Subscribe to San Francisco Magazine

Mod Lux Feeds

Now Playing

What the !*#@?

The real story behind the head-spinning, gut-wrenching, totally warped, get-in-now/get-out-now, surprisingly indestructible (oops! shouldn’t have said that!) 21st-century Bay Area real estate bubble.

Karin de Gier hadn't read UCLA economic guru Edward Leamer's gloomy forecast on the Bay Area real estate market when she put her Bernal Heights cottage up for sale late this summer. In a paper entitled "Bubble Trouble?" Leamer had joined a chorus of real estate wonks, economists, and national magazines in declaring that the Bay Area's roaring Real estate market was unsustainable and heading for a crash.

Oblivious, de Gier listed her "800 sf 2/1, w/vu" for $549,000, more than twice what she'd paid in 1990. Ten days later, after hundreds of people had poked through the microscopic closets and tried out the heated towel rack and remote-controlled skylight, 17 offers rolled in, several of them hovering around $650,000. The would-be buyers weren't done, though. Given a chance to throw more money at her, one desperate, determined couple tacked on another $15,000, pushing the final price up to $665,000.

"I thought, ‘Omigod, this is madness,'" says de Gier, a former project manager at Egreetings.com who lost her job in the tech bust and now builds custom furniture for a living.

Leamer's incredulous reaction to the Great Real Estate Rush of 2003: "What are they smoking up there?"

You can hardly blame him for asking. By any sane standard, the Bay Area real estate market should have gone into free fall long ago, around when Webvan and Petopia.com bit the dust. That's what normally happens when unemployment skyrockets (Santa Clara and San Francisco Counties lost 240,000 jobs in 2001 and 2002), population shrinks (they also lost more residents in that period than any other counties in the nation), and political uncertainty rattles the nerves and boggles the brain. Look at Houston in the 1980s; after oil prices tanked, real estate did, too, with home prices falling 35 percent. Or at San Francisco a decade ago: During the state's last big recession, from 1990 to 1993, median home prices in the city slid 13.6 percent. Or at Austin, Portland, Seattle—all tech centers whose housing markets have been slowed by the dot bomb.

Yet the postboom Bay Area real estate market is still partying like it's 1999. Since March 2000, when the NASDAQ began plummeting back to earth, losing 80 percent of its value along the way, the median price of a Bay Area home has taken a head-scratching turn in the opposite direction: up 27 percent, to $447,000 by early this fall. (It goes without saying that prices here are among the highest in the country, period.) Selling a home in most of the Bay Area hasn't changed that much since the wild '99er days: You slap on a coat of paint, list with an agent, hold one or two open houses, then wait for the offers to flood in. And flood in they do, at least on properties in what is laughingly called the low and middle end—depending on location, under $600,000 or $700,000. Of course, many of them don't stay in that range. In late July, agent Ira Serkes listed a 1910 Craftsman in a tree-lined neighborhood near the North Berkeley BART station for $599,000. It was, he says, "strategically priced"—read: priced low enough to set off a bidding war. Thirteen offers later, the three-bedroom, one-bathroom house sold for a stunning $802,000.

Some things have changed, of course. Unlike a few years ago, when it seemed as if anything with a roof would sell within days for 25 percent over asking, "if a property is overpriced, it will sit," says Suhl Chin, an agent with Pacific Union in San Francisco. Houses that do attract multiple offers usually don't get bid up as much as they once might have. Even well-priced properties may get only one or two bids if they don't "show well"—meaning they haven't been glammed up with the real estate equivalent of mascara and lip gloss. At the high end, the market is positively mushy. "In 2000, everything in Los Altos Hills sold for 20 to 50 percent over asking," says Vivi Chan, an agent with Coldwell Banker. "I closed one house in April of 2000 for $7 million; now it would be maybe $2.7 million."

In other areas, the softness can start a lot lower than that, as Linda and Ed Hancock* discovered when they decided to sell their three-bedroom Noe Valley house. They listed the Edwardian charmer, purchased in 2000 after Ed landed a high-flying—but short-lived—job at a now-defunct dot-com giant, for $1.1 million in early March, just before the Iraq war. One price cut later, it finally sold in June for $940,000—just 8 percent over what they had paid for it and an actual loss when you consider the improvements they made, plus fees, transfer taxes, and broker commissions.

Still, what's surprising is that such real estate sob stories aren't more common. Why hasn't one of the worst recessions in Bay Area memory made a dent in this hyperactive housing market? Why aren't more people losing their shirts? How do you explain such a dizzying disconnect between the predictions of experts and the deal making on the street?

But wait, how's this for a provocative notion? Maybe the know-it-alls have been wrong precisely because they expected the bad economy to hit local home prices as hard as it slammed jobs and 401(k)s. Maybe they just don't understand what makes this housing market—which can be as anomalous as anything else in Northern California—tick. Indeed, it could be argued that, far from dampening the Bay Area's real estate mania, the national recession has actually helped feed its irrational exuberance.

Let's start by looking at the most obvious reason for the current home-buying binge: intoxicatingly low interest rates that dipped below 5 percent this summer for the first time since JFK was president. (By contrast, in 1999 and 2000, rates were at 7 to 8 percent, and in the last real estate downturn in the early nineties, they were in the 9 to 10 percent range.) These historically low rates are a direct reflection of the nation's economic doldrums: an attempt by Alan Greenspan and the Fed to spur business investment and job creation. So far, cheap money hasn't succeeded much on those fronts. But it's had roughly the effect on Bay Area real estate that million dollar stock options and signing bonuses had a few years back. "What's happened to all the liquidity the Fed is providing?" says Michael Carney, executive director of the Real Estate Research Council of Southern California at California State Polytechnic University in Pomona. "It's gone into housing."

With mortgage rates in the bargain basement, Bay Area housing prices don't seem so daunting, even if they are up 6-plus percent in the last year alone. Making credit easier yet are loans with 10, 5, or 0 percent down, as well as adjustable-rate mortgages, fixed as low as 3 percent for a few years, then indexed to move with inflation. "The rates allowed us to do a bigger mortgage than we otherwise could have," says Roger,* a lifelong renter who recently bought a three-bedroom place in Berkeley with his wife.

Low rates haven't just pumped up demand; they've also kept the supply of houses low by kicking off a refinance boom that's put billions of dollars into home owners' pockets—sometimes to  pay the mortgage. "Renters who lost their jobs left the area," says David Bigelow, an agent with Marvin Gardens in Berkeley, "but people who were owners refinanced." That's how Ed and Linda, the hard-up Noe Valley couple, held on to their house for a while: with a $100,000 home equity line of credit. In past recessions, the bank might have foreclosed on their place after Ed lost his job, or the couple would have been forced to sell a lot sooner. But this time around, Bay Area foreclosures are way down (last year, they were about 40 percent below the 1994 figure). Easy credit has made pink-slipped home owners much less desperate than they might have been, meaning fewer distress sales and a tighter supply of houses looking for buyers. 

Here's another way the recession has fueled demand: fear of the stock market. A lot of people who saw their portfolios sliced in half starting in 2000 figure real estate is much safer—especially in the blue-chip Bay Area, where a sunny Victorian seems as solid as a share in Warren E. Buffett's Berkshire Hathaway. (In fact, over the past 20 years, the Dow has risen nearly three times as fast as local home prices; see "House vs. 401(k)? No Contest!" page 62.) "There's only one San Francisco," says Robert J. Cohen, a financial adviser with clients across the Bay Area. "So it trades more like precious jewels or something." Ditto for Palo Alto, Sausalito, and other gems. "I tell people they can get more for their money in Oakland, but they say, ‘I want Berkeley,'" says Coldwell Banker broker Rita Zwerdling, who's having one of the best years of her 24-year career. They want it so much that at least twice in the past six months, houses there have attracted 50-plus offers (see "53 Offers for This?!" below). "It's fail-safe," Zwerdling adds. "Anywhere you go in the world, people have heard of Berkeley."

The other emotion driving the Bay Area market—an emotion the bad economy seems only to have intensified—is a fierce, primal, almost obsessive yearning for one's own castle. "We've seen national calamities and war," says Bigelow, "and it just seems to feed people's insecurities in a way that makes them even more desirous of owning a home, of getting in their nest to hunker down against the stresses of the world."

This urge is so powerful that it's prompted tens of thousands of home buyers around the region to take huge risks. This summer, Tim,* a 60-year-old East Bay teacher, bought a 711-square-foot home in suddenly hot El Cerrito. The price was reasonable by warped Bay Area standards—$360,000—but Tim had almost no savings to make a down payment. Though he got a sweet loan package from a teachers' pension fund, his monthly payments will be $2,400, about half of his take-home pay. "Very tight," he says of his new economic reality. "I'll have to cut my discretionary spending in half. And I think I can't retire at 65." What happens when he has to buy a new roof or deal with a plumbing disaster? "The gamble is that the house will appreciate. If it does, I've got money that I can tap into by refinancing or borrowing on the house." And if it doesn't? "I've considered the possibility that it won't work out and I'll have to sell the house. That's a definite possibility."

Ironically, just as the recession has had the perverse effect of fueling Bay Area home prices, an improving economy may end up cooling things down. In recent months, as the economic picture has looked a little less glum, interest rates have begun to edge up, to 6 to 6.5 percent—still lower than at any time since Watergate, but a big jolt to buyers and sellers nonetheless. One short-term effect has been to push more fence-sitters into the market (sales during August, when rates ticked higher, broke a 15-year record). The other effect has been to price some unlucky people out of it.

In June, Michael Hardwick, jobless since the investment firm Robertson Stephens went belly-up last year, put his three-bedroom in Vallejo on the market. Demitra Barnes, an Oakland single mom who was looking for a safe place to raise her 11-year-old son, loved the house and offered $330,000, $90,000 more than Hardwick had paid three years earlier. But her 4.75 percent loan ran into problems, and mortgage rates bumped higher, pushing the monthly payment up nearly $300—out of her range. Now Barnes fears she's lost any chance to buy, and Hardwick, who's over two months behind on his $2,700 mortgage, is faced with foreclosure.

This is just a hint of what's likely to happen if the real estate bubble bursts—and make no mistake, if this summer's frenzy is any indication, the Bay Area market is riding a whopper. One warning sign, says UCLA economist Leamer, is when the purchase price of a home is way out of whack with its potential income on the rental market—in other words, if you can't rent your house for enough to cover your mortgage. (The concept is something like the price-earnings ratio of a stock.) Compare Bay Area rents—down 20 to 25 percent since 2000—to housing prices, up roughly the same amount, and it's easy to see why Leamer and other pessimists say it's time to get real.

Getting real is exactly what our Bernal Heights friend, Karin de Gier, was doing when she put her place on the market. After living there for a decade, she moved in with her partner in 2001 and rented it out for $3,250. Even with a two-year lease, she was forced to cut the rent twice, to $2,850, and when the lease expired early this year, she did a market analysis. "I realized if I had to rent it on the open market, I'd be lucky to get $2,400," she says. As it was, her cash flow was already negative (she'd pulled out equity after refinancing). So she decided to sell and made out "beyond my wildest dreams."

But what about the seven-months-pregnant couple who ponied up $116,000 over de Gier's asking price? Assuming they put 20 percent down and got a 30-year loan at 6.5 percent, their monthly mortgage, property taxes, and insurance would come to a gut-twisting $4,500. What if Mom decides not to go back to work? What if Dad loses his job? At this point in the market cycle, every Bay Area resident who's recently bought a first home or traded up to something spiffier has to be asking similar questions. Forget real estate; for now, maybe we'd all be better off investing in the companies that make Maalox and Xanax.

Remember how, back in the day, Stupididea.com, with millions a year in expenses and no hopes of ever earning an e-dime in profit, still sold, oh so briefly, for $200 a share? The Stanford geeks who drew up that business plan on a paper napkin got funding only because there was so much venture capital money to go around. Many prognosticators think free-flowing credit is having the same bubble-bubble-toil-and-trouble effect on home prices, not just in the Bay Area but across the United States. A few see disaster ahead; economic consultant John Talbott, author of the new book The Coming Crash in the Housing Market, predicts real estate will collapse nationwide and urges consumers to stop buying houses and to dump any stocks connected to the housing industry.

But Talbott's projections strike most experts as overwrought. Locally, the flood of layoffs and bad business news seems to have ebbed; barring a terrorist attack on the Transamerica Pyramid or a catastrophic jolt on the Hayward Fault, the economic worst is probably behind us, the talking heads say. Interest rates remain low, and with George Bush feeling more defensive about his 2004 prospects, we can count on the White House doing all it can to keep mortgages from going much higher. Instead of bursting like a bubble, these experts say, the Bay Area market is more likely to develop a slow leak, like a pooped-out helium balloon after a raucous party. They see a more modest correction, in which prices stay flat or sag for a few years—rather like what happened after the downturn of the late eighties and early nineties—then slope up again.

Of course, even this scenario—though great for buyers, especially first-timers—can be brutal for people like Ed and Linda, who overextend themselves, buy at a moment when prices are especially inflated, then are forced to sell before they can recoup their investment. Or those like Tim, whose small down payments translate to monster monthly mortgages and zero equity as long as the market stagnates. Even longtime Bay Area home owners sitting on a small fortune in equity shouldn't feel too smug. They could be caught in the real estate fizzle, too, if (for example) they've refinanced to pay for a glitzy remodel, only to find their home's value hasn't appreciated enough to cover the cost of granite counters and a Sub-Zero fridge if they suddenly must sell.

The key to riding out the bubble, the experts say, is to have a financial safety net and to plan for the very long term. "Back in the seventies, people were also talking about how expensive houses were, and interest rates were higher than they are today," says longtime San Francisco real estate agent Ray Brown, coauthor of Home Buying for Dummies and Mortgages for Dummies. "In the eighties, we went through a period where we had 18 percent mortgage rates, and people hung in there. They are happy that they did. Yesterday, I talked to a lady who is the daughter of the very first buyer I ever worked with, back in 1974. At that time, she bought a house on Laurel Street for $70,000. Sold it in 1987 for $470,000."

Drumroll, please. "That house is currently on the market for $1.65 million.