To repeat what we first wrote in January 2008:

There’s no doubt Bay Area average rents are up. And while we wouldn’t be surprised to see another 10-15% increase in 2008 (at least for San Francisco proper), keep in mind that the current housing Price-to-Earnings ratio is still well above its long-term average for the San Francisco MSA.

An analysis by Credit Suisse pegged the historical housing P/E ratio for the San Francisco MSA at 24x Earnings (or annual rent) versus a top 52 market average of 16.6x. So yes, we have long paid a premium (compared to most other areas) to buy versus rent in the Bay Area (or as many often comment, “it has always been expensive to buy here”).

That being said, the same Credit Suisse analysis pegged the housing P/E ratio for the San Francisco MSA at 42x in 2006. Assuming no change in property values and a 9.4% increase in rents during 2007, the current P/E ratio would be 38.4x. And a return to the historical 24x would either require rents to rise another 60%, property values to fall 37.5%, or a combination of the two.

At the end of 2010 the P/E ratio for the San Francisco MSA weighed in at 27 as rents have risen and values fell. And once again, a return to the historical 24x would either require rents to rise another 12.5%, property values to fall 11.1%, or a combination of the two.

Bay Area Rents Surge, But Housing P/E Ratio Remains Out Of Line [SocketSite]
San Francisco’s Housing P/E [SocketSite]

20 thoughts on “San Francisco Housing P/E Ratio History And Three Year Drop”
  1. Yup, there are lot’s of areas in the east bay part of the MSA where prices are off 50-60% from peak but the better areas have done well so far. Another 11.1% wouldn’t be shocking.

  2. Is the San Francisco “bubble”–if indeed it still exists–price point specific?
    The market I know best is the Mission. Nice (but not extraordinary) 3 BR condos are now selling in the Mission for about 15x-18x annual rent, give or take.
    For a particularly clean comparison, consider the new three-unit buildings on 22nd St. b/t South Van Ness and Shotwell. Of the three buildings, the westernmost consists of rentals and the other two are owner-occupied. (The former building was I think designed to be sold as condos, but the units hit the market right when the stock market blew up and the developer went the rental route. The fixtures in the rental building are not quite as nice as in the adjoining owner-occupied building, but they’re in the ballpark.)
    A 3/2 in the rental building was advertised on craiglist last summer for $4295, and scooped up pretty quickly. Let’s say the rental value is $4000/month. This may be a bit conservative; the asking rent on a 2/2 in the attractive newish building at 3520 20th St (b/t Mission and Valencia) is now about $4000 ( $4000/month translates to an annual rent of $48,000.
    Now look next door. Last summer, the middle and lower flats (both 3/2s) in the adjoining building hit the market as new construction and sold for $795,000 and $790,000 respectively, about 16.5x annual rent. This is well below the 27:1 ratio said to be “current” for the SF MSA per Moody’s, and also well below the “historic” 24:1 ratio for the 1980-2000 period. And it’s very close to widely cited 15:1 historic average across the nation as a whole.
    So what’s going on? Either (1) my example is an anomaly, (2) the Moody’s figures are way off base for San Francisco (distorted perhaps by rent control), or (3) the “bubble” is highly specific to neighborhoods and price points.
    I suspect that both (2) and (3) contain an element of truth. The very nicest condos in the Mission sell for *much* more money (for example, the upper 3 BR units at Nove on Guerrero b/t 22nd & 23rd sold for around $1.6M last summer, and the penthouse unit at 3280 22nd sold recently for $1,380,000). It’s hard to believe that such units have a rental value anywhere close to commensurate with their sale price (i.e., north of $7k/month).
    Some plausible conclusions: (1) There’s still an “SF bubble,” but only at the high end. (2) Perhaps it’s the case high-end units always trade at a higher price/rent ratio than mid-end units, the “ownership premium” rising with the quality of architecture and finishes.

  3. just for the record price/rent = GRM, not P/E.
    P/E would be more like the inverse of cap rate or price/net operating income. but not exactly.
    yes i know we’re talking about a statistic used for comparison and that’s fine. and we’re looking at it from a rent vs. buy standpoint, not an investment standpoint.

  4. I think you’re right that it price point specific, but it’s more about price than neighborhood. Generally, the lower price point you go, the better the ratio. The 27:1 ratio is likely skewed by some insanely expensive homes that function more as trophies. The $800k-ish condos are going to have more reasonable ratio than the $2 million-ish homes. So, it’s not at all surprising that condos in the Mission buck the average.
    My friend bought a $140,000 shack in Richmond (the city) and rent it out for $1,100 a month. That’s under 12:1. Likewise, $50,000 condos in Las Vegas can rent for $500 a month. The lower you go, the better the ratio in general.

  5. Samuel’s point is surely right with respect to the rental/investment market. At the very low end, the buyer is dealing with dodgy neighborhoods and tenants with unreliable income streams and no assets. A greater return (higher GRM or “P/E” ratio) is needed to compensate the buyer for the greater risk.
    What’s not so obvious is why there should be a higher ownership premium for units marketed to the “rich” (say, families with annual income in the neighborhood of $500k), versus the “upper uppper middle class” (say, familiies with annual income ins the neighborhood of $250,000-300,000, who make up the market for condos in the $750,000 – $1M range).
    In the mid-1980s, someone I know sold his 1000 sqft, 2 BR, pre-war co-op on the Upper West Side and bought a 4 BR, 2500 sqft pre-war co-op on Central Park West. He got about 15x rental value for the former, and paid about 15x rental value for the latter.

  6. couple of quick comments/queries..
    1. This appears to be for the MSA rather than SF itself.Presumably the historical average for The City of Sf would be above 24.
    2. getting from 42x to 27x – is it known what mix of falls in prices/rise in rents caused this?
    again, of course MSA prices fell (far?)more than in SF itself.

  7. Busts like this often lead to an overshoot on the downside (the bitter pill of just having been burned).
    I would expect a ‘P/E’ of 20 to be in the cards for the SF MSA. The bulk of that will likely come from rising rents as the recency bias pushes the marginal buyer to renting.
    Changes in monetary policy, mortgage support, and local emplyment conditions could impact these numbers materially, but I wuld still hold that in 2-3 years, a P/E of 20 is highly likely. Figure a 15-20% rise in rents and a 10-15% drop in home prices should just about do it by 2014.
    Of course, if support for the home prices is deemed critical to the wealth effect, then we could reasonably expect that the adjustment to the historical p/e will take a very very long time.

  8. how are the data calculated? Are we looking at average selling price/average rent price? If so, any underlying differences in the characteristics of the distribution will skew the numbers. Or are we looking at the average ratio of the same property rented vs purchased?

  9. Not sure I’d agree that the MSA has fallen more than SF. However, I would agree that (1) some areas within the MSA have fallen more than city-wide SF (while some areas have done better), and (2) some areas within SF have fallen more than the MSA-wide experience (while others have done better).
    Does that “historical 24x” include the skewing from the bubble itself? It looks like it. So the relevant “historical” multiple – excluding the bubble effect – would be far lower. This makes sense. I know that when we bought our place in 2000 (so there was even one bubble baked in, but we were also in a rent bubble) we paid just about exactly 15x annual rent. And we did not get some great steal as we we paid 20% over asking and were among 17 bidders.

  10. I don’t find this report to be at all useful. The area is just way to broad. If this statistic was just for the city of San Francisco it would still be hard to come to any useful conclusion, but the SF MSA is somewhere between 3 and 9 counties, which is just way to broad to be of use.
    Even just in SF it would be hard to use this information, with rent control, and the huge variation from 1 neighborhood to the next, but for the entire MSA I find it completely useless.

  11. resp wrote:
    > just for the record price/rent = GRM, not P/E.
    I agree with resp and I have never heard a “real estate person “ use P/E to describe a property GRM. In the world of small investors GRM is used quite a bit while more sophisticated investors don’t care about the GRM very much and will just use the Cap Rate (NOI/Price).
    Then REpornsddict wrote:
    > couple of quick comments/queries..
    > 1. This appears to be for the MSA rather than SF itself. Presumably
    > the historical average for The City of Sf would be above 24.
    I just pulled the “San Francisco Bay Area” median home price of $397K and at 24x that comes out to a median rent of $827 a month (that seems a little low since I don’t think that 50% of the rental homes in the Bay Area rented for less than $827 in 2000).
    In 2005 the Bay Area median price was $730K and at 40x that works out to a median rent of $1,520 (that seems about right when we are talking the entire 9 county SF Bay Area with areas like Richmond and San Leandro).

  12. “Not sure I’d agree that the MSA has fallen more than SF”
    So A.T., you think that prices in City of SF have fallen by over 40%? Because I believe the MSA has.

  13. The rent in SF is awfully volatile. Even a moving average would be too volatile to assess the price. More stable price/income ratio would be a better measure. And rent/income to guage the rent. Any way you look at it, SF is still highly expensive city to live in.

  14. The Kansas City Fed has an extremely interesting paper looking at financial outcomes of owners vs renters at different price/rent ratio’s over the last 30 years.
    While they are clear that they are attempting to look at the price vs rental value of a particular house. (i.e. as opposed to median rent vs median house price or other ratio’s of aggregates). They present all their findings as a rent to price ratio denominated as monthly rental price per $100,000 value. (i.e. $500 represents $500/month or $6,000/year rent for a $100k house or a price/rent of 16.7. Similary $1,000 represents a price/rent of 8.3)
    While it is quite plausible that the Credit Suisse and Moody’s price/rents were calculated differently with all the issues posters mention above, it is worth noting that the numbers are well above the “lower bound” of 16.7 used in the paper.
    While the paper is definatly worth a full read as it among other things illustrates a clear method for performing a buy vs rent calculation, here’s a summary of the findings.
    “The article finds that for ten-year occupancies beginning during most of the 1970s and 1990s, homeowners built more wealth than renters. In contrast, for ten-year occupancies beginning during most of the 1980s, renters who invested their savings from lower house payments (than owners) built more wealth. For other periods (about a quarter of the ten year occupancies), it is unclear whether owning or renting built more wealth. This ambiguity arises from the difficulty of measuring the market rent and purchase price on identical houses.”
    “To this point, the analysis has focused on determining whether renting or owning a house built more wealth over a succession of ten- year occupancies. But how large was the wealth gain or loss from choosing one tenure type rather than the other? Did choosing “correctly” yield a sizable difference in wealth?
    The answer is clearly “yes” for most years. When the rent-to-price ratio differed from the breakeven ratio, the difference in final wealth between renting and purchasing was typically quite large. For example, when the market ratio was 10 percent above the bond-based breakeven ratio, rent- ing and investing in bonds would have resulted on average across ten-year occupancies in final wealth that was 12 percent lower than a homeowner’s final wealth. When the market ratio was 10 percent lower than the bond- based breakeven ratio, renting and investing in bonds resulted, on aver- age, in final wealth 12 percent higher than a homeowner’s final wealth. Across ten-year occupancies, the corresponding differences in final wealth ranged from 2 to 26 percent.
    For stock-based breakeven ratios, a 10 percent difference with the market ratio would have caused an average final wealth difference of 24 percent. The corresponding range across ten-year occupancies was 2 to 62 percent. These wealth differences scale proportionally to alternative percent differences between the breakeven and market rent-to-price ratios.
    An obvious conclusion would be that it pays to make a good buy/rent decision.
    Their Appendix 2, along with a number of the footnotes, makes some points about how to properly calculate price/rent ratio.

  15. I think the P/E in SF is currently higher than 27. I have been searching high and low for top end 2bdr 2ba condos. For the most part, I am finding that $1,000,000 in price equals somewhere between $3000-$3400 in rent. P/E mostly above 30.

  16. also, i still find that using the NY TImes rent vs. buy calculator, it still makes mroe sense to rent in SF. The only way that I can get the buy equation to be better in a 7 yrs time horizon is if housign appreciates at 6% or more annually.

  17. It can be worthwhile when using the rent vs buy calculators to explicitly look at both the final home price and final price/rent ratio at your breakeven appreciation assumption.
    It’s one thing to assume a 6% per annum increase from a historically low price/rent upto an average value, quite another to assume the same 6%/year appreciation from a very high price/rent to a never before seen value.

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