Jobs and Home Prices

San Francisco home prices have finally started to soften. With interest rates hitting record lows, buyers are sensing opportunity and are starting to come out of the woodwork. Are they too early? Will prices remain soft, or will record-low mortgage rates and massive federal stimulus drive them back up?

A look at the economic fundamentals suggests that San Francisco home prices have further to fall. Exhibit A is the divergence between home prices and household incomes, which I addressed in an earlier blog entry. But home prices can diverge from 'fair value' for long periods of time, as every Bay Area resident knows -- you could grow old waiting for the fundamentals to reassert themselves. Most buyers want to know what's likely to happen in the next year.

If you want to predict home price fluctuations over the next twelve months, it makes sense to consider input variables that fluctuate on a similar timescale. That suggests that we consider interest rates, stock prices, and the local job market. I'll consider interest rates and stock prices in future blog entries. For now, let's focus on the job market.

The technology industry is the engine of the Bay Area economy. In 2006, 25% of all new office leases in San Francisco were signed by tech companies. Lately, however, the technology engine has been sputtering. The NASDAQ Composite Index fell 40% during 2008. More or less as a consequence, venture-backed IPO's hit a 30-year low last year. That can't be good news for jobs. Economic forecasting company Global Insight expects that the Silicon Valley region will lose 26,000 jobs in 2009.

That's far better than the post-dotcom experience (when the valley lost 200,000 jobs), but it's much worse than we're accustomed to. It may be too optimistic as well, considering what's going on in the broader economy. According to a November survey conducted by the Bay Area Council, roughly 40% of Bay Area companies are considering layoffs in 2009. The national employment numbers announced last Friday were dismal -- 524,000 jobs were lost in December, and the unemployment rate jumped to a 16-year high. According to yesterday’s Wall Street Journal, total hours-worked declined by 7.7% in the final quarter of 2008; that’s the largest drop since 1975.

The near term impact on home prices is likely to be negative. How could it be otherwise? Most people remember that home prices took off when the Fed lowered interest rates in the aftermath of the dotcom meltdown. That memory is not quite accurate. Take a look at the chart, below, which shows Bay Area home prices (left axis) along with Bay Area unemployment and 30-year mortgage rates (right axis).

The Fed started lowering interest rates at the end of 2000, as unemployment rose. Bay Area home prices did eventually respond to the lower rates, but not until 2002, when the local job market had stabilized. During 2001, when Bay Area unemployment was doubling from 3.5% to 7%, home prices fell by roughly 5%.

I'm not suggesting that we're in for a repeat of the post-dotcom experience. (For starters, San Francisco home prices have already fallen much more than 5%.) What I am suggesting is that the record-low mortgage rates and the massive federal stimulus packages won't start pushing home prices back up until the job market stabilizes. Judging from what we're reading in the press, that's still some way off.