UBS Bubble Index 2016

According to UBS Wealth Management’s Global Real Estate Bubble Index, the residential real estate market in San Francisco is increasingly overvalued and approaching bubble territory, while New York and Boston remain fairly valued and Chicago is undervalued, as was the case at the same time last year.

The index is based on a comparison of current price-to-income (PI) and price-to-rent (PR) ratios in each of the cities versus their historic norms, with low affordability per PI ratios pointing “to diminished long-term price appreciation prospects” and high PR multiples indicating “a dangerous dependence on low interest rates.”

Vancouver was atop UBS’s list of cities in bubble territory, followed by London, Stockholm, Sydney, Munich and Hong Kong. “What these cities have in common are excessively low interest rates, which are not consistent with the robust performance of the real economy,” said Claudio Saputelli, Head of Global Real Estate in UBS Wealth Management’s Chief Investment Office. “When combined with rigid supply and sustained demand from China, this has produced an “ideal” setting for excesses in house prices.”

And per one of UBS’s Real Estate Economists, “a sharp increase in supply, higher interest rates or shifts in the international flow of capital could trigger a major price correction at any time.”

Keep in mind that UBS’s ranking above isn’t based on a screen of all cities but rather a specific analysis of the select 18. And, “a bubble cannot be proven conclusively unless it bursts, but recurring patterns of property market excesses are observable in the historical data.”

100 thoughts on “San Francisco Approaching Bubble Territory per UBS”
    1. Given Chicago and Illinois crippling public pension debt (MUCH worse than California), I for one wouldn’t buy property there. Renting would be great though, until the sh*t truly hits the fan.

      1. Could you elaborate more on this or link me to more info. I’m considering Chicago for rental properties.

        Thanks in advance.

  1. Interesting analysis in general, however, I think it’s worth noting that the index looks at past historical performance in each market and the delta in the current market relative to historical pricing. Interesting that New York City is not in bubble territory, largely because it’s had a long term historical/stable pricing at the high end.

    While San Francisco has always been an expensive market, it’s only recently attained what could be considered tier one price status. One could argue that the market here has fundamentally / permanently changed and that over time the stability of the market will stabilize the SF GREBI rating.

      1. I believe what Eddy is referring to (or at least I would refer to) is the increasing role San Francisco and the Bay Area has been playing in US wealth creation through the tech industry. As has been repeated here ad nauseum, SF proper once had only a supporting role to Silicon Valley, but now is firmly a part of the whole ecosystem. As long a tech and Silicon Valley continue to grow (a big if with lots of qualifications and short term fluctuations), I would agree that SF deserves to ratchet up a notch or two in comparison to its past historic norms.

        1. Keep in mind that increased incomes are already reflected by the ‘price to income ratio’. And look at the timing of the changes in the ratio which seems to move more in tune with the ability to lever up via loose lending (2007) or low interest rates (now) vs any structural changes in the tech economy.

          And tech itself has gone through and will continue to go through significant boom and bust cycles.

      2. Here are three: Google, Apple, Facebook. They are worth a combined $1.52T (with a T) today, from negligible valuations just 15 years ago. Of course it’s not a perfect measure, but it’s not bad. The money lives on. Mark Z, for one, is now funding huge spending in disease research. Much of that will be spent here. Etc. etc.

        And that’s just 3 companies.

        1. Biggest factor in current pricing is the sheer number of double-income households who are under 45 years old, with incomes of 250k, 300k+ household, with x00k in savings – it’s just a huge number in SF proper and SM and SC counties. Everyone I know who is coupled and owns property makes money on this level. I work in a large company.

          Now, when significant job losses happen, we will see declines. I do believe this will happen, yet slowly, and over many years. I.e. late stage rounds from foreign sources won’t continue forever, and many companies will never achieve liftoff.

          1. It’s been like that since the early 90’s in Silicon Valley. These couples working at sun micro, silicon graphics, HP, Cisco, etc. making high incomes, plus money on their stock purchase plans. These were the main drivers of why palo alto, Cupertino, Menlo Park, etc., etc. went up so much in value. In the mid 90’s a $500k home is what today is a $2-3 mil home. Same types of people, but only a hell of a lot more of them. And the ones who got established in the mid 90’s can coast now if they want to. Most are staying put, and their homes won’t be on the market in a long time. Which is why the home next door now costs $2-3 mil.

          2. “It’s been like that since the early 90’s”
            Exactly. Since the early 90’s. So it doesn’t do much to explain the 2000 dot com bust or the 2007 housing boom and bust or what’s going on now.

          3. Google, Apple, and Facebook are much, much larger than HP and Cisco were. SV has expanded to include almost everything from SF to SJ.

    1. While SF is nice, it’s hardly in the same tier as global cities such as London, Paris and New York.

      Also, if you look at the timing of when SF’s price to income ratio has shot up way above average, the first time was during the 2007 era housing bubble and more recently the ratio has shot up along with a handful of other cities coincident with global economic stimulus.

      It would be quite a coincidence for SF to suddenly join a higher strata of global cities exactly at the same time that financial factors are bubbling up other areas of the world.

      As UBS said in the 2015 version of their report: “When inexpensive financing is combined with bullish expectations, real estate prices eventually uncouple from the real economy. We have seen this in the current cycle, particularly in the world’s leading financial centers, where housing prices are now, in many cases, fundamentally unjustified. The risk of a real estate bubble in these cities has risen sharply. While it is not always possible to prove conclusively the existence of a bubble, it remains essential to identify the signs of one early on.”

        1. It’s informative to see what cities UBS graced with a full page writeup: London, Hong Kong, Zurich, Singapore, New York. Those are tier 1 global cities. SF is nice. But it’s very provincial to think that it has moved up into that tier.

          1. That grouping has little to do with being a “tier 1” city, but rather represents the “four most important financial centers” around the globe (and hometown).

          2. SF’s far too small to be tier 1. Name a tier 1 city with less than a million people. Most have ten million, some have twenty, some even more. And no, the greater BA pop. doesn’t count.

          3. FYI Zürich has less than half the population of San Francisco and the GMA of Zürich is only 1.5m compared to the 9m of the Bay Area. Also, people mention the cyclicality of Tech as a major liability for SF real estate market, but London, NYC and Zürich are highly dependent on the financial sector which is losing jobs by the tens of thousands.

  2. The conclusion re SF in the report is quite odd given the details it discusses. The report primarily considers price-to-income (PI) and price-to-rent (PR) ratios — high ratios for either or both are indicators of a “bubble” while low ratios indicate fair pricing. Yet, when both ratios are discussed in the report, here is what it says:

    P/I: “Due to relatively high incomes, purchasing an apartment is also still feasible for residents of San Francisco and most European cities, with the exception of Paris and London.” SF has the 6th lowest P/I ratio among the 18 cities considered.

    P/R: “Overall, more than half of the covered cities have PR multiples above 30. House prices in all these cities are vulnerable to a sharp correction should interest rates rise. PR values below 20 are found only in the US cities of San Francisco, Boston and Chicago.” SF has the 3rd lowest P/R ratio among the 18 cities considered.

    Thus, based on its own supposed methodology, San Francisco housing prices are among the lowest “bubble” risk of the 18 cities. The report simply throws all that out the window and says this: “In the wake of the technology boom and buoyant foreign demand, real house prices have increased in San Francisco by more than 50% since 2011, while the national price level has risen by just 15%. Moreover, the price level in the City by the Bay has surpassed the previous peak in 2006 by 5%. Even though income growth rates have been above the national rate, the imbalances in the city’s real estate market have increased.”

    In short, (my words now) — “our own methodology indicates that San Francisco housing prices are near the bottom for bubble risk among the 18 cities we considered. But SF prices have gone more than the U.S. as a whole since the bubble trough (along with SF incomes), so we’re just going to disregard our own methodology and say SF is ‘overvalued.'”

    Look, I do this sort of economic analysis for a living. I’m not saying SF housing prices are at zero risk of turning downward. But this particular report is garbage.

    1. So then why is the headline for this article insinuating we are moving into bubble status? Before this report came out I would have assumed we are already there based on the articles written by this site. This chart made me pleased to see we are not even there yet but this article puts the spin that we are approaching trouble.

      1. They didn’t pick on SF. Their conclusions are across-the-board sloppy. For example, Singapore’s reported P/I and P/R ratios are well above SF, yet it is “fair-valued.” Stockholm’s reported P/I and P/R ratios are right in the middle of the pack. but it is a top-3 “bubble” risk. They just present numbers and then make up a conclusion that has little to no relationship to the actual data on which they rely. It is a joke.

        1. As we noted above, the report primarily rates bubble risk based on the deviation of each city’s ratios from their own historic norms, not relative to the ratios of other cities in the data set.

          The real question is whether the deviation from San Francisco’s historic ratios are being driven by fundamental changes in the market and represent a sustainable new norm.

          1. That’s not what the authors of the report say in describing their own methodology. And if that were the methodology, it would be worthless as it would disregard historical changes in the city. Any city that has gentrified would look like a bubble.

          2. Any city that has gentrified would look like a bubble.

            That’s not true. Ratios have a denominator and numerator. And in a gentrified city, incomes would rise along with prices/rents, or rather vice versa.

          3. “Any city that has gentrified would look like a bubble.”
            Not if incomes went up and prices went up proportionally.

            “adding a fudge factor to get to the conclusion they want ”
            And why would UBS want this conclusion?

            Belying the assertion that SF is a tier 1 city in the full UBS report SF doesn’t even get a full page analysis instead getting a paragraph lumped in with “Select Cities”. Why predetermine a conclusion for one of a handful of “Select Cities”?

            Is the Economist in on this anti-SF conspiracy as well? “Yet in some cities, such as San Francisco, affordability looks stretched when compared against income—prices in the City by the Bay are 40% above their long-run average when compared to income. Theory suggests that they should eventually fall back down to earth.”

          4. My point was that in the purported UBS methodology (which is not the actual methodology described by the UBS report authors), any gentrifying city would look like a bubble because prices would be increasing beyond historical trends. That would be the problem in calling a “bubble” based on some “historical norms.” Incomes in SF have risen, of course.

            The editor is correct is stating that “The real question is whether the deviation from San Francisco’s historic ratios are being driven by fundamental changes in the market and represent a sustainable new norm.” But that is not a question that this report addresses at all. Hence, it is flawed.

          5. Don’t confuse the report’s primary methodology (which focuses on the deviation from historic norms) and subsequent benchmarking of the 18 cities’ ratios relative to each other (which certainly should raise an eyebrow/question or two).

          6. “That’s not true. Ratios have a denominator and numerator. And in a gentrified city, incomes would rise along with prices/rents, or rather vice versa.”

            Expecting price/income ratios to remain constant in this context doesn’t make sense. Price/rent ratios are always higher in desirable places to live, just as creditworthy companies borrow money at lower rates than dubious ones. IBM pays a lower rate than Joe’s Tire Shop does to borrow money. San Francisco in 2016 is different from San Francisco in 1996 or even 2006. The report is based on series that go back at least to 1990 and in some cases 1975.

            Here is a link to the actual report that includes an elaboration of the data on page 17.

            [Editor’s Note: We shouldn’t have shorthanded “…along with prices and/or rents” as “prices/rents” above.]

          7. But SF already had a higher price to income ratio vs less desirable areas.

            Did SF coincidentally become more desirable during the 2007-era housing boom when easy lending let people lever up more? Did it become less desirable coincidentally when the rest of the country was busting?

            Did the 2007 introduction of the iPhone and the staffing up for future iterations stop the bust in the bay area?

            Is SF now coincidentally becoming more desirable just when low interest rates are causing bubbles in other areas around the world?

          8. Economists everywhere (Policy makers and their constituents too, if they are wise) wish that economic growth (GDP growth) of around 4% could be attained. During the much-yearned for manufacturing heyday of post WWII USA, this was a standard.

            We still have dynamic GDP growth in the USA – not in aggregate, but in some locations. (Wait for it…) Urban centers of innovation have grown and continue to grow dramatically. Here is a report from the US government Bureau of Economic Analysis.

            From 2010 to 2014, SF and SJ Metro GDP increased 22% and 30% respectively. Over the same time period, (2010 to 2014), SF housing inventory increased by (7,032 new units / 372,560 existing) or 1.9%.

            GDP [does not equal] buying power, but it serves as a good proxy for economic activity and desirability.

            If our GDP is growing this rapidly, does it make sense to compare to historic averages from 20/30 years ago?

          9. If one wants to use “historical norms” to gauge whether or not a real estate market is overpriced, well, Manhattan tops the list, as during its history, the entire island once sold for $24.

          10. From 2010 to 2014 US GDP increased 16%. And remember that SF was already running at a higher price to income ratio vs the rest of the US. Do you think that an extra 1.5% per year GDP growth should result in a even more elevated price to income ratio on a permanent basis?

    2. You’ve got it backwards. They are comparing the cities to their own historic norms first, and then to each other second.

      1. Historic norms disregard cases where things have actually changed significantly. In the case of a big financial center like NYC or London, maybe they are more valid than for a city like SF which has had repeated waves of tech induced change.

      2. No they don’t (and if their emphasis was just on recent price increases or decreases, that would be completely meaningless). Here is the kicker from their own stated methodology: “As the drivers of bubbles vary across the cities, the method results in city-specific weights on sub-indices.”

        Translation: “we just make up our conclusions based on our own, unstated feelings about what the numbers should mean rather than what they, in fact, indicate.” This is what I see sloppy economists doing all the time in my work — adding a fudge factor to get to the conclusion they want (or, in my work, the conclusion they were paid to reach).

        1. You know what I think is pretty meaningless- your constantly repeating that “we’re not in a bubble, but I wouldn’t be surprised to see a correction of up to 20%”. Really strong conviction there.

          1. I don’t know if there is a correct definition, but I don’t think 20% over-valued constitutes a “bubble”. I tend to think of bubbles a 50-100% over fundamentals at least, or much much more. Historically we’re talking the South Sea Bubble, Tulipmania, and more recently the dot com boom. A 20% is a significant correction/bear market, not a bubble popping.

      3. No they don’t (and if their emphasis was just on recent price increases or decreases, that would be completely meaningless). Here is the kicker from their own stated methodology: “As the drivers of bubbles vary across the cities, the method results in city-specific weights on sub-indices.”

        Translation: “we just make up our conclusions based on our own, unstated feelings about what the numbers should mean rather than what they, in fact, indicate.” This is what I see sloppy economists doing all the time in my work — adding a fudge factor to get to the conclusion they want (or, in my work, the conclusion they were paid to reach)

  3. //As soon as this whole internet mobile phone thing blows over, we’re going back to being a refuge for artists and beatniks…//

    1. The internet never blew over after the dot com bust, and housing never blew over after the housing bust. But it turns out they were indeed bubbles.

        1. Not to mention all the other companies in SV and SF that are growing. To generate a preliminary list, one just has to go on LinkedIn and look at job openings for engineers and sales reps to see. But some people prefer abstract theorizing divorced from actual experience re: buyers, employers and regional incomes.

        2. Do you see that Google was founded in 1998? Apple was founded 1976. And even Salesforce was founded in 1999. So how does bringing up these older companies prove anything about the current bubble? Except that the strongest few companies will survive, while the masses of wannabes and johnny come latelys will either be taken out back and put out of their misery like and Webvan, or get bought up and fade into irrelevance like AOL, MySpace, and soon to be Yahoo and Twitter.

          Every bubble starts out rational, then becomes irrational as all the kooks pile on, like the fake mayo, bogus blood tests, sketchy lenders, all the companies trying to the Uber of laundry service and the Airbnb of muffin pans etc.

          1. You said to me, “prove it” re: earlier post. Well, you are the master of unproven assertions. Can you really not understand that there are so many more companies in the Bay Area that are profitable and large today? Do you have any idea about how big job growth in the region is? And how many sales reps and employees are making huge money even in those companies that are NOT profitable? (psst…they buy homes.) And that….oh, well. You deny “supply and demand”. Despite NO evidence that the vast majority of home purchases are made with cash and from foreigners, you continue to basically assert that they are. And therefore, there is nothing “real” about home prices here.

            And in this post, when you babble about the tech industry, your business shallowness is showing again. Reminds me of your assertions about cash purchases, and not knowing that you don’t need the full value of a cash purchase to make one. You’re just amateur-hour, day 1, shallow pseudo-intellectual nonsense. And arrogant on top of that. Just, wow.

          2. I fully understand how many people are making lots of money right now, and I fully understand that many of those people will not be making lots of money soon.

            I never said the majority of purchases are cash or foreign, I said those purchases have an disproportionate impact on rising property values. And the only reason I’m saying that, is because you people think that building more housing is the silver bullet to solve this riddle, when it’s not.

            And finally, you still haven’t provided us with anything but rhetoric.

        3. Sabbie, you brought up the dot com bust. I brought up Apple, which was worth about $30B then vs $600B today. I see you didn’t mention Facebook. Please list which companies from the dot com bust were worth $320B like Facebook is today.

          As I’ve mentioned earlier, Apple, Google, and FB are much larger today than they were in 2009. Not to mention Airbnb, Salesforce, Uber, and the smaller next generation companies.

          1. Again, we see a handful of new and successful companies added during each successive boom. We also have a ton more that don’t make it in every bust. For every Apple you bring up, I could list twenty Webvans. The words may change but the song remains the same. Boom and bust. We look at stocks today using the same technical analysis that was already used 100 years ago because human nature never changes. Greed and fear.

            Market cap proves nothing, Dell’s market cap was $130B back then and today maybe $25B, despite the fact that “computers aren’t going anywhere”. Investors look at opportunity cost, and today that is zero, so of course they are going to throw money at large cap dividend and momentum stocks. That could change very quickly.

          2. Twenty Webvans per Apple? Really?

            Ok, let’s do some math. Webvan went public with a valuation of $4.8 billion. We’ll round up and say 20 Webvans would be worth $100B. Apple is now $600B+, so you actually need 120 Webvans. Do you have 120 Webvans?

            The point is that Apple is huge. Significantly larger than the companies that came earlier. Apple is also profitable, unlike all of your Webvans.

          3. “The point is that Apple is huge” Yes, Captain Obvious, Apple is huge, so what? That proves nothing when talking about whether or not we are currently in a tech startup bubble. Apple has been doing great since 1976. Everyone is throwing money at them because of it. Awesome. But since 2009, there are about 900 startups that have gotten at least $20m in VC funding, 177 companies have gotten over $1B, fifteen have gotten tens of billions. Many of them are locally based and paying their employees very well. But how many will survive to become like Apple?

          4. As for your math, I found this article from 2000: “ asked the market data and research firm Birinyi Associates of Westport, Conn., to calculate the market value of the 280 stocks in the Bloomberg US Internet Index at their respective 52-week highs and their current market value. The combined market values of the 280 stocks had fallen to $1.193 trillion currently from $2.948 trillion at their peak, a loss of $1.755 trillion, most of which occurred between March and September of this year.”

          5. Apple, Google and FB combined have maybe just north of 100k global headcount excluding apple retail employees? Only some part of that is in the Bay Area and I’d guess that most of those folks have already been able to find adequate housing.

            The SF and SJ metro areas have a population of about 6.6M.

            Do you expect that Googlers will double or triple up on housing if prices weaken and other companies start to close?

            The reason people look at interest rates and zero down loans is that those factors apply to all buyers and thus have much more force to sway markets than one or two solid companies.

          6. “Apple has been doing great since 1976”

            That is not accurate. Apple was mediocre until the late 1990s. It is now worth more than all the unicorns in San Francisco combined. They all could fail and the impact would be smaller than the rise of Apple. Of course they all won’t fail. (Some will, but that’s how this works.) Moreover, Apple is not the only big company fueling the market. Google is almost as large. Facebook is huge, etc. etc.

            If Apple or Google went bankrupt, then we’d have a problem.

            The article you cited said that stocks fell $1.7T.

          7. Google recently closed a deal on land at TRIC (Reno/Sparks) with distribution, manufacturing and R&D expected to be the initial uses. Google car if it happens rumored to be done there. Several other SV companies are expected to join Google there.

            A shift of some jobs out of the Bay Area. R&D use at TRIC would be one such.

            Tesla’s giga factory is also at TRIC. There has been talk of, rather than ship the batteries to Fremont, why not build the cars in Reno near the giga factory.

            Again, a potential shift of some jobs out of the Bay Area.

          8. That’s the other thing people forget. Many of the qualities that made these companies locate to SF, to attract the best talent, are being destroyed by the techies. The diversity, liberal views, creativity, and bohemian lifestyle. The parasite is killing the host. We’re left with Victorian facades and pretty views. And then you have the issue of your lower skilled staff not being able to find an affordable place to live and struggling to get by, how much can you pay a receptionist or CS rep?

          9. Turns out apple estimated their 2016 local headcount for the EIR for their new campus and listed 24k employees. How many of these 24k people are currently under-housed and what can/would they do to prevent a housing decline in a region of 6.6 million?

          10. I had thought the Bay Area’s population was around 7.5 million. The 6.6 million figure surprises me.

          11. @Sabbie Lower paid/middle level staff and how to house them is and has been an issue. Back to TRIC in Reno/Sparks – Switch is building an optical fiber network from the TRIC area to LV, LA and the Bay Area which will allow fluid communications between these centers. Meaning some of the workforce of companies in higher priced areas like the BA can be shifted to Reno/Sparks and LV and done so in a way that does not compromise business functionality.

          12. For regional population, the total used is normally for the 9 County Bay Area (these are the member of MTC and ABAG). Not exactly coterminous with the US census metropolitan areas. The 9 County Bay Area has a current estimated population of 7.7 million (up from 7.1 in 2010).

  4. Fully agree with JR. These reports do not adhere to some scientific methodology, but rather to the need to drive sales or support a specific narrative. Real Estate markets are regionally specific due to tax laws (mortgage interest deduction in US) & local economic drivers(e.g. Tech sector in SF). Yet the method is based on what is most readily available to an analyst in a remote location (historic income and prices). Based on this backwards looking approach, Detroit must have been an undervalued real estate market for a very long time before the sustained decline of the auto industry was fully ‘priced in’.

    1. Precisely! The question is “are tech salaries in a bobble in the SF Bay area?” How high can they get before growing companies will set up shop in San Diego, Boston, Dallas or New Delhi?

      1. That’s exactly why booms and busts can be so dramatic.

        Normally some people get raises, some get fired, some people get married, some divorced. Some companies do well and some flounder. There’s some background level of good and bad fortune which is mostly random.

        But when you get general exuberance you get a great deal of correlated overvaluation. We don’t get one Uber for laundry startup, we get ten Uber’s for laundry. And Uber for cookies, and lunches and flowers and fake mayo and fake blood testing startups. And when growth is more important than profits, salaries don’t matter much to growing companies. And then established companies have to match pay scales to keep talent. And right when incomes are bubbling up, price to income ratio bubbles up as well.

        Everything is double speed ahead, until it isn’t.

  5. @Can’t-Think-of-Cool-Name As to Chicago being a contrarian move, keep in mind this is an analysis of 18 specific world cities – not of major US metros. There are many better home value appreciation plays than Chicago w/o the downsides that area has. Forbes, CNBC, MSN and others recently ranked Pittsburgh, which is undergoing a renaissance, as the best housing play in the US right now.

    It’s not a big city, but one of the folks involved with establishing the Case Schiller index thinks a place east of us may be the best upcoming US housing market.

    Take this chart for what it is – and is not.

  6. “Conviction” about unpredictable future events is just being stupid. I’ll take recognition of a lack of that kind of “conviction” to be a compliment.

    I think most get it, but I will lay it out in plain English. I don’t see any strong evidence that a major SF housing price decline is coming — no rising unemployment, no population exodus, no flood of NINJA loans that are now coming due. Indeed, all the evidence goes the other way. But I also recognize that prices have gotten very high here, and I also don’t see extremely strong evidence those prices could be sustained in the event of a number of possible scenarios. Thus, I wouldn’t be surprised to see prices 20% higher two years from now (but I would not bank on it), nor would I be surprised to see prices 20% lower two years from now (but I wouldn’t bet on it). A prudent buyer would consider whether he or she would be in dire straits should that unlikely but possible downturn hit.

    That’s about the extent of the “conviction” I can provide. “Conviction” from an anonymous internet blog commenter is worthless anyway.

    1. Nothing about the future is guaranteed. But we’ve seen lending go from 20+% down to 10%, to 3% and now zero down.

      Price to income ratio’s are approaching the previous bubble levels. Inventory is increasing and increasing numbers of sellers have been reducing prices. There’s been some weakness in both residential and commercial rents. A few tech startups and one unicorn have folded due to the inability of finding investors willing to put up with continuing losses. There’s a widespread refocus on profitability for tech startups. Which would be great if that were easily accomplished, but many “startups” are long in the tooth and have yet to find a sustainable business model. So if profitability is even possible it will likely fall on the back of employee compensation.

      In addition to UBS’s and the Economist’s take, here’s an opinion piece from the John Burns RE consulting firm that has the Bay Area on the cusp of the RE cycle: “Already we are beginning to see signs that look eerily familiar to prior boom/bust cycles. Builders in more affordable spillover markets such as Sacramento note a surge in transplants. Bay Area buyers are cashing out or are simply priced out of buying close to where they work.”

  7. For those trying to compare the era’s of tech between now and the boom/bust time, there are some very big differences that you have to take into account when looking at how employees are compensated. The big players back then were companies like Cisco, HP, Intel, and Sun. These companies sold a physical product (lap tops, desk tops, servers) that cost money to make. They had lower margins because actual materials went into their product development cycle, they had to be manufactured.

    The companies today of similar stature; FB, Google, and Salesforce (and up and comers Uber, Airbnb, Dropbox) are globally dispersed and they ship no products. these products appear on your phone or in your browser. They are made solely by developers writing code. When you can reach 1+ billion users with just software code, you are a fundamentally different company than one that built a server or desktop computer with parts, and then ships it to a customer who then pays. One is a massively profitable business model where employees can share much more of the rewards than were ever possible in the old model.

    I know one of the arguments is that a company like Salesforce isn’t profitable. The reason it isn’t is because they pay their employees incredibly well (both cash and stock comp), and spend a ridiculous amount of money on marketing to fuel growth. Salesforce could fire it’s entire sales team and never hold another Dreamforce, and it would become incredibly profitable because all the customers would continue to pay for the service, it just wouldn’t grow and therefore the stock would stop going up. The business model is sustainable. That could not be said for the Webvans of the previous era that were not proven business models at all.

    So comparing these two era’s of company and predicting this time will be like last misses some key points. The titans of today are much better equipped to pay their employees well than the companies of the 90’s.

    I’m not saying things will never change, but we are a long long way from SF and Silicon Valley not being the technology center of the world. These titans now have so much money, that they can buy any startup that threatens them in any way, so it’s almost impossible to unseat them. And every purchase of a startup = a bunch of employees who exit with more money and can buy fancier houses. Many of those startup are right here in SF and the Bay Area.

    1. Most of the dot com companies that went bust were pure software companies that had no physical product. The Apple’s Cisco’s and HP’s which survived do have physical product.

      You say all these companies have massively profitable business models, yet have failed to show any profits? Yet look at Apple’s profits from shipping physical products under the ‘old model’. Software’s been around for a while the lack of a physical product to ship is hardly a bombshell in the world of tech.

    2. And look at the economics of the “App economy” for what happened to people lured by the prospect of not only having no physical product but no need for marketing or digital distribution since the app stores would take care of all that for you for a mere 30% cut.

    3. “Bunk” is well named. Google is very much in the hardware business. They design and build not only computers but entire networks of buildings of computers. And they operate them. You should see the electric bill.

      Their custom built data centers filled with custom built hardware that run custom built software deliver ‘virtual’ as opposed to physical products. Factories of UX distributed by light. And almost all paid for by advertising.

      There’s another famous California locale and industry with a history of custom built factories that distributes their wares by lightwavies and makes much of their money from consumer adverts: Hollywood.

      Crazy as it seems, google and facebook aren’t much different from the biggest new media company of the dotcom: AOL, or many of the past titans of media to the masses who sell their audience to product companies.

      FWIW, quite a bundle of those ‘titans’ titanic money stash are stuck outside the USA, and the EU wants their cut. The “so much money…almost impossible to…” argument has been claimed and then failed so many times it is on par with the ‘this time it is different’ argument.

      Anyone that believes “Salesforce could fire it’s entire sales team…. and it would become incredibly profitable because all the customers would continue to pay for the service” has never run a renewal business and have to manage churn, or competition. Bunk for sure.

      As I have pointed out before on SS, the world does not have such a thing as “the technology center”, though SV is the largest concentration of some technologies.

      A consumption recession could drive down iphoney sales and advertising revenues, but this time(warner) is different.

  8. I said this before, even years ago, somewhere in comments on SS: The difference between this tech boom and the last one, in so many words, is 2 billion. Smartphones, that is. On track to reach 2.15 billion by the end of the year. These phones (and tablets) are not a fad.

    1. While the tech economy is much “healthier” and we have Apple, Google, Facebook, Uber, et al to thank .. these companies are also making lots of money off of the frothy ones that will disappear in a bust. What matters is how stable their audience is.

      If anyone remembers how the 2001 dot-com bust went down, it hit the supply chain like dominos. .. first it was the pets.coms and the etoys and the webvans, the companies with basically no sustainable business plan that ran out of cash when money got tight. Then it was the companies that sold servers and supplies and services to them: the Suns, the Ciscos, the AT&Ts. Then it was the manufacturing and materials companies who supplied raw inputs to those, the Cornings and the Applied Materials. (These companies didn’t all go away .. but their stock prices took 90-99% hits) And when everyone lost their money and incomes dropped, the housing market was threatened too. It’s an inter-related, global economy—when something really big gets hit, there’s a ripple effect, nothing is “solid”.

      The thing that’s different this time is many of the companies with the biggest bottom lines are global, have diverse clients (large enterprise as well as small startup) and are better equipped to handle such an event even if their profits take a hit. So while I’d anticipate a big downturn, I don’t anticipate anything as dramatic as 2001.

      Incidentally, you know what dotcom weathered the 2001 bust mostly unscathed? Ebay, because at the end of the day the average American would still buy and sell old junk. Makes me think companies like Airbnb would handle a downturn better than most (even if some of their commission will dry up).

    2. From 1999 to 2002 the number of PCs went from 400m to 700m. In that same time the number of internet domains went from 72m to 172m. Yet somehow that sustained rapid growth in the underlying didn’t stop the dot com bust. Perhaps your understanding of the term bubble is lacking.

      1. One thing that was going on pre-2000 was a lot of tech investment by businesses upgrading systems and software for the upcoming Y2K (the apocalypse didn’t materilize the way it was expected). After 2000 a lot of that investment dried up. I was employed in a non-tech position and my income doubled in 1999 due to overtime. I got put in charge of doing the quality assurance on the data mapping as they converted our software systems to a new ones they purchased/liscensed to replace the old ones that had been developed in house back in the 70’s.

        I do think part of the bubble was due to people seeing the growth of investment in computers/software pre-2000 and thinking it was a long-term trend (there is a long term trend there but the growth rate in the late=90’s for tech was distorted even higher by short term needs)

      2. Sabbie – please keep it up with this comically naive false equivalences. You are doing a much better job of discrediting your own judgement about business and technology (and therefore Bay Area housing) than I.

          1. If you check the chart from the economist link in the message below – set the 2002 index to 100 and you will see that it was 160 by mid 2005 – if that is a true representation of prices, then I would say that the 2002 prediction was wrong. Even at the lowest point of the recession the index did not go below the start of 2002.

    3. tdlr summary — Moor’s Law still rules as foretold in the Merchant of VC: “All that glisters is not gold; Often have you heard that told: Many a man his life has sold … Fare you well: your suit is cold.’ Cold, indeed, and labour lost: Then, farewell, heat and welcome, frost!”

      SV booms when significant tech progress can be converted into tangible benefits. Usually these are due to Moore’s Law opening new applications of semiconductors, such as the PC revolution of the 1980s, the Internet/WWW of the 1990s, and smart phones of the past nine years. (None of those were fads, this ain’t the fashion biddness.) SV crashes when these booms are overplayed/oversold beyond their benefit, including when the core markets are saturated and sales/profit momentum stall. The crashes are usually corrections of the overplayed top, not returns to the pre-boom level.

      The dotcom boom/bust was exaggerated by easy/dumb money buying IPOs before the companies achieved breakeven, which was rare in previous times. Now that action has been extended to the massive and looongterm private funding of some big boys that lose money on their toys but make it up in PR volume. How many years and financing rounds does it take before a unicorn sustains profitability? All of them.

      Over the past couple years tech financing has gotten tougher for IPO and pre-IPO rounds. Investors are being smarter, which has taken some of the air out of the 2012-4 IPO gusts that were reaching 1997ish levels and threatening to go full 1999 blowout.

      The local SV/SF tech employment level is driven by jobs that depend on the financial performance of the big public companies and jobs that depend on the financial promise of the big non-public companies. There’s less coupling between the two now than back in the dotcom, when Sun, Oracle, Cisco, etc got a big share of revenue from VC backed companies. But both will suffer in a consumer recession or a period of actual deflation, not that either of those could ever happen given the econovaccines emerging from genetic programming.

      1. While we are quoting poetic: “The seeds of bad times are in the mistakes which we make in the good times. Yet in the good times no one wants to hear of the mistakes we may be making. The policy then is to ‘get while the getting is good’.” – Henry Ford

        1. Great quote summing up bubble psychology in simple terms — it echoes the late heterodox economist Hyman Minsky’s central thesis, the financial instability hypothesis.

          To which I’d add Upton Sinclair’s, “It is difficult to get a man to understand something, when his salary depends upon his not understanding it.”

  9. Guys, stop arguing with Sabbie. He/she has been crying ‘Bubble’ for a very long time. Neither continuous growth in SF employment nor relatively stable SF real estate prices have been able to change that view. This is why elaborate explanations of the tech market or gentrification dynamics won’t do the trick either.

    1. Even a broken clock is right once a day… but people who say “it’s different this time” have never, ever been right.

      1. Really? You think that people who say it’s different this time have never, ever been right?

        What about the times that it has been different this time? Why is Palo Alto no longer a little college town and San Jose’s largest industry is no longer fruit packing? Change happens, and it’s happening here.

  10. Most of this discussion has slipped into the all so familiar themes of “it is “different this time” or “has San Francisco undergone a permanent economic paradigm shift based on technology” or “the during the dot com era most startups didn’t make money but now many do”.

    Frankly this is all background noise. The bottom line is that housing prices over the long run have a direct correlation to income (really people, talk all you want about tech or any other industry, but the bottom line is income determines how much home you consume).

    Right now the correlation between income and home prices in the City is out of balance (even with significant recent income growth) and the disequilibrium will correct with a regression to the mean at some point. Then home prices will continue to climb as incomes continue to climb in the future.

    1. True, but what is the relevant “income” to reference? Is it median household income, which would include the 2/3 of SF households who rent? Arguably, that makes little sense as those households are not (by definition) homebuyers, so their incomes are irrelevant to the price/income levels. Is it the incomes of those who are buying homes? That makes more sense to me. That metric would explain the 2007 bubble as people with low or no incomes were buying homes as banks lent to anyone with a pen to sign the papers, and thus price/income levels got way out of whack, a bubble formed and popped. I suspect (but have never seen any real numbers) that the incomes of recent SF buyers are quite high and not out of line with historical norms for homebuyer incomes/home prices. And I also suspect (but cannot say with certainty) that we have seen a greater divergence in SF between the incomes of renters and homebuyers than we’ve seen in most other places and times.

      I’m not saying this is the correct way to look at things, but I don’t think I’ve seen it discussed at this level of granularity. The distinction might not matter in most places because a far higher percentage of residents own the home they live in, so homebuyer incomes are about the same as all incomes generally. But it may be a big factor in a place like SF with a disproportionate percentage of renters and greater income inequality. Same goes for Manhattan, London, and other places.

      Even looking at things this way, if incomes of those in the market to buy a home fall (tech crash or something), home prices could swiftly follow. But it would also mean that home prices rising faster and higher than median incomes of renters+owners doesn’t necessarily mean “bubble.” Just a thought – I’ve never seen enough info to really test this. But framing the issues correctly and identifying the relevant factors are critical in any economic analysis.

      1. Ideally what you’d want is an ‘average of ratios’ rather than a ‘ratio of averages’. i.e. each data point would be the ratio of a home price over the buyers income and you’d average those data points vs taking aggregate measures of price and income and looking at the ratio of aggregates. And if you can find that it would be great to look at.

        But while it’s theoretically possible that there’s some statistical fluke going on with the ‘ratio of averages’, SF has been mostly renters for a while and the price/income ratio rose and fell along with the rest of the country during the 2007 bubble. And it’s pretty easy to find anecdotal evidence of people taking advantage of low interest rates to lever up. And notice that the zero down loan product I linked to above was SF focused (and before that SoFI was splashing up billboards promoting their 10% down product).

        The 2007 bubble showed that many buyers are payment driven, looking at the monthly payment more than the loan amount. I find it hard to believe that human nature would have changed so much in 10 years that people aren’t feeling the call of low payments and low/no down payments.

        1. And let’s just totally ignore the 37% of purchases that are all cash (plus many more with large down payments) that may or may not have anything to do with the current income of local buyers.

          1. Lower rates lower payments for buyers using financing. But the effect is similar on cash buyers. Lower rates reduce the risk free opportunity cost for cash buyers.

            If you could get 5% risk free in a savings account, getting 5% from risky RE would not seem attractive. If you get 0% from a risk free savings account, you are much more likely to take a risk on an expected 5% investment.

  11. Interesting chart – so the ratio is not as bad as in 2006, but getting close. Also, if you compare to LA and Portland, the ratios and trajectory are almost identical.

    Second, compare Houston’s chart to that posted in an earlier comment that showed Houston to be on the verge of decline, this shows a rather uneventful history.

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