persistent skepticism is unwarranted. But I am then reminded of so many wise men and women who have been lulled to sleep by the warm bath of good times, and that I enjoy sleeping well at night.

"All of the doom and gloom forecasts of a housing debacle are not only irresponsible, but also downright wrong." - David Lereah, NAR Chief Economist, August 2005
"The impacts on the broader economy and financial markets of the problems in the subprime market seem likely to be contained." - Ben Bernanke, Federal Reserve Chairman, March 2007