Real Estate Construction Costs Skyrockets in SF Peninsula…What is Impact to Real Estate Prices?

Yes, yes it does, but in different ways depending on the segment. First, let’s discuss why costs/budgets have significantly increased over the past year .

  • During the pandemic, while people were shelter-in-place, the need to renovate their existing home increased precipitously so there was an increase in demand for contractor labor.
  • With the combined increase in demand for labor, as well as some migration of contractors out of the area, skilled contractors started getting booked up months in advance creating a labor shortage.
  • As general contractors and sub-contractor’s job pipeline get backed up from 3-6 months in advance, they start to increase their bids/estimates on job proposals increasing pricing.
  • Early in the pandemic when imports totally stopped at the ports/borders, there were major supply chain problems with many industries. Materials like cabinets, countertops, fixtures and many other key house materials stopped coming in from countries like China, inventory became scarce in certain areas. 
  • Good example was in early 2021, lumber prices increased by 5-7x – not a typo. Fortunately, lumber prices have come down.
  • With low inventory, prices began to increase.
  • There are shortages of key finish items, such as high-end appliances with “smart features” that are seeing lead times of 6 months. Apparently, a backed-up supply chain issue created by a shortage of “chips” that is a key material in the production of certain appliances.
  • So with all these delays, cost increases, labor shortages, general contractors must then factor in just more time, effort, challenges, delays that they also need to increase their projected margin to somewhat factor these issues into the equation.

What do any of these factors impacting construction costs have to do with real estate values? Here are some examples of the impacts I have seen first hand as both listing agent and buyers agent in the San Francisco Peninsula marketplace.

  • Home buyers know about rising costs and long lead times that many buyers who would have considered a fixer upper, no longer will contemplate one. Thus, move-in condition homes are in higher demand than ever before.
  • Conversely, fixer uppers in good neighborhoods that may have sold a few years ago with multiple offers, may not still sell right away or command as many offers and the spread between a fixer upper and recently renovated home have widened.
  • Homeowners are finding it much more challenging doing a substantial home renovation or an expansion project due to this significantly increasing cost and longer project timeline. I have two different clients who have been planning an expansion project in  the Peninsula over the past year including architectural renderings and general contractor estimates. Unfortunately, the estimates over the last 6 months increased by more than 50% making the financial economics of a home expansion not as clear cut as in the past.
  • For example, let’s say a homeowner bought a San Mateo SFR 5 years ago for $1m that was a 3bd/2ba 1400 square feet that is now worth $1.5m. They want to expand to a 4bd/2.5ba 2100 square feet for $700k; after completion, it will be a beautiful fully renovated house worth $2.5m imputing $300k of “sweat equity”. However, let’s say the new budget for that project is now $1.0m. Then, the “sweat equity” benefit is negligible and the benefits would be the finished product being to the precise taste of the owner and ability to remain in the neighborhood; the downside is over 1 year of planning, decisions, project management and moving into a temporary apartment. The alternative is to just buy a bigger, nicer one for $2.5m and sell the smaller one. Of course, the decision is much more financially, psychologically and logistically more complex than that, but you can now see the dilemma.
  • The net is that there are more move-up buyers in the market, which is why the $2-3m price point in good school districts with renovated houses and usable backyards to be highly competitive.
  • Interestingly, I am seeing more houses listed by developers be put on the market to be sold with approved plans for a home buyer to construct. Their reasoning is they are too busy with other projects to start which likely is true. However, I am pretty certain the other reason is  their tightening projected profit margins is squeezing builders.

As always, feel free to contact me at peter.tao@cbnorcal.com if you wish to discuss anything real estate related. Any advice from those who have recently undergone a renovation project? Any feedback or real world renovation war stories?

Are you Bearish or Bullish in Today’s Real Estate Market?

Bulle_und_Bär_Frankfurt

Recently I had a conversation with a local Peninsula friend of mine who I’ll call “Fred”. He is one of my go-to-friends for talking about the stock market, investment opportunities, technology industry, and general business topics. We hadn’t talked about the markets in over a year and compared notes about our opinions. He asked me how real estate was going and what my thoughts are of the current marketplace. I asked him his opinion of the stock market valuations and strength in Silicon Valley at a macro level. The local economy, stock market valuations, health of technology sector, regional job growth/decline, etc. are all strongly correlated with the current situation of local real estate markets.

My friend is a former law partner at a Tier 1 law firm turned technology executive of a company that went public several years ago who views business in a highly analytical fashion. Like myself, Fred has also been living in the Bay Area for 20+ years having been through the dot com bubble of 1999-2000, the subsequent bust of 2001, to Web 2.0 & subprime mortgages in mid-late 2000’s, then the economic depression thereafter, and the current surge of the technology sector, and real estate for the past several years.

There are similarities between 2014 and previous strong economic times in last 20 years.

  1. Early stage start ups getting VC funding thereby creating exciting opportunities for technical and even non technical labor offering attractive compensation packages of salary + equity
  2. Established Fortune 1000 players growing year-over-year, generating health cash flow, and reinvesting it in new jobs, capital investment, acquisitions to further stimulate the economy.
  3. Private equity/hedge funds/venture capital firms with surge of capital from insurance companies, pension funds, and endowments looking for attractive investment opportunities. Post equity investment or acquisitions, early employees often get an influx of cash that allows them to pay off debt, invest in equities, and/or buy their 1st home or upgrade houses.

A by product of all this is my observation of traffic on highway 101, airplane flights where there are rarely empty seats, and sub-contractors charging higher prices due to all the construction activity occuring.

Since I am in real estate, and given my financial background, I get asked all the time what I think of the stock market and real estate prices. Are we at a peak? How much higher can things go up? Is this the right time to buy/sell? The challenge is it is very difficult to truly time the market. For example, if someone believes there might be some technology stocks overvalued right now, that investor would want to “short sell” the stock. However, the risk is that even if the prediction of valuation is correct, it is hard to accurately gauge whether it will take 6 weeks or 18 months for the stock price to move in that way given the innumerable variables that factor into everything.

EconomicGreenfield-9-28-10-MacroMarkets-Projection-Chart

It is similar with real estate. I know a friend of a friend who around 1998 thought the real estate value was at its peak and they ended up selling their house to “time the market”, moved back with their parents with the goal that they would buy a bigger house at a lower price when the market correct. Unfortunately, real estate kept going up for several years and when they realized that they “timed” it wrong, they were not able to afford to buy back into the real estate market. What compounded it all was when they realized their mistake, they actually could have bought back in but would have had to purchase a smaller house than what they had before, but they kept holding out hope that they would eventually be right all the while the market kept running up in 1999 and 2000.

Neither Fred nor I really can predict what will happen. We certainly have some predictions and opinions on what is happening. But for me, I view my own house and my stock portfolio on a medium to long-term horizon. My stock portfolio goals is for capital appreciation in the next 10+ years that will serve to pay for my children’s college expenses and eventually my retirement. I seek out investment opportunities for companies that have strong fundamentals and will survive and thrive over time through recession and boom times. Same with real estate, I know I will live in the SF Bay Area for the long haul, and I wish to be comfortable in my own home. Regardless of my beliefs around short-term economic outlook, I continue to be long term positive on Silicon Valley and rest of Bay Area as a geographical location that has great weather, amazing outdoor opportunities, culture, and a hub of highly educated people that companies want to be located near so that will continue to create job opportunities. When I bought my first house in 1999, I thought there was a chance that I was buying at the peak. However, I knew I would be living in the area for a long time so justified it in my mind that over the next 10 years, I felt confident it would be a worthwhile investment regardless of short term movements. That first house turned out to be an amazing investment generating a large IRR and providing comfort to my living situation.

….Party like it’s 1999

In the mid-90’s, I moved to San Francisco after graduating from Columbia Business School in NYC for a fantastic job executing mergers and acquisitions for Bank of America. I was living in the Marina district of SF until 1999 when I bought my first house in the mid-Peninsula. The SF Bay Area in 1999 was a whirlwind of hot Internet companies getting major funding, going IPO and was one launch party after another – Prince’s lyric around “party like it’s 1999…” sure rang true. The real estate market along with the general frothiness of the economy saw rapid appreciation. After losing out on a couple of offers, I saw a nice 3 bedroom, 2 bathroom house in San Mateo – a small, starter home.  As I was debating how much over the list price to offer, I recall saying to many people that “this would be amongst the highest $ per square foot in the neighborhood”. After crunching a spreadsheet trying to best value the house and predict where housing prices were going to go, and comparing it with remaining a renter and putting my savings into the stock market…..I put the purchase into the following perspective that homeownership is as much a personal ‘lifestyle’ choice as it was an investment decision. Unlike investing in the stock market, one gets to enjoy the tangible product of a house and being able to call it home.

I got the house at 7% above the list price which was aggressive at the time. There is a concept called “winners curse”.  Sometimes when you win an auction in a competitive situation…rather than celebrating, one may be tempted to second guess the decision. In my situation, we quickly assimilated to the neighborhood and loved our house so we were happy with our new home even when the dot com bubble burst which temporarily affected real estate.

Since that time, I sold that house in 2006, and bought another home. During that approximately 7 years, the value increased so much even after a temporary post-dot com blip that my 1st house to this day remains one of my best financial investments ever – and we were able to enjoy the benefits of living in a house we owned. The moral of the story is that no one can predict the future with respect to the economy, the stock market, or housing prices. People ask me all the time what I believe the real estate market will do and I certainly have my thoughts. Even more specifically, the question of “should I buy/upgrade now or later?” is even a harder question to answer. That question can only be answered individually factoring in future opinions of housing values, interest rate dynamics, job situation, life stage, savings, and many other personal factors. In a rapidly changing real estate market (either appreciating or declining), having a long term perspective for owner-occupied buyers that the house is both for investment and for lifestyle purpose will make for a healthier mindset.  And in my situation in 1999 when I was unsure of either, it is a great feeling when both the investment and lifestyle choices work out well. To this day, I sometimes miss the days of 1999 when I would be invited to 2-3 Internet launch parties each week.