As we enter a new year, we're taking a look at the impact of the Covid-19 pandemic on Bay Area real estate...
From changing preferences and prices to migration patterns and interest rates, plus a 2021 forecast.
In March 2020, right around the time that Covid-19 hit, San Francisco homes were selling at all-time high prices of $1,100/sqft. By May 2020, all six Bay Area counties had price per square foot declines from March 2020 levels. May 2020 marked the bottom for the three lower-priced Bay Area counties (Alameda, Contra Costa, and Marin). The other three higher-priced counties (San Francisco, San Mateo, and Santa Clara) had further issues, but as of November 2020, all counties are showing strong growth from their March 2020 pre-COVID levels - except for San Francisco.
San Francisco is the highest priced county on a price per square foot basis and the most densely populated, which is a combination that has hurt its desirability during the pandemic, given the economic uncertainty and the shutdowns of retail, restaurants, and other entertainment.
However, different parts of the city of San Francisco have had different price reactions. The dense, popular, expensive middle of the city (Mission, Financial, Pac Heights, and Marina) suffered price decline, while more affordable, tranquil places on the fringes of the city like Outer Sunset outperformed.
The pandemic has affected US workplaces like nothing else in modern history - resulting in high unemployment, the shuttering of businesses, and the shift of many workers to off-site, remote work.
But wait - was there really a mass exodus this year? Are people still moving to the Bay Area? Where are the tech workers going?! We're answering these questions and more...
High taxes and housing costs were already accelerating a trend of companies fleeing the Bay Area for more business-friendly climates - like Texas.
The fact that Texas has had less stringent stay-at-home orders than the Bay Area has not been directly cited by these companies as a reason for their moves, but it is consistent with the overall business-friendly regulatory stance that these companies are seeking.
Data on rental searches does not suggest that more people are moving out of the Bay Area than normal, as a result of remote work flexibility or employers moving office locations, rather, the data shows fewer inbound movers than normal.
Discomfort caused by working from home in cramped conditions and safety concerns from living in crowded buildings. The arrival of the vaccine should alleviate those two concerns and lead to increased inbound interest in San Francisco in 2021 vs. 2020.
There have been several announcements that prominent tech stalwarts are moving out of the Bay Area:
It may be hugely symbolic that Hewlett Packard Enterprise is moving its headquarters to Texas, given that Bill Hewlett and David Packard tinkering in a Palo Alto garage is one of the pivotal moments in Silicon Valley history. Another longtime Silicon Valley citizen, Oracle, announced plans to join them, saying it will relocate its headquarters to Austin.
Look at the largest IPOs in December 2020 and expected for 1Q21, and you see Bay Area companies and Bay Area VCs; Airbnb, Doordash, Roblox, Robinhood, and Affirm, Founders Fund, Y Combinator, a16z, Softbank, and Sequoia.
Apartment List data gives us a strong clue about migration trends based on renter data. The share of renters who are currently living in the San Francisco metro and looking to move elsewhere has dropped, down to 30.6% from 37.7% last year.
Meanwhile, 29.6% of searches for moves into San Francisco rentals from July - November 2020 came from outside the metro. Inbound interest is still strong by national standards, but down significantly from 42.1% during a similar time period last year. So, the data suggests this is less an exodus than a slowdown in immigration.
Tech workers are amongst the highest-paid workers in the US, and Bay Area tech workers are the highest paid of any other US metro area.
Let’s look at their favorite places to live in the Bay Area. We’ve highlighted the top 20 zip codes with increasing tech worker residents, both as a % of the local population to highlight smaller zip codes that punch above their weight for attracting tech workers, and as an absolute number which will naturally include more populous zip codes overall.
I, and all these other Santa Clara tech workers, are skeptical that Apple is going to let its beautiful campus go to waste but only time will tell.
The Bay Area is one of the least affordable housing markets in the country.
Lower mortgage rates help make housing more affordable at a given level of income. When the Federal Reserve was attempting to help the economy recover from the last financial crisis, it didn’t just reduce interest rates; it also provided forward guidance to shape expectations for future interest rates. This is important because if someone is going to buy a home using a mortgage with a 3% interest rate, they would want to know that when they go to sell the home, the next buyer will have access to similarly low mortgage rates. If mortgage rates rise substantially while they own the home, this could make it difficult for the next buyer to be able to pay the same price that the original buyer did. An offsetting factor would be if there is general wage inflation; however, this factor tends to be small.
Looking at the data comparing mortgage rates to home prices in the Bay Area, we can call out four separate phases. The first was from 2009 - 2011, when mortgage rates gradually fell from above 5% to below 4%. During this time, home prices were largely flat as the market was working off excess inventory from the previous boom/bust cycle, and mortgage lending standards were tight by historical standards.
The second phase lasted from 2012 - 2017, with mortgage rates hovering around 4% consistently, which was important in establishing confidence among real estate market participants that mortgage lending conditions were unlikely to tighten substantially and materially impact their home values. During this second phase, home prices rose steadily due to the combination of loosening lending standards, increasing employment, and lack of growth in new home construction.
The third phase was from 2018 - 2019, during which two key factors kept local home prices largely flat again; the first was new tax rules that raised the cost of living in high tax coastal states like California and New York, and the second was a spike in long term interest rates as the Fed attempted to exit some of its accommodative policies.
This led to a fourth phase that started in 2019 and continues today. The Fed once again turned accommodative in 2019 in response to weak economic growth, brought on primarily by increased tariffs and trade disputes, and mortgage rates fell, and as mortgage rates dipped below 4% again, home prices began to ascend.
The response to the pandemic in early 2020 involved further interest rate cuts, and this has continued to be supportive of home prices. We do not consider this a “new phase” but rather a continuation of the lower interest rate trend that started in 2019. The question facing the housing market today is, what will happen to mortgage rates in 2021, and how will it impact home prices? The consensus view is that mortgage rates will increase, and home prices will increase as well.
In other words, higher mortgage rates will likely be a headwind for home prices in 2021, but other factors, such as low inventories and recovering employment, will help maintain upward pressure on home prices. We suggest shopping in neighborhoods that have consistently maintained a low inventory to sales ratio over a long time period, and are still within commuting distance of hot job markets, which will provide some insulation from potentially higher mortgage rates in 2021 and a partial reversal of the work from home trend as the vaccine allows for a return to denser living and working.
It is reasonable to expect higher home prices and higher mortgage rates in 2021. We forecast that these trends won’t line up in a helpful way for homebuyers - forcing buyers to choose between buying at peak home prices with all-time low mortgage rates or buying into a small correction in home prices but with higher mortgage rates offsetting the benefit of the discount.
As discussed elsewhere in this guide, Bay Area home prices tend to peak around April - June, then dip into September, and rebound again in October. Until the vaccine is widely distributed and rolling shut-downs cease, interest rates are likely to be suppressed and demand for scarce single-family homes is likely to be strong.
Home prices could follow a similar seasonal path to those of 2017, when prices rose 12.6% by May, fell 4.4% through September, and recovered to finish the year virtually flat to May levels. Assuming a 5.0% rate of appreciation for the year 2021, this would mean almost all of the 5.0% increase could occur by May. From there, home prices could dip 1-2% by September; but if mortgage rates rise by 0.5% - 1.0% by that time, then your monthly payment could increase by 10%+, from ~$3,500/month to ~$4,000/month, as the increase in mortgage rates offsets the benefit from the lower home price.
Also, given the unique circumstances that have contributed to this interest rate regime, this could mark the bottom for mortgage rates, leaving little probability of refinancing into a lower rate in 2022-2023. This means it might make sense to be aggressive in your home search while mortgage rates are still below 3%, even if it feels like home prices are at peak hotness. A 1% increase in mortgage rates for an $800,000 mortgage on a $1,000,000 home results in $8,000 per year of extra cash interest expense. If you get a 1.6% discount on the home price from seasonal timing, you could save $16,000, which would offset two years of higher interest costs; but if mortgage rates don’t drop 1% at any point during those two years allowing you to refinance and lower your interest cost from that point forward, then the higher interest costs will outweigh the savings on the home price.
Based on our survey of economists, we expect mortgage rates to rise by 0.5% - 1.0% in 2021. Fannie Mae and Freddie Mac are two highly respected forecasters, and they are forecasting a smaller increase, not greater than 0.3% (2.7% - 3.0% rates).
However, we believe that the impact of government stimulus and a post-vaccine economic output recovery is an unprecedented combination in US economic history, and has the potential to lead to an overshoot in interest rates.
Inventory rose 1.4% in 2020 vs. 2019 in the Bay Area. Underlying this was high growth in San Francisco and San Mateo, and lower levels in all other counties. Expect this trend to continue into 2021. However, we believe increased demand for urban living in late 2021 will help to absorb the inventory and drive a rebound in prices in urban areas that were depressed during 2020 like Pacific Heights, Marina, and Noe Valley.
Total home sales in the US are expected to increase by approximately 5% in 2021, according to our survey of economists. We expect a similar trend in the Bay Area in 2021 because, historically, the Bay Area growth has matched the US levels. Overall home sales in the Bay Area rose by 3.4% in 2020, while home sales in two counties, San Francisco and Alameda, fell 7.7% and 5.0% respectively. We believe the impact of the vaccine and less work-from-home in the second half of 2021 will drive a rebound in sales in those two counties and home prices will increase because of supply constraints.
Sales growth should outpace inventory growth leading to continued upward pressure on home prices across the region. Months supply as of November sits at 1.61, down from 2.03 in November 2019. Overall months supply in 2020 averaged 2.13; we forecast a drop to 2.06 in 2021 which is suggestive of a tight market that will benefit sellers and drive increased home prices.
We expect it will take multiple years to recover the jobs lost during the pandemic, with only 20-30% of the jobs returning in 2021 as small businesses take time to rebuild. However, combined with continued government subsidies for lost wages, median household income should rise close to the 2015-2020 average rate, at 5 - 6%. It’s unlikely that wage growth will materially exceed home price appreciation, so combined with higher mortgage rates, affordability (defined as payment/income) is expected to suffer in 2021 relative to 2020, but remain at or below 2015 - 2020 levels. In other words, affordability will continue to be a headwind for home prices in the Bay Area in 2021, but not any worse than the past 5 years of experience.
1. 30-Yr. Fixed-Rate Mortgage Average Rate, Freddie Mac Primary Mortgage Market Survey
2. Census, BEA
4. Calculated as the total monthly payment (principal, interest, tax, insurance) on a median home with a 20% down payment
5. Based on the change in the median price per square foot of sold homes
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