July 18, 2016

Home Prices in San Francisco… Decreasing???

In April, 2016, Business Insider published this article which had a headline that was sure to garner some attention from anyone who knows anything about the high cost of living in San Francisco. The article itself is a fairly incomprehensible amalgamation of quotes and data points, so I wanted to take some time to try to unravel its economic points here.

The main thrust of the article seizes on the observation that “house prices fell 1.8% year-on-year in March, the first such drop in four years.” The first takeaway from this is that it may be an indicator that the extremely hot San Francisco housing market is cooling down. To investigate whether this is the case, you should probably be asking yourself, what economic reasoning would produce this result. A decrease in prices could be the result of a decrease in Demand, an increase in Supply, or some combination of the two. I’ll examine the likelihood of either of these scenarios based on the information provided in the article, and then entertain a few other possibilities which should be explored.

A decrease in demand (whether due to people exiting the San Francisco housing market, a change in taste for San Francisco housing, or some other undisclosed reason) would, ceteris paribus, result in a lower quantity of housing demanded as well as a lower equilibrium price for the average unit.

This is a possible cause, and receives support from the quote in the article where the Chief Economist for Redfin talks about the reduction in listings which were subject to a bidding war. However, the article then immediately switches gears by implying that San Francisco has an “undersupply of housing coupled with a healthy demand.” If this is truly the case, then that “healthy demand” would be maintaining or even increasing the level of demand, leading to the opposite result in terms of price and quantity changes.

If Demand isn’t the main cause of lower prices, then surely it must be due to a change in Supply. More specifically, lower prices would be caused by an increase in Supply, which would also lead to an increase in quantity supplied.
Whether we consider this increase in supply to be newly built homes, or simply an increase in the number of homeowners who are considered in the market to potentially sell their homes, an increase in Supply would contribute to lower home prices. However, the article once again contradicts itself, noting that “there simply aren’t enough homes for sale…” and “many sellers are sitting this year out.” The quotes would suggest, if anything, a decrease in Supply, which would actually result in higher equilibrium prices.

So if we can’t be sure whether year-over-year decrease in housing prices is attributable to a change in Demand or Supply, how should we proceed? One option is to consider whether the market is truly in a long-run equilibrium state. It may be that the market is still adjusting to find the correct price for these homes, and therefore does not meet the assumptions used above. Another thing to note is that the data-point used to generate the article in question is simply that -- one data-point. In order to determine whether market forces are contributing to a true and sustained decline in home prices in this area one would want to examine many more data points and possibilities. Long-run trends in home prices and other contributory factors should be examined, to determine whether a slight decreases in one month compared to that same month one year before are truly indicative of a changing market. For instance, it could be that the homes that happened to be sold the previous year were larger and/or higher quality than those sold this year, which would lead to a lower average sales price, even if overall prices were still increasing. All in all, I’m not as confident as the author of the article is to conclude that “[h]omebuyers are so fed up with San Francisco’s crazy housing market that prices are now falling.”

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