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Lack of New Construction Pushes Bay Area to the Brink of a Bubble

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Has the Bay Area housing market finally peaked?

A dearth of new development in San Francisco compounds the Bay Area's housing problems.
A dearth of new development in San Francisco compounds the Bay Area's housing problems.
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The San Francisco Bay Area’s booming tech industry is transforming lives and changing habits around the world. But it is also deepening one of the nation’s worst income gaps, and setting up the region’s housing market for a potentially nasty correction.

Consider the latest numbers. Silicon Valley home sale prices rose for the third year in a row in 2015, to $830,000, more than double the median price of $411,000 in California. One-bedroom rentals are averaging $3,500/month in San Francisco, the highest rent in the nation.

Looming behind the buzz over whether a bubble is primed to burst is the dysfunction: new construction in the Bay Area is not keeping up with job growth. Neither are salaries, as high as they seem for the tech crowd. Even as the clamor for more affordable housing gets louder, new development remains politically risky, and it's tough to see where, when, or how relief will arrive.

"Bay Area housing prices have been growing at a large margin faster than incomes," said Marc Gilbert, an analyst at Fitch Ratings, who co-authored a report earlier this month showing that home prices are now 10 percent above their prior peak in 2005. "At current levels it puts the area at risk of a greater fall than other areas" of the country, he said.

Median household income in Santa Clara County, home to Intel and Sun Microsystems, is $91,520, which is 72 percent higher than the U.S. level of $52,746 according to the National Association of Realtors.

The average income in the top 20 percent of Bay Area households is $263,000 greater than the bottom 20 percent—a spread that is 50 percent higher than the nationwide gap of $178,000.

While many Americans complain about the growing disparity between the haves and have-nots, in the Bay Area the gap has gotten particularly egregious. A study last year by the Joint Venture Silicon Valley found that the average income in the top 20 percent of Bay Area households is $263,000 greater than the bottom 20 percent—a spread that is 50 percent higher than the nationwide gap of $178,000. (The study was based on 2013 census data.) The Bay Area had the highest percentage of income earners over $250,000 in the nation last year, according to the National Association of Realtors.

While Mark Zuckerberg at Facebook and Tim Cook at Apple are paying many of their employees sizable salaries, others in Silicon Valley may not be so lucky. For them, the solution involves, for sure, more housing.

Across the Bay Area, housing is tightening up at a time when the region's job market is among the healthiest in the country.

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In San Francisco, unemployment is 3.5 percent, compared to the national average of 5.5 percent. Even with looming layoffs at Yahoo and Twitter, "a lot of firms are desperate for tech and marketing people," said Alan Mark, president of The Mark Company, a real estate marketing firm.

Still, "we can talk about how great it is to have so many job opportunities every year but if we don't have enough housing to actually place these people it becomes a problem," said Trisha Motter, president of the Santa Clara Board of Realtors.

Consider that in 2015 the Bay Area added 64,000 new jobs, most of them in the Silicon Valley, but less than 5,000 new homes were constructed, Motter said.

The inventory of Silicon Valley housing has declined by 10 percent since 2014, and the region has experienced a shortage of nearly 25,000 units since 2007, according to the Joint Venture Silicon Valley Institute for Regional Studies.

In San Francisco, there are less than 600 condo units for sale on the market, said Mark. Looking at the construction pipeline for the rest of the decade he doesn't expect more than 1,500 units to be on the market at any given time.

Some 5,500 apartments currently under construction will provide some relief for the San Francisco rental market.

Broadly, Bay Area construction seems stuck in the mud. Last year, there were 2,451 housing starts in Santa Clara and San Mateo counties, down from 2,624 the year before. The high point in housing starts was in 2006, with 6,289, according to figures from Metrostudy, In 2015 the Bay Area added 64,000 new jobs, most of them in the Silicon Valley, but less than 5,000 new homes were constructed. a housing market intelligence firm. In the Oakland-San Francisco-Hayward area there were 5,096 housing starts, more than 3,000 of them single-family homes, up from 4,606 in 2014.

In San Francisco, developers have struggled more than in most cities to win approval for condo projects. "In this economy the biggest hurdle is not economics, it is entitlement risk and political risk," Mark said. "There are a huge number of 'developers' that are not developers, they are entitlers. They are looking to flip the buildings" before they get built.

Flip artists often add another year to the development timeline until new developers take over the projects, Mark said.

Citizens are known to push back, especially when the housing situation has gotten downright scary for middle class residents. Affordable housing discussions are heating up in San Francisco and San Jose, especially after the California Supreme Court sided with San Jose last June by ruling that developers had to set aside a percentage of units in new projects for affordable housing. The court noted the scarcity of such housing had reached "epic proportions."

San Francisco is looking to address the crisis even more aggressively, with Supervisor Jane Kim introducing a charter amendment to more than double the city's affordable housing requirements for market-rate projects to 25 percent.

The Bay Bridge between San Francisco and Oakland.
kropic1 / Shutterstock

There are discussions of "impact fees" in Oakland, home to Uber, which would join a host of other cities with such fees in place to try to alleviate suffocating rents. Governments charge these fees to developers in exchange for permission to develop the land; in the Bay Area, the fees have gone toward affordable housing projects.

It's unsettling how fundamentally different housing regions can be. In Miami, enough out-of-town foreigners have been buying up condos and spec homes to make the question, "Is there job growth to justify all this construction?" an almost meaningless query. It helps explain why the high-rise Brickell neighborhood is again awash in a sea of construction cranes.

But in the Bay Area, the market has shifted more acutely to a local buying phenomenon. While international buyers, in particular from Asia, helped super-fuel the area’s housing surge a in recent years with speculative investment purchases, over the past year that trend has been dying down, brokers and marketers say.

"Most of the over-bidding or multiple offers taking place over the last year are from locals in Silicon Valley," Motter said.

Is there a breaking point? A day of reckoning coming soon? History suggests that a housing correction, if it comes, won't be as painful as in other places.

After the 2001 dot-com boom—where the surging tech industry was built on a less solid foundation of questionable startups stoking their stock prices more than building sustainable businesses—prices only dipped by 10 percent and started rising again a year later. The secular rebound in the national housing market lifted the Bay Area up, dulling what could have been more pain, Gilbert said.

The recession was tougher. Prices plummeted 27 percent over three years. But developers managed to move forward on a new clutch of tall towers, including the 16-story Madrone in Mission Bay, which started construction in 2010 and opened in the summer of 2011.

"Everyone was just focused on getting this town going again and half the economists in the U.S. said we are slipping into a second recession," Mark recalled. "We were selling 7 units a month, which is pretty good, and then finally by March of 2012 the market took off and we were selling 30 a month."

By 2013 Madrone had sold all 329 of its units for an average of $1.36 million. Buoyed by a new community of tech startups and companies that went public, like LinkedIn, the Bay Area market found its footing and began its surge. And the rest, for now, is history.