In recent weeks there have been several unrelated news articles that, taken in the aggregate, paint a picture of what might be expected in the future. These stories are discussed below and are not in any order of reporting date or importance.

The City of San Francisco is experiencing a crisis of growing shortages of residential rentals and rapidly escalating apartment rents.  Not only is there a serious shortage of affordable housing but a shortage of housing period.  There are many contributors to this problem.  One major contributor is the failure, years ago, of planners to adequately anticipate and accommodate growth in their planning codes. Instead, the planners and politicians followed the cries of anti-high rise activists and neighborhood preservationists resulting in more stringent land use codes which, among other thing, massively reducing allowable densities at a time when builders and developers were anxious to develop. The code changes resulted in disrupting new supply at a time when the best thing for the renters would have been the creation of a substantial over-supply of housing as that would have forced rents downward.  Couple the code changes with residential rent control which, while benefiting existing tenants greatly reduced normal levels of turnover. Those with “affordable” rents were economically dis-incentivised from moving unless absolutely necessary.

 There was a legal decision, many years ago, involving a zoning issue. The judge opined something along t following lines “Zoning is a tool to be used in planning for the future.  It should not be used to deny the future”.  However, restrictive land use codes and policies do just that – they deny the future.  As if the problems are not big enough, San Francisco has an entitlement process that uses up valuable time (12-18 months or more) and substantial money in going through the process. These factors cause a dramatic increase in rent as rent is related to project cost. One potential  solution might be to change codes to permit higher densities, streamlining the entitlement process to stimulate timely commencement of construction resulting in more rapid delivery of supply. This would apply to office buildings as well as apartments. The annual limitation of entitlements for offices is a classic example of governmental interference with the economic forces of supply and demand and result in artificially driving rental costs upwards at the point where shortages develop.

 The barriers to new construction help drive the prices of property upwards as investors adopt the notion that the downside risks of ownership in San Francisco are minimal.

 Single family home prices have risen to a point where the middle class is being driven out of the market and, coupled with runaway residential rents threatens to drive all classes of service and labor workers out of the City.  This is not good for the long term economic future of the City and the sustaining of growth in property values.

 Calpers (The California Public Employees Retirement System)) announced a new commitment to real estate investments by boosting its $26 billion in real estate investments by 27%.  This decision follows a loss of $10 billion or about 50% of the value of its real estate portfolio during the downturn in the market following the 2008 market meltdown as well as following an indicated increase in the value o high quality properties of over 80% in the past 5 years. Calpers will reportedly concentrate on fully leased office buildings and apartments. This type of investing is not opportunistic because it depends on increasing rents for long term growth rather than depending on value added management that can come from repositioning properties. One should question whether “buying in” after a 5 year period of explosive increases in prices is a sound investment decision.

 Nationwide, the prices of residential rentals and single family homes appear to be increasing, particularly in those markets where the excess supply has been worked off.

 Interest rates on mortgages remain relatively low.  However, the behavior of REIT stocks has recently underscored the sensitivity of values to borrowing rates.  The prices of REIT stocks declined in reaction to fears that the Fed would increase rates.

 These observations lead to the question of whether or not low borrowing rates may be a major contributor to the demand for and current increases in value of real estate?  Is the current real estate market a “bubble market” that could collapse if interest rates increase measurably? If interest rates increase, will business investment and growth decline?  If the answer is yes would it impact offices and residential rents? The answer would be yes.

 To some observers, there are more forward risks inherent in real estate ownership than are being built in to current offering and buying prices. Volume and price activity, in many sectors and many regional markets appear to some as exhibiting patterns like those in 2008 when a frothy market and cheap money drove frenzied activity


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