Interest Rates, Inflation, San Francisco Housing Market
Many people believe interest rates are as low as they are going to get and once the Federal Reserve really starts having inflation fears they will do what they can to raise rates. Up until recently the Federal Reserve has consistently stated interest rates will remain low for the near future usually giving a time line of about two years. In 2008 we heard rates would stay low through 2010 etc. The message has changed, however and the Fed has stated interest rates will remain low as long as unemployment is above 6.5% and inflation remains mild. The projection, as related by the Federal Reserve is that unemployment will remain above the 6.5% rate until 2015, over a year from now but the difference is that the Fed could begin influencing interest rates upwards any day, by ending QE3 for instance, when either unemployment or inflation changes substantially. Some people believe inflation has already begun rising in earnest but is being under reported and still others consider inflation an excellent way of reducing the value of US debt by making that debt worth less.
Those are national issues; as a San Francisco real estate broker my interest is in the San Francisco housing market. Home prices in San Francisco have shot upwards in the past 12-18 months in no small way spurred on by low housing inventory. Low interest rates are of course a factor, but I think it is possible that if/when interest rates begin to climb buyer competition may only get that much more heated.
What will happen to home prices in San Francisco as interest rates begin to rise?
The typical feeling, in my opinion, is that home prices will fall. This got me to research what happened last time interest rates peaked in the 1980′s.
In February 1972 the prime rate was 4.5% (today it is 3.25%).
10 Years later In February of 1982 the prime rate was 17%
A 370% rise!
What was the effect on the median price of homes in the US during this period of rocketing interest rates?
A 250% rise in the same 10 years!
Of course these home prices are much…much lower than the $1,000,000 people are spending for small unimproved homes in the Noe Valley District of San Francisco today but I think this shows the correlation between mortgage interest rates and home prices is not exactly clear. Also, keep in mind, that in a rather efficient real estate market such as the one in San Francisco a home will sell for what the market will bear at any given moment, meaning that the price paid always seems like a lot to the buyer.
I helped a client sell a home in the Excelsior District a few years ago. He had bought the home in 1974 and still had the original contract showing the amount he had paid: $17,400! My client chuckled when I remarked on the low purchase price, and told me in 1974 $17,400 seemed like an enormous amount of money. The property ended up selling in 2010 for about $500,000.
What does inflation mean for the San Francisco real estate market?
Let’s consider what inflation actually is. Inflation is the increase in the cost of goods and services caused by either a decrease in the supply of a good or service (supply side) or the increase in the number of people interested in buying a good or service (demand side). As an example, an act of god, like a hurricane, wiping out a harvest of pineapples would increase the cost of the remaining pineapples when pineapple buyers are fighting over a smaller number of the tasty fruit. On the other hand a decrease in unemployment causing higher wages and more money in peoples’ pockets would cause more competition for, let’s say, San Francisco houses. Inflation is what happens when competition for goods and services is fierce (to many dollars chasing too few goods), and, as seen in the 70′s and 80′s demand for real estate can continue to increase even in the face of inflation.
One big change since the last recession is the popular awareness of the value of San Francisco real estate. Even though home prices did go down in the city they held up quite well relative to other assets and with interest rates offered by banks on saving accounts at such a low, parking money in the San Francisco housing market has become quite popular as seen by the prevalence of all cash offers.
Add to the mix that San Francisco’s population is increasing.
Census Year Population
The population actually went down in the 1970′s as residents moved out to the suburbs. Now the focus is back on the city. Think of the tech workers with jobs in Silicon Valley who would rather live in San Francisco even though that means commuting sometimes an hour each way to work. Apple,Google, etc shuttling their employees to and from San Francisco everyday is a good example of the popularity of urban living.
As mentioned earlier, in the short run, a rise in interest rates may actually cause demand to intensify, but, as Yogi Berra said, “It’s tough to make predictions, especially about the future.” The point is that just because interest rates are expected to rise doesn’t mean the San Francisco Housing Market is headed towards disaster. Interest rates will rise when the economy is on a better footing with more people employed and more money to spend.
There are many forces at work and underlying it all, people love living in San Francisco!