Thoughts on the Bay Area economy…

GDP dropped over 31% in the second quarter of 2020 due to the lockdowns throughout the U.S. The economy made a strong rebound late in 2020 and throughout 2021. The Q4 2021 growth rate was 6.9% and the full-year 2021 rate was 5.5%, but the first quarter of 2022 was a decline of -1.5% followed by another decline of -0.9% in the second quarter. This meets the technical definition of a recession. The third quarter of 2022 saw an advance growth rate of 2.6%. Return to more normalized growth is expected by the Federal Reserve in 2022 and 2023, but there is a high level of uncertainty tied to this expectation and locally, in real estate markets, there are significant signs of a recessionary trend including fewer transactions, lower prices in some markets and layoffs in real estate related businesses. Layoffs have also become common with local companies, as well.

Over time, the West Bay counties have seen the greatest growth in employment with more modest improvements in the other Bay Area counties. Recent announcements about tech company headquarters being relocated out of the Bay Area pose significant concerns for the future, however. The companies relocating headquarters out of the area include Oracle Corporation, Tesla, Hewlett Packard Enterprise, Palantir and Credit Karma. Commonly cited reasons for the departures include the high cost of living and high taxes. More broadly, a sample of major layoffs that have been announced of late: Stripe, financial tech firm in South San Francisco laying off 14% of its workforce; Credit Suisse, bank laying off around 5% of its workforce; CBRE, nationwide brokerage announced a $400 million cost cutting plan including undisclosed layoffs that will save $300 million; Snap, parent of SnapChat social media app closed its 33,000 square foot San Francisco office and announced the layoff of 1,200 of its staff.

Total current (September 2022) Bay Area employment of 4,026,900 is the peak figure for the past 18 months but is below the all-time high of 4,174,300 set in December 2018. The labor force is 4,300 below the recent peak figure of 4,134,300 and the all-time high of 4,284,700 set in November 2018. Job growth over the past three months was 59,800 versus 85,600 for the same period last year.

Overall, inflation dropped during the pandemic in the San Francisco Bay Area market. It is trending upward sharply now in SF, the west and nationally. The local rate of inflation as measured by the CPI All Urban Consumers for the San Francisco Bay Area was 5.69% in August 2022 compared with 8.26% on a nationwide basis. As of August 2022, the 24-month average CPI for the San Francisco Bay Area was 3.66% versus 5.16% nationally, but 4.91% locally over the past 12 months versus 7.42% nationally.

The PCE (personal consumption expenditures) inflation index used by the Fed is prepared by the Bureau of Economic Analysis (BEA) instead of the BLS and it tends to run lower than the more volatile CPI measure. The CPI is a better-known index, and it is also frequently used in real estate transactions, especially leases, as a measure of inflation.

The Fed raised the discount rate in November 2022 and the new Fed Funds Target Range is 3.75% to 4%. The rate for the 12th District (San Francisco) is 4%. It is expected that more rate hikes may take place in the near future. The discount rate remains low by historical standards and the correlation between interest rates and overall rates of capitalization is often fuzzy. There is, however, expectation that capitalization rates may rise over time.

The FOMC also announced plans to begin selling treasury and mortgage-backed securities (CMBS) in June 2022 to reduce its balance sheet. The Fed has trimmed rougly $61 billion out of its once more than $2.74 trillion portfolio of CMBS since the peak holdings set in April 2022 but has slowed sales recently. The effect this will have on markets will play out over time.

Single-family mortgage rates fell in the first half of 2021 but rose in the latter part of the year. Longer rates had been less volatile, but all rates have shown significant variability as shorter-term government yield rates rose, fell, and then rose again recently. A year ago the FHLMC 30-year fixed rate was 2.98%. Over the past 52 weeks, the rate hit a low of 2.98% and a high of 7.08%  with an average of 4.82%. It was 6.95% as of November 3, 2022. Even with relatively low mortgage rates home sales have been limited by a small inventory of property for sale and stringent credit requirements for borrowers. 

In the real estate markets, brokers report more uncertainty. Larger institutional investors and owner-users seem to be more active than smaller investors based on anecdotal information from brokers. Likely in part due to a more difficult commercial lending environment. The residential market is reportedly showing signs of reduced activity at lower price points more susceptible to the influence of mortgage rates.

Housing prices increased during the pandemic in core areas with buyers looking to escape urban areas and a lack of inventory for sale pushed prices much higher. Home prices have stabilized or fallen month-over-month and year-over-year in most Bay Area counties. This has been consistent with the sharp increase in mortgage rates recently.

Residential land markets were active through 2021, but slowing has been evident recently. Land prices have reached very lofty levels and there are concerns that the high rental prices that drove land purchases may not be sustainable in the long run. Anecdotal evidence from interviews with brokers and developers suggests larger multi-family projects do not “pencil” right now because of the conflict of stable to slightly higher rents versus higher costs of construction and economic uncertainty.

In the Bay Area, apartment rental rates were under upward pressure in areas with strong employment growth such as San Francisco, San Mateo County and Santa Clara County but prices moderated in 2019 and fell during the pandemic. According to Kidder Mathews, Bay Area vacancy stood at 5.3% as of the third quarter of 2022 – a significant improvement over the 8% rate in Q4 2020 but an increase over the 5% rate in the prior quarter. Average asking rent is $2,515, an annual increase of 4.57%, but a nominal decline over the prior quarter. New construction is down -2.3% year-over-year.

Some speculative commercial real estate developments will likely continue. The life sciences sector appears to remain in favor along with industrial markets. Large investors are still acquiring sites for larger-scale multi-family development and life-sciences development, as well. The multi-family market remains active, but at lower levels than before the pandemic. The office market and retail sectors saw the greatest impact with vacancy levels still elevated.

Gold and silver prices have moderated. Over the past 30 trading sessions the price of gold has ranged from $1,623 to $1,721 with an average of $1,661 per ounce while silver has ranged from $18.02 to $21.04 and averaged $19.31 per ounce. Oil prices have been volatile for some time. Over the past 30 trading sessions the price of WTI crude has ranged from $77 to $93 with an average of $86 per barrel . Some analysts suggest prices could move higher, but others noting the potential for a recession conclude prices may move lower on reduced worldwide demand.

The economy was strong prior to the impact of the novel coronavirus. The real estate markets faced headwinds in 2020 due to uncertainty over recovery and uncertainty continued in 2021. Difficult issues like Covid variants, political issues surrounding Russia and Ukraine, inflation, interest rate and recession fears, Fed policies and labor market issues continue in 2022. Overall, property prices have been high which further suggests more market risk in the near term especially if the risk of broad market recession grows.

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