Is A Bubble Forming In The Bay Area? Not Exactly, CRE Experts Say

It is no secret Bay Area housing prices are expensive. Recent data revealed three counties now have average housing prices above $1M. Housing dynamics remain strong, but a lack of affordability could be a problem in the long run. And rents and pricing do not appear to be heading downward any time soon.

The natural vacancy rate in California for multifamily is about 5%, according to USC Lusk Center for Real Estate Director Richard Green. If rates go above that, rents start to fall. Just about every major city in California has a vacancy rate under 3%. Even though Bay Area rents have declined slightly this year, rents will likely rise and continue to rise because of the low vacancy levels, according to Green, who kicked off USC’s Executive Forum in San Francisco on June 22.

Even with all the construction in places like Downtown Los Angeles and San Francisco, California rents will rise because this construction is conspicuous and in a small area, Green said. But in places like San Mateo County there are mayors who are considering curtailing development and not pushing for job growth because they believe it would decrease housing demand.

The upper Midwest and California are the two places in the U.S. where there has been little construction relative to the size of the region. In the Midwest it has been from an absence of demand, but in California the financial and regulatory environment has stalled much-needed housing, Green said.

Green said compared to the period from 2004 to 2006 when housing prices rose rapidly, the current market dynamics are different. During the years leading up to the Great Recession, rents did not rise. Now rents are rising and housing prices are rising in tandem.

While Green said he does not think there is a housing bubble, he is concerned about tech companies that do not technically make any money, like Uber. The Bay Area is filled with tech companies that are doing good things, but the industry does not know what they are actually worth.

"The question about a bubble is not about the real estate itself, but about the users of real estate,” Green said. "How solid are they? How long are they going to be around?"

FivePoint CEO Emile Haddad said he is not too concerned about the concentration of tech companies in the Bay Area. When you look at companies that are truly tech instead of companies that are using tech as disrupter, such as Uber and Airbnb, the market is very dynamic.

The Bay Area is more diversified than New York City, which has a heavy concentration of media and financing, according to Haddad, who also serves as USC Lusk Center for Real Estate chairman. In the Bay Area, there are finance, energy, health and tech industries, among others.

With So Many Challenges, Why Develop Here?

The Bay Area is easily the tech capital of the world and great jobs and an educated workforce will keep developers coming, he said.

"Everybody in the tech business has to have a significant presence in the Bay Area whether it’s Samsung or Mercedes-Benz or Nissan or Amazon or Microsoft," Jay Paul Co. Chief Investment Officer Matt Lituchy said. "Everybody is here. It has proven to be a great place to be here long term if you can navigate how difficult it is to entitle."

About 80% of the venture capital that comes into California goes toward the Bay Area, according to Haddad. The Bay Area lifestyle also is attractive.

“If you look at the full package, next to New York, no other city rivals San Francisco,” Haddad said. “The question is why wouldn’t you want to be here?”

Even for developers who like San Francisco, it is very difficult to be here. Entitlements can take years, regulatory burdens slow down the process and there may be a lot of upfront costs. 

"If you can be a little more creative and are able to deal with the public, there are rewards," Related California CEO William Witte said. 

Shorenstein Properties Vice Chairman Glenn Shannon said the Bay Area is really attractive because landlords are able to attract tenants and income streams. Once developers navigate all the difficulties to build, they can still succeed in the Bay Area. Comparatively, you could do everything right in other markets and not succeed, he said.

But What About Non-Tech Workers?

While the Bay Area continues to attract highly skilled and talented tech workers, affordability is putting a significant financial crunch on many of the workers and companies that support tech jobs.

Witte, who also serves as USC Luck Center vice chairman, said about 12% of jobs in San Francisco are in food service. If these workers cannot afford to live here, it could have an impact on tech employment.

"I worry about that," Witte said. "It is hard to predict what happens when people who aren’t in the upper tier can’t afford to live here."

What is more concerning is a lot of jobs that keep the Bay Area running that require technical skills are being left vacant or agencies are holding onto senior management for much longer than before, according to Shannon.

“How do we fill the jobs in the Bay Area that don’t require a four-year degree?” Shannon said.

Jobs at places like San Francisco Airport and PG&E are not as attractive as those at Facebook and Google. The Bay Area also is struggling to keep healthcare workers, Shannon said. Nurses and healthcare professionals come to the Bay Area to train, but leave as soon as they finish because of the lack of affordability.

"The Bay Area has done a bad job of creating its share of housing," Lituchy said. "Santa Clara County, San Mateo County and the peninsula just have not built their fair share of housing."

About 170,000 people commute through the Altamont Pass each day, which is about a two-hour commute one way.

"We are building more housing than we have been, but it is still a trickle based on the jobs we are creating," Lituchy said.