Don't Count on Foreign Buyers to Rescue San Francisco Real Estate

When the housing crash started grabbing headlines last year, real estate insiders were hopefully espousing the theory that foreign buyers would prop up demand for San Francisco housing. The idea was that the declining dollar made US real estate cheaper for foreign buyers, who naturally preferred world class cities like San Francisco and New York. Unfortunately, the theory makes little sense. The reason for any sudden drop in the dollar is that foreigners are trying to reduce their holdings of US assets. Why, then, should they suddenly increase their demand for San Francisco real estate?

The dollar has indeed declined over the last several years, but the decline has been gradual and modest. A careful look at the facts suggests that the resulting impact on foreign demand for San Francisco real estate has been marginal at best.

Currencies rarely move in lockstep with one another: while one currency is appreciating relative to the dollar, another one might be depreciating. In such cases, how can we say whether the dollar is getting cheaper or dearer? Economists address this problem by using trade-weighted exchange rates. The idea is to create an index whose value is adjusted from period to period by applying a weighted-average of the percentage changes in a representative group of exchange rates. The weights are chosen to reflect the amount of trade that each country does with the United States.

Take a look at the chart, below, which shows the inflation-adjusted value of the dollar, measured against a trade-weighted basket of foreign currencies.

Remember that this 'exchange rate' is actually an index: a 10% increase in the level of the index indicates that the dollar has appreciated by 10%, but the level of the index itself is meaningless. (I obtained this series from the Federal Reserve. I re-scaled it so that the average of the index over the last 20 years is 100.)

The index reached its peak value of 117.7 in February of 2002. It reached its recent low of 88.6 in March of 2008. The peak-to-trough change was approximately -25%, which is indeed a sizable decline. Keep in mind, however, that most of this decline happened gradually, over a six-year period. In other words, it's not as if San Francisco real estate suddenly went on sale. The index did fall at an accelerated rate beginning in late 2007, but the cheap-dollar/foreign-buyer theory had taken root long before then. And when the sudden fall did occur, foreign buying slowed, just as I suggested above. (The National Association of Realtors reported that fewer Realtors were working with foreign buyers in August of 2008 -- when the dollar was near its low -- than in August of 2007.)

The latest index value is 98.6. That represents a discount of 16 percentage points relative to the 2002 peak. Again, that's a sizable discount, but it's not exactly a half-off sale. I'm not saying that foreign demand for San Francisco real estate has not increased, but a discount of that size seems unlikely to have had anything more than a marginal impact. And once you reject that simplistic explanation, the notion that foreign demand will prop up San Francisco real estate starts looking like wishful thinking.