Is San Francisco ripe for a housing bust?
House prices surprisingly fell in the Bay Area. Will the bursting Chinese bubble and a potential tech credit bubble cause money to flee the Bay Area?
Back in January I asked, Is San Francisco, the most overvalued US housing market, going to crash? At the time, I challenged housing bears to construct a scenario where house prices could drop in the face of an improving economy and successful lender can-kicking.
The premise of the original housing market collapse went something like this: People took on mortgage debt which couldn’t be sustained by current income; those borrowers were going to default, lenders would foreclose, lenders would liquidate their inventory, and the resulting flood of must-sell inventory would push prices lower quickly. For the most part, the bust played out in that fashion until the rules were changed — mark-to-fantasy accounting, loan modifications, shadow inventory, long-term squatting. Once the rules were changed, lenders were able to gain control of the flow of inventory, and house prices bottomed and the bubble reflated strongly. With all these measures in place, and with no pressure to remove them, a housing bust with rapidly declining house prices is very unlikely in the foreseeable future.
Not much has changed domestically to convince me lenders are suddenly going to begin rapid processing of their long-term delinquent mortgage squatters and flood the MLS with must-sell inventory, particularly since they’ve been very successful with their can kicking efforts. Due to redefaults on loan modifications, I do believe foreclosure and delinquency rates will remain elevated much longer than most housing pundits expect; however, I also believe lenders will slowly process these problem mortgages to prevent a crash.
There is a very real potential source of must-sell inventory that’s highly concentrated in Coastal California: Chinese investors. I recently wrote that a Chinese government policy change kills Coastal California housing market. At first it seems implausible that decisions made by a foreign government could impact our domestic housing market, but the scenario is very realistic.
Chinese investors make up a substantial and increasing portion of California homebuyers. Last year it these capital inflows amounted to about $22 billion, and 35% of that was concentrated in California. Over time, this influx of cash has helped drive up house prices, and it’s made Chinese nationals a significant owner base.
This money was allowed to leave China in a semi-clandestine policy that is officially against Chinese law. Chinese nationals are not allowed to move more than $50,000 overseas, but lenders in China have been facilitating the outflow while government officials looked the other way. Political pressure is mounting to stop this flow of capital.
If the influx of Chinese investment capital stops, the housing market won’t crash, but a big portion of the demand will suddenly evaporate, and the market will adjust. What’s of far greater concern is what happens if the Chinese government demands the repatriation of this capital back to China — a policy they could institute and implement with fear of imprisonment or death.
If the Chinese government gets serious about repatriation of Chinese capital, Chinese investors will be forced to sell their US holdings and wire the money back home — and neither the Chinese government nor the investors will care the slightest bit about how this would impact the California housing market.
Those who read Zero Hedge regularly will be aware that for us no other regional US housing market is more important than that of the San Francisco. Recall from June:
When it comes to critical housing markets in the US, none is more important than San Francisco.
Courtesy of its location, not only does it reflect the general Fed-driven liquidity bubble which is the tide rising all housing boats across the US, but due to its proximity to both Silicon Valley and China, it also benefits from two other liquidity bubbles: that of tech, and of course, the Chinese $25 trillion financial debt monster, where since the local housing bubble has burst, local oligarchs have no choice but to dump their cash abroad.
This double whammy theory has a veneer of plausibility, but if you look beneath the surface, the idea that a credit bubble will pop and the Silicon Valley tech investment will stop isn’t very realistic. Perhaps the flood of liquidity is causing extra money to flow into technology, but money will continue to flow there whether we have a credit bubble or not. The potential gains from investing in a successful Internet startup are too great for this flow of money to abruptly stop. The implosion of the NASDAQ tech bubble didn’t cause Bay Area house prices to drop by any significant amount, and few believe we are witnessing a tech bubble today.
It is no surprise that during ever single previous bubble peak, San Francisco home prices managed to post a 20% annual increase, starting with the dot com bubble in the year 2000, the first (not to be confused with the current) housing bubble peaking around 2005, and then the European sovereign debt bubble.
Which is why, while today’s Case Shiller data was widely disappointing across the board, indicating a significant slowdown in price gains (and on a sequential seasonally adjusted basis, practically a decline), the one market we paid particular attention to was San Francisco. What we found is a red flag for everyone waiting to time the bursting of the latest housing bubble. Because after an unlucky 13 months of posting consecutive 20% Y/Y price gains, the San Francisco bubble appears to have finally burst, posting “just” an 18.2% price increase, the lowest since January of 2013.
Well, in the aftermath of yesterday’s data which beyond a reasonable doubt showed that the Chinese housing bubble has burst, we can now report that the “flashing red” market that is San Francisco was just smacked by a “double whammy” perfect storm, when not only was the annual increase in home prices the lowest it has been since October 2012 (but in the wrong direction), and next month the July double-digit Y/Y increase of 10.3% will once again be single digits, first positive and soon negative, an inflection which has in the past only happened when a major bubble has just burst as shown below…
After a huge increase in prices during the dot com bubble, house prices only correctly slightly for a very short time during the 2001 recession. The price increase in 2010 had nothing to do with the European Sovereign debt bubble, that was the tax credit program that pulled housing demand forward. The most recent price increase was caused by lender manipulation of supply. Also, despite the rather ominous looking down arrow, prices are still up 10% YoY.
… but that according to the just reported Case Shiller data, San Francisco was also the only city to see a monthly decline in house prices…
… which now also means that the ultra high end of US housing is now sliding fast, and that unless some other central banks steps up and resumes the injections of some $100 billion in outside money into inflating asset prices such as stocks and billionaire mansions, then all bets are soon off.
While that sounds scary, it isn’t very substantive. First, let’s assume the influx of capital stops. So what? Unless some of those owners need to sell, it just means house prices will stay flat for a while. Big deal.
I outlined the scenario above where Chinese owners become must-sell inventory, but if that scenario doesn’t come to pass, I don’t see another potential source of must-sell inventory that would push prices lower. Until the bears identify that source of desperate sellers, I remain unconvinced about the impending doom of the housing market.