Bay Area Housing Bubble or Crisis?

The two most common questions I get asked as a real estate agent lately are:

• Will prices continue to rise?
• Are we in a bubble?

While no one can definitively answer these two questions, I can attempt to explain some of the underlying market dynamics and let you decide where you think the Bay Area housing market will go from here.

It’s easy to understand why demand for housing in the Bay Area is so strong. Our economy and job market is as prosperous as any in the country, if not the world. High salaries and fast-growing profitable companies are creating wealth and attracting talent, and foreign buyers are snatching up properties as long-term investments. But if population growth, rising incomes, and low interest rates are the basic drivers of strong housing demand, why are there not more homeowners stepping up to sell at record prices? Basic economic principles would suggest that more homeowners cash-in by upsizing or downsizing, moving across or out of town, or pocketing the profits and becoming renters, each of which would increase the amount of homes available for sale. Yet, we see relatively the same or even fewer homes for sale, but prices keep going up. Let’s examine why supply is so constrained:

Taxes – Taxes are impacting housing supply in at least 2 ways. First, property tax bills generally do not increase more than 2% per year, an inflation factor that lags far behind rates of property appreciation in most Bay Area markets. If a longtime homeowner sells his or her property and purchases another home, the new property tax will be computed on the market value of the new home, which may result in a sizable step-up in annual property tax liability, effectively increasing the costs of selling. Second, taxes on capital gains are scaring off some would-be sellers. While up to $500K of profit may be tax-free on a home sale, many Bay Area homeowners may be sitting on gains of $1M or more on their homes meaning they would face capital gain taxes on at least $500K or more of profit on the sale of their homes. If they wait until one or more of the homeowners passes away, the cost basis gets “stepped up” to market value and the heirs could then sell the property without having to pay any or only minimal capital gain taxes.

Post-sale options limited – It may be very lucrative right now for homeowners moving out of the Bay Area to sell, but those merely looking to upsize, downsize, or move across town face a quandary. Entering the market as a buyer or renter is enough to frighten many would-be sellers into staying put. Bidding wars, scant inventory options, and competition from overseas cash loom on the other side after the sale of their home. And despite low interest rates, mortgage financing is still relatively tight and some homeowners that purchased pre-recession may find it challenging to qualify for a new loan today.

Additionally, post-foreclosure inventory has mostly dried up and is at its lowest level in years, and the combination of low inventory, high demand, soaring rents, and low refi rates mean that more than ever would-be sellers are renting out their homes instead of selling. When you add this all up, only the most committed and persistent buyers succeed in purchasing a home as fewer homes are available to change hands.

So what needs to happen in order to reverse the trend? On the supply side, new construction would need to go up faster than demand growth. On the demand side, we would need to see an exodus of jobs and people. A natural disaster, another recession, or a sizable uptick in interest rates could certainly have impacts as well. Any guesses when any of these will happen?

Will the bubble burst? High prices may be the symptom of a bubble, but high prices alone do not indicate a bubble. Unsustainable trends generally accompany a bubble; which of the current market forces are the most unsustainable and which will be the one(s) that pop the bubble?

One thing I can offer with certainty is that the market will come back down again eventually…and then it will go up…and then it will go down…and then it will go up again. I just can’t tell you exactly when each of these will happen.

Good news is that there are great opportunities even in this market. With proper planning, sellers may be able to defer or mitigate their taxes, and studies show that it is still cheaper to buy versus rent in our region, especially while interest rates remain low. And having the right realtor in your corner can make all the difference between a quick sale and a profit-maximizing sale, or getting your offer to the front of the line and accepted in a multiple bid scenario. As such, if you know anyone presently or in the future that is contemplating a real estate transaction or simply wants to discuss the market or a property, I would be honored if you think of me. I would work tirelessly to ensure I exceed the already high expectations that would come from your trusted referral.