Should I buy a house in San Francisco?

March 29, 2005 3:58 PM

Is there going to be a correction in urban real estate prices in the United States?

I'm 24 years old. I currently live in Boston. I'm planning to move to San Francisco in about a year. I've spent a fair amount of time there (or here, technically, since that's where I am as I write this) and I have a feeling I may want to settle there. I think I'll know within the next three to five years, which is about how long I think it would take me to feel financially comfortable with buying a home.

Problem is, a tiny two bedroom place could sell easily for a million dollars in San Francisco proper, and that's not even in the swankiest neighborhoods. I like Noe Valley quite a bit, but on the whole I think I'd be happy living in any pleasant neighborhood of the city. The situation in Boston is somewhat similar, but prices are a little lower. If I were to stay here, I would have the same fear. Namely, that I might plunk down upwards of $700k for a home, and within a few years have the bottom fall out of the market. It just seems to me that current real estate prices cannot possibly be sustainable in the long term. While I recognize that real estate should be a long term investment anyway, I am afraid of being in a situation where I am forced to sell at a loss. Should I be?

posted by autojack to work & money (16 comments total)

I just went through that a year ago. Just north of you, up in Marin County, I spent a lot more money on a house than I every thought I would. I moved up from Southern California, where real estate was expensive, but not quite this expensive, as a whole. I adjusted my expectations upwards and jumped in.

As for the volatility and potential loss in the real estate market, I dealt with it by figuring that it was a little bit of a gamble. This area seems to be somewhat resilient to housing depreciation, based on historical evidence, but even so, what would a drop in pricing mean? Only something if it coincides with you losing your job, having no ability to pay, and being in a situation that requires you to move immediately. I look at savings as my backing for the short term -- I can deal with a six month layoff from work. If I still cannot find a job after six months, I would have a problem. Again, that would only be a problem from a real estate standpoint if my house hadn't appreciated in value first. This would only be devastating if values dropped within 6-12 months after I purchased it. I am now, personally, into month 12 and have indications that I have 20% appreciation on the house. I can take a hit and still be in the black, which is helpful.

In the end, and despite my rambling, I think you just have to take a chance. As long as you can afford the payments now and have the ability to save for the "rainy day", buy the house and know that it would take a confluence of factors within the first year of ownership to really affect your future.
posted by xorowo at 4:30 PM on March 29, 2005

You may want to read this Economist article on the real estate bubble [link is premium content, bugmenot will get you through the login].

The short answer is "yes." Housing is definitely overvalued, especially in SF. This means you can make a killing or get screwed, just as with a real estate bubble. One of the most important considerations is your time horizon - e.g., how much time you expect to own the home.

If your time horizon is long (20-30 years) then whether or not there is a correction is not especially relevant, since you will be holding the property long enough for it to make its value back (assuming that the economy doesn't go into a decades-long tailspin).

If your time horizon is extremely short (5 years or less) then you are taking a very serious risk. You could luck out and make a killing if prices continue to spiral up. Or you could be completely screwed if there is a correction in that time period.

If your time period is moderate, then, well, your risk is moderate. You are more exposed to a correction (b/c you're holding on to the house for longer), but also more likely to be able to make some of that value back.

And this doesn't even begin to take into account the regular financial considerations relevant to buying property...
posted by googly at 4:45 PM on March 29, 2005

autojack - It may be helpful to ask the question in reverse: what do you see as the disadvantages of renting? If they aren't many, then why not rent?

Also, for what it's worth, I read in the last week that housing prices in the SF Bay Area are the equivalent of 33 times rentals (which, I think, means that if one buys a $990,000 house and rents it, the rent would be $30,000 per year, or $2,500 per month). The ratio of 33 makes the SF Bay area an outlier - in other areas of the country (and historically?) the ratio is 20 to 25 times.
posted by WestCoaster at 4:53 PM on March 29, 2005

If I'm reading the question right, you are at least 3 years away from buying a house. In that case, sit tight and don't worry. The market is almost certainly due for some cooling off, but whether that means a steep fall in prices or only a leveling off is really anyone's guess.

One caution, though, is that SF and Boston are both somewhat notorious for sharp swings in real estate prices. Boston had a real condo meltdown in the late 1980s. And SF has seen some huge run-ups and run-downs also.

The key to protecting yourself, regardless of when you buy, is to pick a place that you would be happy with in the long term. If you like the place, you can always hunker down in a bad market and just wait it out. This means picking a good neighborhood and likely getting enough room to handle at least one kid (if there might be a kid in your future). The people who get clobbered in a bad market are those that are forced to sell.
posted by Mid at 4:59 PM on March 29, 2005

I'm in the same boat as you - thinking about buying a place in an urban area soon - and I'm a geek, so I always turn to journal articles or academic research for help.

The FDIC has done some 'bubble' research that I thought was helpful (from the first one):
"we have seen that most booms usually do not go bust but instead tend to result in a period of price stagnation. Finally, busts do sometimes follow booms. In those instances, severe economic shocks—often including a net outflow of population—appear to be a key factor in pushing nominal home prices sharply lower....
Although this paper demonstrates that relatively few metro area housing booms have ended in busts, there are reasons to think that history might be an imperfect guide to the present situation. [goes into a discussion of sub-prime credit markets and high leverage lending]"

Robert Shiller, of "Irrational Exuberance" fame, is cited a few times in those papers (and this NYT article), as he has done quite a bit of work on housing bubbles (a cited one that's not behind JSTOR).
posted by milkrate at 5:13 PM on March 29, 2005

Yes, there will be a housing correction. The question you should be asking yourself is when.
posted by Nelson at 5:35 PM on March 29, 2005

Generally follow the fundamentals:
1) If the total nut is more than 25% of your gross income (principal & interest+property tax+insurance, escrowed) forget it.
2) Buy a house that is 'entry level' (2-3 BR, 1.5 BA) in a desirable neighborhood. Less value loss.
3) Never, EVER, get an interest-only loan.
4) Never, EVER, get a COSI loan or other sci-fi pseudo-indexed loan. You'll want to slit your wrists.
5) Always pay 20 percent down.
6) Never, EVER buy a home based on its point-in-time value. Do the math. Work out the cashflow on a tax basis.
7) If possible go for a biweekly payment 20 or 25 year mortgage. Do a 30 if you have to.

Too many lenders want you to think that 33% of your gross is sufficient and that I-O loans are sustainable. They are not. Too many will also say, 'less that 20 percent? No Problem! Private mortgage insurance!'

And the real scum try to sell you on COSI ('Cost of Savings Index') loans that appear to offer you a very attractive rate but screw you because your principal loan amount goes UP in the 18 months you're paying these 'low, low' rates.

If you can't meet these criteria go for other tax sheltering of your income (IRA/401K/etc).

Good luck! This is a personal decision, not an investment.
posted by nj_subgenius at 5:40 PM on March 29, 2005

Note that if the choice is between buying a house very soon and buying a house only somewhat soon, what you save in waiting for prices to drop may be offset by your paying a higher interest rate on the mortgage. Prices have gone especially high right now in part because the availability of loans at lower rates raises the up-front price you can afford for the same monthly payment.

But to the extent that home prices really are in a bubble -- and anecdotal evidence of speculative buying in hot major markets suggests that they are -- then prices would drop by more than the expected rise in interest rates alone would predict.
posted by grimmelm at 6:00 PM on March 29, 2005

Generally follow the fundamentals:

Normally this would be true. San Francisco is in wacky backwards land so disregard "the fundamentals" entirely. I bought a 2 bedroom/2 bath condo here last year and have the scars to prove it.

I think your 3 to 5 year timeline for a purchase is spot on. In the meantime keep your credit squeaky clean. Lenders like to make safe bets so have consistent paychecks coming in about 6 months before you plan to purchase. Save your money like a miser. That 700k condo you want now will be a cool million by the time you want to buy. You'll need at least 5% down. Yes - that's 50k. Go as black belt on the loan as you can given current rates. I'm talking 3/1 ARM or 5/1 ARM. Don't worry about about paying down the principal. People don't do that here. I'm being partially factitious.

I realize everything I just stated completely contradicts the previous post. Again, this is wacky backwards land.

Places like Zephyr offer free seminars for those interested in buying. I went to one about a year before I purchased my condo and it started me down the path.

Is there going to be a correction in urban real estate prices in the United States?

Who knows. This is a crystal ball-type question. We can only rely on historical data. If you look at a chart of home prices in SF since the 40s it goes up, up, up . . . even after earthquakes. Feel free to email me if you have questions.
posted by quadog at 6:20 PM on March 29, 2005

re: nj_subgenius

There are viable mortgage options for people who can't make 20% down payments that DO NOT require PMI. 80/20 programs aren't terrible, and there are even some 100% programs for people with good credit that require no mortgage insurance.

If you're going to stay in an area for an extended period of time and you know you want to buy a house there at some point, why throw ALL your money away on rent while you save up for a down payment?
posted by metamarcusb at 6:55 PM on March 29, 2005

People are fleeing the north and heading south. Supply and demand being what they are, it's hard to see why the market would fall dramatically... but again, maybe that's the hopeful speculation of a new home buyer.

'Course, remember that in SF -- like Boston -- you have excellent public transportation. Riding the train rather than commuting by car really opens up the range of potentially affordable places, if you're willing to get out of the city.

... Which, let's face it, you may be ready to do after a few years there anyway, who knows?
posted by ph00dz at 6:57 PM on March 29, 2005

I agree with others that you have to take it city by city and not rely on national trends.

San Francisco is almost an island (at the end of a peninsula actually) and there is no more room to add housing. As long as SF continues to be an enviable place to live (this may reverse, who knows?) people will want to live here and that means house prices will continue to go up even if that seems irrational.

In a sense "new" housing has opened up in that previously unlivable areas (because of crime etc) are now the hotspots. I'm thinking of places like Bernal Heights which in the space of 10-15 years went from being a bit of a wasteland to a pretty, family oriented community with a large lesbian population and killer views to boot. A friend of mine bought a house there a couple years ago at just under $700k ( a small 2 bedroom) and thought it was overpriced. Recently, a real estate agent told her she could easily get $850-900 out of it and quickly too.
posted by vacapinta at 7:30 PM on March 29, 2005

Probably. But when the chattering classes all start saying that a correction is due, it's usually good to ignore them.

Anyway, you may be able to hedge that risk soon.
posted by trharlan at 8:56 PM on March 29, 2005

I would say n_j subgenious is overly conservative.

For one thing, you can do a 10% down / 10% Home Equity / 80% mortgage and not pay mortgage insurance. There's nothing bad about that deal, for most people. I agree, though, to run for the doors if anyone trys to make you pay mortgage insurance (known as PMI).

N_j's 25% of gross income is about right, as long as he means after tax income (is that gross?) and including the effect of the mortgage interest deduction.

Vacapinta is a little overly optimistic with this: "As long as SF continues to be an enviable place to live (this may reverse, who knows?) people will want to live here and that means house prices will continue to go up even if that seems irrational." This assumes that the market goes up with a steady, progressive relationship to population growth/demand. It does not. The market can (and does) get way out ahead of demand, even when demand is increasing at a nice clip. The market can also undershoot demand, leading to a quick upturn in price. The point is: the market moves in fits and starts, not a nice upward curve.
posted by Mid at 8:25 AM on March 30, 2005

I live in the chicago western burbs, a much more "normal" market than SF. But the prices are still a little concerning -- 10% incease per year for the past decade or so.

I've noticed that (regarding my market) the more left-leaning a person is politically, the more convinced they are that the market will crash, and soon. The more right-leaning they are, the more convinced they are that there is no bubble. Not sure what that means for predictive value.
posted by goethean at 8:50 AM on March 30, 2005

I apologize that it has taken me a couple of days to repond here - wrapping up my vacation in San Francisco took priority :-) There's some fantastic information here, and no way that I can select one comment as the best. Thanks for all of your opinions, I think I'll be able to put them to good use when the time comes. The lessons I've learned:

1. Save, save, save.
2. Plan to buy for the long term (the suggestion about having room for a kid in particular was something I hadn't considered).
3. If I'm lucky, the correction might happen before I buy; then I benefit!

And surprisingly enough, as I was waiting for my ride to the airport this morning and watching channel 4 news in SF, there was a blurb about a new study rating which housing markets in the US were most likely to experience a correction in the next 2-3 years! Weird! San Francisco was rated the third most likely. San Jose was second. Guess what city was first? Boston.
posted by autojack at 6:28 PM on March 31, 2005