Rents are rising in the San Francisco Bay Area

Various media outlets report recently that rents in the San Francisco Bay Area are increasing. As a landlord, I have noticed this and certainly participated in this trend. But how much are rents really up. 10-15% from 2007 to 2008? Yes, that much. But how do rents look in a historical perspective?

People who are new to the Bay Area may not know what was going on in 2000, and 2001, when the dot-com bubble burst. At the peak, let's say in 2000, rents were very high. I remember the rates in 2000, when a friend moved to Foster City. I think she paid $2500 for a small 2-BR apartment in the 'Lantern Cove' complex, and was very happy to get it. Location, location, location - "Walk in 5 minutes to the Oracle towers". The photo shows Lantern Cove's rec room.

It's a clean apartment complex and back then it was one of the few who allowed her big dog. I believe the regular rent was $2300 and $200 extra for her Dalmatian.

What does this place rent for today?

I found this source which shows that her 2-BR/ 2-BA would rent for about $2000 today.

• $2300 in 2000
• $1400 in 2002 <--- estimate
• $2000 in 2008
  

Yes, rents have risen, but they are not where they were in 2000. Today's rent looks even better if you factor in inflation since then. Inflation over these 8 years should be at least 30%, so $2300 in 2000 are $3000 in today's money. Rents are still low!

This also gives you an idea..

1. how good it was to BUY in 2000, (mortgage vs rent),
2. how renting in 2004 was MUCH MUCH cheaper than a mortgage (on a 2004 purchase),
3. how now it is reverting again.

Will it revert to the 2000 scenario? Renters certainly hope not!

State of the market in Capitola, CA

Capitola - pictured on the left hand side - is a small beach community in California, about an hour south from San Francisco and 30-40 minutes from well paying jobs in Silicon Valley.

The city has a large percentage of single people and also of retired people.

How does the real estate market hold up in Capitola during the 2006-??? downturn?

As a built-out area, Capitola does not have new construction and thus no 2 properties are the same. Appraisers often cannot find a "true" comparable property.

But there are a few exceptions. K&B (KB Homes) built a small tract of about 50 houses near Clare Street. I lived an 1/8 of a mile away from this development and know it very well.

The property at 2183 Francesco Circle, Capitola CA, 95010 came on the market in June 2007 and went pending in only 5 days. Asking price was $870k, it sold for $850k.
Personally, I thought the buyer overpaid by $100k. The property was in like-new condition because supposedly it had rarely been used (vacation home).

Only 8 months later a neighbor (2171 Francesco Circle) closed for $712k. This property has actually a lot nearly twice as big (5000 sqft versus 2600 sqft), yet sold for $138k less. That's a 16% drop.

Further, property #1, being on a tiny lot, almost has an apartment feel, while property #2 has the character of a free standing house. This should more than make up for a necessary paint job.

I don't think prices fell 16% on average. The first buyer overpaid by $100k. Fair market value in July 2007 was between $750k and, with some good will, $800k.

That would mean a drop of 10%.

Is worst over soon in San Diego?

I read this article and it states a positive view about the real estate market in San Diego:

"In cities like San Diego, one of five major metros where transactions rose, that's good news, assuming it's sustained. What makes transaction volume a good indicator is that it shows how easy it is for people to get loans and how much confidence there is in the market. If mortgages are available and buyers have some faith in the value of the home, they're more likely to buy.

San Diego's present conditions suggest that over the next half-year, prices may start to rise. That's because "there's usually a three- to six-month lag between when transactions go up and prices go up," says Jonathan Miller, president of Miller Samuel, a Manhattan real estate appraisal firm."

Source: http://promo.realestate.yahoo.com/americas-riskiest-real-estate-markets.html

Unfortunately Mr Miller, the person quoted, owns an appraisal firm and has a vested interest in the market to turn around. And worse, the sales volume increase he talks about is the month-to-month trend. Not year over year. I believe it will be a longer than 6 months until prices start to rise, but we shall watch.

Since this article is a positive one on real estate, I will add it to the collection of links.

Overbuilding

Doomers like to point to areas where large housing projects have been undertaken by greedy builders. Las Vegas, Phoenix, Florida and parts of central California come to mind.
But this is certainly not the case in most US markets.

Speculators drove up prices

This is true, and some of those who bought multiple 'investment' homes in the hope of quick appreciation are in trouble now. The lucky ones sold in time, 2005, 2006, maybe 2007 (for less than top Dollar). The others will either foreclose or sink money into those 'money makers'.
These speculators were not really 'real estate investors'. An investor would look at rental income and quickly see that buying a $500k house in Las Vegas, that rents for $2500 a month is a bad idea. The speculators are gone, and some of them are now renters. They are paying now rent to the 'real' investors.

Shortage of first-time buyers

Doomers argument that the tighter lending standards and high prices with flat salaries are unfair to young families, especially those with children, and that there will be a shortage of first-time buyers.

That is true.

However, this does not mean that there are no buyers. I expect that more properties will be bought by investors, at prices where the purchase makes sense to use them as rental properties.
The United States has a very high percentage of homeownership. I think I read a number of 60% early in 2008.
By comparison, in Germany, only 11% of the population own the place they rent. That does not mean that Germans are poor or live in slums. It has to do with a lot of things, among others the higher population density - much more people live in the cities, than in the US.

I expect that this 60% number will see a dramatic correction. There is and will continue to be a shortage of first-time buyers, but investors who did not buy on speculation will jump in and seize on the opportunities.

Interest rates increasing

Interest rates are increasing. Housing doomers say that this is good because it will bring prices down, and there is truth in it. Higher interest rates are good for people who can/ want to make large down payments. Higher interest rates reduce the purchasing power, even more so, if the prospective buyer has only a small amount available for down payment.
Doomers say that you can always refinance into a cheaper loan, but you cannot re-negotiate if you paid too much. The second part is true, the first part may be true or not, because it might take very very long until mortgage rates come down again. Right now they are still low by historic standards. Quite a few experts think that double digit mortgage interest rates will come back. It might take 10 years until you can finance a your primary residence for under 6% again.
If you wait now to time the exact bottom (which is nearly impossible, at best one can wait until the recovery has started), then you may end up with a high interest rate that cannot be refinanced into a lower rate for many, many years.
Ideally the prospective buyer will use this waiting time to build up a bigger down payment, a concept known as 'saving', but from my experience, this is not a popular strategy.

Foreclosures ruin property values

Yes, there are foreclosures, and many of them. Slowly but surely they are used as comparable sales, depending on how many of them are in a particular market, and they will drive down prices further. Does that mean buying is a bad decision? No. You *may* lose equity in the short term, but if you find a property that you like, that fits your financial situation, and is comparable in cost to renting, then the short term equity loss should not be of concern to you.

Salaries vs house prices and inflation

During the housing bubble (approximately 2001-2006) in some 'bubble areas' house prices rose much faster than salaries. Adjusted for inflation, salaries have actually gone down. Since then house prices have fallen, in those bubble areas up to 20%, in some isolated cases as much as 50%.
The US government reports inflation using a formula that excludes the cost of food and energy. The real inflation figure is several percent higher than reported by the government. This means that the house prices are not as inflated as you may think.
Example: if a house cost $100k in 1999, went up to $300k in 2006, and dropped then to $200k in 2008, then that is 100% increase over 9 years or 8% annually (on average). The government's CPI index would say that $100k in 1999 are $130k in 2008 (http://www.westegg.com/inflation/), because they tell you inflation is 4%. If you include food and energy, inflation is higher. Maybe 8%? Suddenly an annual gain of 8% of that house does not look reasonable!
In fact, if bought at a reasonable price, real estate is an excellent hedge against inflation: Over the past 50 years, on average real estate appreciated one percent above inflation.

Rent vs Own

As people are afraid to buy a home, more competition on the rental market arises. The foreclosed homes are not automatically available as rentals, as some doomers try to make you believe. Las Vegas is a leading foreclosure center, yet has currently a very healthy rental market; the best since 2003.

This means rents are going up, and house prices have already fallen, more or less - depending on the area.

Check the numbers. Buying in your area may already be cheaper than renting.

Your feedback is welcome.

Answers to the housing doomers

Please visit US Housing Recovery where I explain why housing is going to come back, and why real estate is still a good investment.

Also feel free to leave comments here, or you can email me at ptiemann_2000 AT yahoo.com

I plant to collect links to other articles that are rational and positive on real estate. So if you find such articles online, please leave a comment here.

Thank you,
Peter