Why San Francisco real estate is actually pretty affordable

TL;DR: High cost city real estate looks expensive, but when you dig into the numbers you realize that the prices are relatively affordable for the residents living there. This is because they earn more, and also because most costs of living (outside of housing) remain relatively flat no matter where you are in the country. So as you earn more, you can afford to put more of your income toward housing. This is definitely what we’ve seen in San Francisco, and I expect that the trend will continue for the foreseeable future.

Yes, I said it. Real estate in SF is actually more affordable, and certainly more sustainable than most would think. While prices are stratospheric – averaging ~$1M in 2017, vs. the US average of ~$200K – they aren’t out of reach for the folks living and working in the area. This is the result of two things:

  • Very high earning potential
  • The fixed cost of most living expenses

The truth is that the cost of living for most items other than housing remains relatively fixed wherever you live in the country (there’s some good data here documenting that as well). Healthcare, food, transportation, technology… all of those things are similarly priced whether you live in San Francisco (SF) or Kansas City (KC). The result, is that when a given region experiences great prosperity with rising wages, the majority of that wage growth gets funneled toward housing, resulting in housing price growth that outstrips earnings growth. In short, a little extra earnings, on the margin, will drive a lot of housing price growth – this ‘fixed costs, marginal gains’ interaction is one that exists in many walks of life, and real estate price growth is a great example of it playing out in the high growth cities across the country. The key takeaway is that the growth in housing prices is still affordable given the complete financial picture.

Let’s compare

To illustrate let’s take a look at two households – one in SF and another in KC. Let’s assume they each earn in the 5th percentile of household earnings for their respective region. In SF, that’s ~$350K / yr, and in KC that’s around $183K / yr. If we assume the SF family has a $1.5M home, and the KC family has a $400K home, we get the following results:

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Source: Ramen Retirement Cost of Living & Affordability Comparison

The SF household has ~2X pre-tax and after tax earnings. When it comes to cost of living, the SF housing line item is ~3.5X more expensive ($98K/yr vs. $28K/yr). But… their ‘other’ living costs which include technology, transportation, healthcare, food, and entertainment, are basically the same. The result is that total cost of living in SF is only 89% higher than KC. Given that after tax income is 109% greater, and costs are only 89% greater, the result is that the SF household saves ~2.5X more after tax money per year than the KC household ($76K vs. $29K). Even as a percent of after tax income, the SF household is saving more.

Which household is better off?

Yes, the SF household is spending ~42% of after tax income on housing compared to the 25% spent by the KC household, but the other fixed costs of life offset that difference. So you tell me, which household is better off in this example? The SF household is saving more after tax in both absolute dollars and as a percent of earnings. In that context, it’s hard to argue that the SF household is burdened by their housing costs, because it seems to more than make up for it through earnings.

On the flip side, a $400K house in KC could be a nice home in the city, or a mini mansion in one of the suburbs, with abundant space for kids to play, and good public schools. A $1.5M home in SF is basically a starter home, 3 bed, 2 bath, 25 square feet of street frontage with a modest back yard, and I haven’t included the cost of sending your kids to private school, which feels almost like a necessity given the broken ‘busing’ program the city has chosen to perpetuate. So I suppose it all comes down to tradeoffs and preferences.

Is this sustainable?

But winning or losing aside, are the housing prices in SF sustainable? It doesn’t feel like the SF household is burdened by the higher housing costs. Certainly if their earning power remains the same they should be just fine. So it becomes a question of whether you believe the drivers underlying the job and wage growth in the region will continue. The main driver is the technology companies, with 4 out of the 5 FAANGs headquartered in the region, along with the top venture capital funds, and the entire ecosystem that goes along with starting and growing new businesses. Given the size and momentum of this technology machine, it seems hard to believe that freight train will be slowing down anytime soon. These technology companies have a license to print money with their relative monopolies. The amount they can afford to pay their employees still hasn’t hit the ceiling yet. So even while it feels like it will be hard for wages to continue their stratospheric rise, it’s also hard to believe that things will cool down in a meaningful way. Certainly, companies and employees are starting to move to lower cost locations, and that will help to temper future price growth, but the long term trajectory still remains up and to the right.

So to wrap things up, digging into the details is important to understand the true dynamics of any real estate market. Rules of thumb are useful, but not always applicable to every situation. SF real estate is actually pretty affordable in this context, as long as you’re one of the high wage earners working in tech. Admittedly, if you’re not part of the tech bandwagon, then the area starts to look downright unaffordable. Even doctors and dentists living in SF feel like it’s difficult to get by, and they’re right! If you’re only earning $150-200K per year, you can barely afford a condo, let alone a starter home. I can’t imagine what the math would look like for a teacher or firefighter. Moving outside the city to the surrounding suburbs is an option, but it’s not that much cheaper out there, and the commuting lifestyle in the Bay Area is nothing short of a shit show. In this context, it’s understandable why people are leaving the Bay Area and California entirely. Other parts of the country offer a much more reasonable balance of earning potential and cost of living, if you’re operating on a more modest middle class income.

That said, I wouldn’t expect to see a material decline in SF real estate. As an old-time SF real estate investor once told me, SF has always felt expensive to buy. Even back in the 70’s it felt expensive. It will probably remain that way, and it will probably continue to grow, backed by the huge technology momentum, and general desirability as a place to live, work, and play.


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