San Francisco housing bubble 4.0

The housing bubble in San Francisco is the fourth unsustainable price rally in the last 45 years. The only question is when the correction will happen and how deep it will go.

In the ashes of the first technology bubble, the term web 2.0 was coined to describe the new and improved mania gripping Silicon Valley today. Adding the term “2.0” is now synonymous with any resurgent industry in the aftermath of a near total collapse.

Some would like to call the housing bubble inflating in San Francisco today housing bubble 2.0, but that wouldn’t be accurate: We’re on housing bubble 4.0.

Comparison of home prices and value - Irvine California - 1975-2009

Housing bubbles 1.0, 2.0, and 3.0

The first housing bubble in California inflated shortly after the passage of CEQA put unprecedented power in the hands of local Nimbys, giving them the power to slow or even kill the development of new housing units. When house prices began to rise, market forces were not permitted to bring new supply to the market, and price increases got out of control.

Lenders responded to the desire of homeowners and speculators to pay any price, so they greatly relaxed debt-to-income standards. Rather than tell borrowers no, lenders extended credit with debt-to-income ratios in excess of 60%. At the time, lenders and borrowers justified these onerous DTIs by rationalizing that wage inflation would soon turn the onerous payment into a manageable one. In a world of permanent 10%+ wage growth, perhaps this craziness is justified, but absent runaway inflation, DTIs that high are certain future defaults.

Irvine debt-to-income ratios 1975-2009

Paul Volcker recognized this madness as part of the problem. He raised interest rates to staggering heights to eliminate the expectation of inflation in the economy. He’s lionized as a hero for saving us from the stagflation of the 1970s.

By the mid 1980s house prices stabilized, but the chronic shortage of real estate remained. A surge in demand from Baby Boomers entering the workforce caused housing bubble 2.0 in the late 80s, peaking in 1990. House prices slowly drifted lower for seven years until fundamental values were reached.

Housing bubble 3.0, the Great Housing Bubble, inflated in the early 00s and reached heights only dreamed of by bullish speculators in the previous bubbles.


The crash from housing bubble 3.0 was devastating.


The previous three housing bubble each had slightly different causes, but they had several commonalities. First, debt-to-income ratios were allowed to get too high. Second, unstable loan products proliferated. Third, lenders didn’t seem to care if the borrowers had the ability to repay the loans. In response to these common problems, Congress passed the Dodd-Frank financial reform in 2010 effectively preventing a recurrence of the common problems of previous bubbles.

As long as the Dodd-Frank provision limiting DTIs to 43% remains in place, we will not see a repeat of the 70s bubble. If wage inflation strengthens, pressure will mount to raise DTIs, but given the disaster witnessed in the 1970s, cooler heads will likely prevail.

As long as the Dodd-Frank provisions mandating lenders document a borrowers ability to repay the loan remain in place, we will not see a repeat of the last two housing bubbles because these provisions will likely prevent the widespread use of toxic affordability products or imprudent lending standards.double-bubble

Unfortunately, these protections also carry a cost: Future housing markets will be very interest rate sensitive. When borrowing costs rise, lenders don’t have their old book of tricks to fall back on. It’s very likely that mortgage rates will rise very slowly when they do finally begin to rise because otherwise, the housing market will be a disaster.

The economic bubble

Mass layoffs and declining wages cause foreclosures and force house prices to go down. Since this isn’t an issue systemic to housing finance, nothing in Dodd-Frank addresses this problem. When a local economy overheats and then crashes, it can easily take the local housing market with it. When these forces are exacerbated by severe housing shortages, the swings in the market can be enormous. Such is the nature of the San Francisco housing market.

San Francisco real estate looking like it did before dot-com crash in 2000

By Daniel Goldstein, Published: Feb 9, 2016knife-catcher-award

John Burns Real Estate Consulting of Irvine, Calif., and Pacific Union, a San Francisco real-estate brokerage, say that based on the appreciation (and apparent correlation) of venture-capital deals and rent prices, the Bay Area’s rapid property-value and rental-cost appreciation today is looking more like a repeat of the dot-com bust of 2000.“The San Francisco Bay Area is on our watch list for a correction,” said John Burns, his company’s chief executive, in an interview. He said that … the recent increases in home prices and rents have been fueled mainly by speculation.

“Affluent older buyers, often for investment reasons, have identified San Francisco as a place they want to own or live and have driven up prices dramatically,” he said. About a third of all-cash buyers in the Bay Area are purchasing property only as an investment, he said. …

Ordinarily, I would opine on the foolishness of this kind of speculation, but given the current investment environment, I understand why it’s happening.

During the 00s real estate speculation was rampant because people believed they would make a fortune buying houses. This kind of foolish optimism always ends badly, but the current speculation may be less driven by expectations for rapid appreciation and more driven by real estate being the least worst alternative available. Where else can the wealthy park their money right now?loan_owners_underwater

Burns also noted that in the three years that followed — as VC funding collapsed during the 2001 recession and the turmoil that followed the Sept. 11, 2001, terrorist attacks — rents fell with the decline in VC funding, which plunged from an average of $16 million per VC deal in 2001 to just over $7 million by 2004, a decline of over 50%.

During the same time frame, average rents in San Francisco plunged from about $2,300 a month in mid-2001 to about $1,600 by 2004, a decline of about 30%, according to data compiled by Burns’s group ….

Rents in San Jose fell even further, from a similar average of $2,300 a month to $1,400 a month, or a decline of about 39%, Burns’s research showed. …

That’s a remarkable decline in rent, particularly for an area many people believe immune to such declines.thank_housing_bubble

In San Francisco, the average rent soared from about $1,900 a month back in 2010 to more than $3,200 last November, a gain of 68%. In San Jose, the average rent in 2010 was about $1,600 a month. Now it’s $2,800. That’s a 75% rise.

“Rents in San Francisco and San Jose have, respectively, eclipsed prior dot-com bubble peaks,” Burns said. “We think another decline this time around is inevitable.”

While a future decline seems inevitable, housing bulls in the Bay Area will deny any such possibility to the bitter end. Right now, with venture capital money flowing freely, the economy booming, the shortage of housing acute, and mortgage rates near record lows, I expect Bay Area house prices will rise sharply this year.

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