May282015

Are high house prices in Silicon Valley pushing businesses out?

Shortages of both residential and commercial supply forces workers and businesses to flee high-priced California markets for lower prices elsewhere.

reluctanceCalifornia house prices are very high because we endure a chronic shortages of housing. We aren’t in a house price bubble because the two alternatives for obtaining housing, rent or ownership, balance. As long as the relationship between renting and owning is balanced, the market for both is as stable as the overall economy.

The weakness in this analysis is that it assumes either renting or owning is affordable, but if neither one is affordable relative to incomes, the market can be very unaffordable despite the balance between ownership costs and rent.

I wrote that chronic shortages of housing supply inflates California house prices. When there are more jobs than houses or rentals, people are forced to bid up house prices and rents in order to obtain housing. This forces people to substitute down in quality and move further away from job centers, and it prices out the lowest bracket of wage earners, forcing them to live with multiple families in the same house or put upwards of 50% of their income toward housing, lowering everyone’s standard of living. This downward substitution effect lifts house prices at every level of the housing ladder and prices out the lowest tier of the housing market.

greedThis phenomenon has been going on for so long, that most Californians resign themselves to the idea of living in lesser quality housing than they could obtain elsewhere based on their income. The tipping point comes when businesses no longer want to play along. When businesses relocate — and take jobs with them — then California’s high house prices weaken the entire economy, which is where we are today.

Soaring housing costs forces talent to flee Silicon Valley

By Glenn Kelman, CEO of Redfin, May 21, 2015

At a recent conference, the founder of one technology titan asked another if it was even possible to build a platform-technology company outside of Silicon Valley. It was a fair question, given the dominance of Google, Facebook and Apple. But from where I sat, it seemed easier to build a company of that size today almost anywhere except Silicon Valley.

Others have had the same thought. A spate of start-ups and now venture funds have recently left Silicon Valley for LA (Snapchat), Chicago (Keepsake), Seattle (Sherbert) and even Ohio (Drive).

The company where I work, Redfin, understands this impulse better than anyone. We are real estate brokers, with technology used by 10 million-plus people each month looking to move. And the simplest trend we see in American life is that Silicon Valley is no longer just the place talented people move to; it’s the place those people are moving from.

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In 2011, 1 in 7 people in the Bay Area searched Redfin.com for homes outside of the Bay Area. Now it’s 1 in 4. As Adam Wiener, our chief growth officer, announced to other executives last month: “The dam has broken.”

In the past four years, the number of Bay Area people searching for Seattle homes has quadrupled; for Portland homes, that number has quintupled. For every 13 Bay Area people searching for a home, one is now searching in the Pacific Northwest alone. …

The chronic shortage of housing that inflated house prices historically forced out the lowest rungs of the housing ladder. If the working wage barely covers rent, working for less somewhere else where housing is affordable greatly improves quality of life, so people leave. What’s unique about the phenomenon described above is that it’s not just the bottom of the housing ladder that’s decided the high cost of housing is so detrimental to quality of life that they are leaving.spend_irresponsibly

Folks are leaving Silicon Valley, mostly because they can’t afford to stay. For the first time ever, the median price for a Silicon Valley home just exceeded $1 million. That’s about double what it is in other tech cities, like Boston or Seattle, and triple what it is in aspiring technology hubs, like Portland, Denver or Austin. …

According to compensation data company PayScale.com, Silicon Valley engineers earn nearly 50 percent more than their Boston counterparts; in Seattle that difference is smaller, but still significant, at 12 percent. Nowhere is the pay difference large enough to offset the cost of housing.

As long as the shortage of housing persists, this will not change.

The shortage of housing causes people to take pay raises and bid up rents and house prices. No matter how large the pay differential gets, it will never overcome the problem with the cost of housing because the added pay will contribute to the problem.

If we had a free market without artificial barriers to new construction, builders would react to higher prices by providing more supply; however, growth restrictions prevent builders from providing more supply, so prices just keep going up and up and up.walk_away

Salaries aren’t the only costs that are lower in other places. Silicon Valley commercial rents are nearly double what they would be in Denver or Portland, and 50 percent higher than Austin or Seattle. For a 100-person office, the difference is $400,000 a year, lowering operating expenses by about 2 percent; in a typical software company with 15 percent margins, this difference is significant.

Many high-tech businesses are starting to worry about the rent: When we asked a CBRE broker, Owen Rice, for this data, he wrote back with a funny-that-you-should-ask email, noting that “more and more we are creating multimarket analyses for our clients,” including those based in a suddenly more expensive Seattle, as well as the Valley.

The same growth restrictions that prevents residential real estate costs from coming down also inflates commercial property costs. Shortages that cannot be remedied by market action will cause both residential and commericial prices to rise until the substitution effect causes workers and businesses to locate somewhere else.

Now of course, Silicon Valley isn’t going to empty out. Its population remained constant over the last decade and will remain so again in this one. More people will come here, but more will leave, too. The result will be the Valley-fication of America, a form of gentrification more extreme than most of America has seen before, with high-tech jobs, high incomes and more expensive coffee, yoga studios and—yes—houses, too.

The increase in home prices since 2012 did wonders for bank balance sheets, but it did nothing to help consumers or the economy. Future homebuyers must pay significantly more to buy houses, and the extra money going to payments is not be circulated in the local economy to buy goods and services. Higher rents and higher home prices benefits existing landowners and bankers at the expense of everyone else. But despite the problems higher house prices create, few want the system to change, so Californians will continue to struggle with high housing costs, probably forever.

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