4/18/2016

San Fran Housing Costs on the Decline

The city of San Francisco has had an inflated housing market that could come to an end with its prices beginning to decline for the first time in almost four years.   In a year over year report there has been a decrease in housing prices with an estimated 2% drop.  Most notably from the report was that demand of housing in San Francisco was declining.  The March YOY report suggested that there was a decrease of houses sold of 22%.  Using the reports suggested percentages; we can conclude that that there is a price elasticity of demand of eleven. Due to the cost of living in the city, there have been arguments from others that the San Francisco market price was inelastic, which is proven to be invalid.  The actual effect of decrease in demand-increase in supply is making a change in the market’s equilibrium.  The housing market in San Francisco will continue to decrease until the demand becomes balanced with the supply. 

While it is simple to see that the decrease in demand of houses has also decreased the sale prices of them, there is another variable that could come to be a factor over the next couple years.  As the start of the San Francisco housing prices decreasing, the state of California has approved an increase to minimum wage.  Since the house market price of San Francisco was high with a possible cause of the lack of willingness for consumers to purchase housing; that may all change with the possibility of the ability to purchase.

The price elasticity of demand value suggests that the housing prices will continue to fall until that value becomes one or less.  That would require either an increase in demand, the price continues to fall, or the supply decreases.  However, increasing minimum wage could cause an effect to the market equilibrium and slow down the price decrease.  It will be interesting with the current and future speculation from either consumers or housing suppliers and if that speculation could impact the market.


5 comments:

Dr. Tufte said...

CJ: 82/100 Would you abbreviate San Francisco in conversation with your boss (particularly since you didn't abbreviate it in the body of your post)? I let this slid. Then you say "... actual effect of decrease in demand-increase in supply is making a change ..." where you have multiple singular/plural disagreements (-6). You also wrote "As the start of the San Francisco housing prices decreasing ..." which makes the same mistake (points not taken off a second time). Then there is this sentence: "Since the house market price of San Francisco was high with a possible cause of the lack of willingness for consumers to purchase housing; that may all change with the possibility of the ability to purchase." (it's not clear if the subject is causing the object or vice versa, -6). Frankly, there's a lot more that I could take off for, but they all demonstrate the same issues with kludgy, run-on sentences.

Moving on to the economics, I doubt that a reversal of 4 years of price increases is that big of a deal. The big issue in San Francisco is the decades of pervasive price increases that have happened so far. is much of a trend to reverse.

I applaud CJ for attempting to calculate an elasticity (no, really, I do — most people wouldn't try). But this method follows contrived textbook examples, when the real world is a more complex place. In particular, that estimate of 11 mixes together demand and supply elasticities. There are methods to sort these out, but we don't usually teach them in MBA classes (although I have done it some semesters in my face-to-face sections).

I am not sure what CJ means by "... housing market in San Francisco will continue to decrease ...". How does a market decrease?

CJ also asserts that: "The price elasticity of demand value suggests that the housing prices will continue to fall until that value becomes one or less." That isn't the way that elasticities work; they do not have a "correct" value which they tend to revert to. Instead, we think of goods being elastic or inelastic, and that's it.

would require either an increase in demand, the price continues to fall, or the supply decreases.

Dr. Tufte said...

Oops. That last line there is a stray I should have deleted.

Anthony Graham said...
This comment has been removed by the author.
Anthony Graham said...

CJ, thank you for posting about this interesting subject. I would like to suggest that California raising the minimum wage to $15 per hour will have little effect on the costs of the housing market in San Francisco. Per the articles you referenced, the median sales price for a home in San Francisco is $1,042,500 and the median monthly rent in San Francisco is $4,426. Per research done by the Urban Land Institute's Terwilliger Center for Housing, the most important factor for individuals when considering a future residential community is the cost of housing. As a professional in the field of real estate finance, I would add that the cost of housing on a monthly basis is almost the exclusive thought of those considering renting or buying housing - cash-flow is king!

As one looks at the above numbers, one should also recognize that the current monthly median household income in San Francisco is $7,013. The mortgage industry recommends a monthly income-to-housing debt ratio of approximately 33.33%. By multiplying $7,013 by 33.33%, one will come up with a maximum monthly housing expense of $2,338. Obviously, there is not enough income to cover the median monthly rent of $4,426 per month, without other sacrifices being made. Per a study released last year by the Harvard Joint Center for Housing Studies, the cost of housing has become an increasingly urgent issue for many, as record numbers of people spend too much on housing, forcing them to cut back on health care and other critical expenses.
Ultimately, the the median income needs to rise proportionately with median housing costs, otherwise sacrifices of health and other necessities must be taken. Many are not willing to make those sacrifices when they consider the community they live in.

Let's regress to the minimum wage increase to help with household income, thus helping increase housing affordability for those living, or wanting to live within San Francisco. Currently, the minimum wage in San Francisco is $12.25 per hour. With an increase in 2018 to $15.00 per hour that equates to a $2.75 per hour raise. Making an assumption that a household has two full-time income earners, each working 40 hours per week, this converts to an additional household monthly income of $953. Based upon the possible increase of monthly income to a total of $7,966, the maximum monthly housing payment, based upon standard debt-to-income ratios, would rise to $2,655. Clearly this is still not enough to justify an increase in real estate prices. Frankly, based a new median monthly income of $7,966, median home prices would still need to drop to $656,250 before they would be considered "affordable".

I cannot project home prices of the future. However, based upon my research, I have great doubts that the minimum wage increase within the San Francisco market will play any relevance to home prices. Frankly, my liberal assumption that those households who are already earning the monthly median household income of $7,013 will see an additional $953 per month in 2018, when minimum wages are increased, are probably exaggerated at best.

Thank you again for writing on a subject that interests me. Best of luck to you as you complete your education!

Dr. Tufte said...

Anthony Graham: 50/50

Thanks for the long and complete comment. Let me redirect in two ways.

First, the contention by both CJ and Anthony Graham that the minimum wage is that relevant here is probably misplaced. Most people do not earn the minimum wage (it's only about 4% of the population). Most people who do earn the minimum wage are not the people making shelter payment decisions (the largest group getting the minimum wage has always been teenagers living with their parents). And, it's not clear that the current minimum wage is binding that often in San Francisco, or that the new one will be (the problem with California's minimum wage move is not the changes it will cause in San Francisco but rather the ones a one-size-fits-all policy will cause in, say, Fresno).

Secondly, no doubt many people believe that the minimum wage should be raised because of housing prices. This falls within the water balloon criticism of regulations, and regulatory urges. In this metaphor, the world is a water balloon. If we don't like one side of the water balloon, we squeeze it with a regulation. But this causes an unsightly bulge on the other side, so we squeeze there too. In the case in this thread, there's a ton of evidence that land use restrictions in coastal California are a huge component of housing costs there.* Addressing that with a regulation on labor markets is kind of like working to turn the regulatory system into a Frankenstein's monster of ill-fitting parts.

* Yes, San Francisco will have high housing costs without land use restrictions, because space is limited. In computer science, they like to ask whether something is a feature or a bug. In this case, are high housing costs a feature of San Francisco to be extolled, or a bug to be fixed? Many people take the latter position. For them, I'd ask whether they'd be OK with solving the problem by making San Francisco a less desirable place to live? I think in most cases the answer is no. But that makes me dubious that this is about housing prices per se, rather than price that person would like to be able to pay for a property they find desirable.