Bubble, Bubble, Toil and Trouble... But Not in Our Market

We hear talk of bubbles, especially during increasing markets, but we don't typically know what to look for beyond high prices and a feeding frenzy of buying. 

Bubbles expand, blowing larger and over-inflating the market; we are in more of a constriction as available inventory remains at near-historic lows. That's not to say these prices will continue their current trajectory, but more on that later.

A component of real estate bubbles beyond lack of supply for high demand is speculative buying and building. Sure there are people flipping houses again and yes, that is considered speculative, but at these prices there's not nearly the number of flippers out there that there were a decade ago. People are paying high prices as they look toward living in their new home "forever" (which tends to be around 10-15 years, depending on the growth of the market and their family size). On the side of speculative building, we're not seeing that in the Bay Area. There are few, if any, builders betting on the Field of Dreams, "if I build it, they will come" philosophy. Instead we're seeing building in response to demand for housing from incoming jobs, and thus new residents needing somewhere to live. And even still, the builds are slow going as cities negotiate percentages of affordable housing with developers.

The chief economist at Realtor.com put together a list of six factors he used to create a "bubble index" which he then used to create the graph below comparing how this index measured up in 2005 in cities around the country compared to today. The six factors are: price appreciation, the prevalence of house flipping, the share of buyers financing their purchases versus paying cash, price to income ratios, price to rent ratios, and housing starts to housing formation numbers.

Based on the graph above, there are some cities that are pretty close to bubble territory, if not deeper into it than they were in 2005, however you can see that San Francisco and San Jose have a ways to go. Still, that doesn't mean we will continue to realize the kind of gains we have in recent years (17% since 2012 in Oakland alone). 

The steady average increase of 5% year over year is not likely to continue forever, though it's doubtful we'll experience a crash like we felt in 2007-2009 which resulted in a 30% dip in values. No, instead it's more likely that we'll see a gentle slowing, more of a plateau than a real dip. In fact, San Francisco's condo and loft market began to feel a slowing down earlier this year with more price reductions and longer time on the market. 

Curious what you can keep an eye in our Bay Area market? In addition to the aforementioned speculative building, my eye is on the tech money. Anecdotally I've heard there are big tech companies opting to scrap the ESOPs and other stock based incentives and instead pay their employees the cash value of those options. Talk about a cash infusion in the market! I'm also eying the not-so-elusive unicorns, companies with a valuation of $1B or more. They are not as rare as they once were and according to techworld.com, between 2000-2003 it took 8.5 years for a company to become a unicorn; between 2009-2013 we're down to 2.9 years on average. Unicorns are dying too as investor confidence softens or user numbers dwindle. Tech is big money in the Bay Area. We are lucky to be home to so many giants with solid future growth securing the livelihoods of their employees, but not everyone can be a Google, Apple, Intel, or Facebook.

If you've been thinking about selling, this is a great time to begin planting seeds. No one has a crystal ball and though it doesn't look like a bubble, we could be hitting a plateau in prices. Get the most you can out of your investment now and time your purchase plan well by moving swiftly and smartly. Call me to learn how to reap your largest benefits.

The Price is Right

Regardless if I'm working with sellers or buyers common questions circle around pricing. A continued pattern of homes being underpriced and selling for sometimes 150% of the asking price stirs up feelings in buyers and sellers alike. Still, given the economic model of supply and demand one must consider that the ultimate sales price for these homes is market value. Be that as it may, creating a feeding frenzy of buyers to seemingly boost a sales price up to market value tends to beg the question: Why not price at market value to begin with and take offers as written instead of the current auction-type environment? 

Here's where psychology comes in to play. Back around 2010 in the doldrums of the recession someone got the great idea to generate interest and get buyers off the fence by listing properties for less than their value. And it worked! Buyers started buying again. Someone wanting something only when someone else wants it even has a name: mimetic desire. According to this article in Scientific American from 2012 (how timely!), "Mimetic desire is more than jealously wanting something because someone else has it. Rather, it's about valuing something because someone else values it." How better to demonstrate value than to offer to pay money for something -- at a time when people weren't typically throwing money at anything!

Flash forward to our current market and you might wonder why this strategy persists. I can see a couple reasons, one being that mimetic desire doesn't have anything to do with real estate or any other fluctuating market, it's psychological and carries its own baggage. In fact there have been local agents who have attempted to buck this trend (because believe it or not, some of us would also prefer a more measured market with realistic pricing). Multiple agents from a variety of firms (read: it wasn't a company practice) priced listings at market value and, knowing the trends, were vocal in their marketing to agents and buyers alike that the asking price was one the seller would accept. But no one wanted them. Those houses sat longer on the market and ultimately sold for less than the market would otherwise value them. Disappointed and with their proverbial tail between their legs, those agents fell back in line with the pricing strategy de jour.

So what else is happening besides the "I only want it if someone else thinks it's worth something" thinking? Well since the 2010-ish era buyers learned to tack on 20% or 30% to the list price when considering if they could afford the house. If a house is priced closer to market value and a buyer comes in and mentally increases the sales price by 25%, that home now feels overpriced -- even though it's really at market value already. It's a pattern that's ingrained in the minds of buyers who have been watching and participating in this market.

So, let's look at what tends to happen when you underprice a property and how it ends up with its ultimate sales price. When analyzing pricing for a property I base a home's potential sales price on recent sales of similar homes and the current market conditions. When looking to establish a listing price for that home I also consider the list prices of recent homes in the area because if buyers looking in that area are used to seeing houses priced under $800k, I could inadvertently reduce exposure by alienating potential buyers who now believe a house priced at $849k is out of their price range, or worse, overpriced. Still, my seller is hoping to get over $900k for their house, and I think it's possible. The seller agrees that pricing the property low to generate more interest is the route they want to go and sets an asking price of $789k. Skip ahead about 10 days to the date we're accepting any and all offers (come one, come all, come now, or not at all!). The strategy succeeds and we end up with 11 offers. What tends to happen is about half the offers will not be competitive in the least. In this scenario offers under $850k would be unlikely to receive any further play. Another 25% of the offers will be reasonable, possibly even strong offers, but they still end up knocked out of the game by the top 25% of offers. Typically there will be two or three very strong offers which are really the ones the whole game is geared toward; occasionally there will be one offer that is heads and shoulders above any other and ends the game entirely. All any property needs is that top 25%, those two or three offers that rose to the occasion, knew the market, bid accordingly, and possibly in accordance with an increasing market. The winning bid now sets a new value for the neighborhood and the next home listed will likely follow suit.

This way of pricing has resulted in benchmark sales which make sellers happy and is exhausting buyers (as an agent I can tell you that a price increase of $10,000 or $30,000 doesn't affect my commission in a way that has me planning any vacations -- even a weekend trip to Napa, but it is my job as a listing agent to get my seller the best and highest offer for their property). How do we get back to asking prices in greater accord with market value? At this point, your guess is as good as mine. It may take a psychological shift away from mimetic desires, and anyone who's spent any time in therapy can tell you those kinds of shifts take time.