The coming Foreclosure Wave in San Francisco

San Francisco has largely been protected from the catastrophic price drops that other Bay Area counties have been suffering. The arguments for San Francisco not suffering a similar downturn is partly that we have very restrictive zoning laws that don't allow any new construction over existing building heights in the majority of neighborhoods. However, the SOMA, South Beach & Mission Bay neighborhoods have been approved for thousands of new condos in dozens of buildings in the recent past and in the near future. So the supply and demand differential is far different in the south eastern part of town vs the northern parts of San Francisco.

However, a large supply, with more slated to come on the market, is only one part of the problem. The other is that the prices that Buyers of new or newer building condos paid made no sense. I expect to take some heat on that comment, not because it isn't true, but because it is easy to make that comment in hind sight. But you'll just have to trust me on this. I walked into many buildings dating back to 2004 and saw prices that matched those of the best properties in Pacific Heights and Russian Hill. In fact, as I watched only a handful of the most special properties in the north end of town reach $1,000 per SqFt, I seemed to be finding far more places asking $1,000 per SqFt in SOMA including condos that were eye to eye with Bay Bridge on-ramps, complete with 24/7 traffic noise and the resulting dirty windows.

One of the buildings that I predict will have a steady stream of REO's and Short Sales is The Beacon (250 & 260 King). Back in 2005 a colleague of mine was selling condo after condo in The Beacon, and it stumped me. I mean I like the location, especially since I'm a huge baseball fan, and because it's got phenomenal access to commuting (Caltrains and the 280 on-ramp) and it's got great access to shopping (Safeway & Borders among others in the building) and bars/restaurants (District across the way - although that hot bar wasn't even a gleam in the owners eyes when the building went on sale). But the building was original built as rentals, it was situated on leased land, none of the parking spots were deeded, there is no air conditioning in the condos... overall, there was nothing special about the building, only the location.

Yet prices were $800 per SqFt, above most of the condos I was visiting at the same time in the Marina, Cow Hollow, Russian Hill, Pacific Heights and so on. So I asked my colleague what was going on at the building that I was missing. I'll have to do a poor job of paraphrasing because I dismissed her comments at the time, but she claimed it was a great opportunity, a great building, and that the coming neighborhood amenities would cause prices to keep going up. I dismissed that because prices already seemed ABOVE where I would have expected them to be AFTER the neighborhood became what she was predicting.

The more I visited SOMA, South Beach and Mission Bay, the more I came to believe in my "new car" theory. That the Condo developers were pricing the condos like a hot new car... Buyers were buying them because they had the new car smell... and as soon as they drove the car off the lot it depreciated by 10%. You can always buy last year's model for a significant discount to the new model, yet there always seem to be plenty of people who just have to have the new car (although even that is changing in America today).

In real time (back then) the moment The Beacon came onto the market, 140 South Van Ness was last year's model. Then The Palms (555 4th St) came on the market and no one wanted The Beacon any more. When One Rincon Hill came on it was all the rage even as softness in the market started to become evident. Once The Infinity came on no one seemed to care anymore about One Rincon, and now phase 2 of The Infinity has just hit the market, so phase 1 is "last year's model" and any re-sales will be at least 10% below what the original Buyer paid.

The prediction for a coming wave of foreclosures and short sales is easy to make because it's already happening. There are 2 for-sale REO's in The Beacon right now (see the below post) and 1 each at 140 South Van Ness and The Palms. And virtually anyone who has ever bought in any of the three buildings, except maybe those who have purchased in the last couple of months (and even some of those are already under water) will be so far under water, that they will have to come up with money in order to Sell for many years to come.

Again, the 2004 to 2007 prices paid were basically "tomorrow's prices" and by tomorrow I mean some future expectation of the neighborhoods and market. The original owners at 140 South Van Ness are more protected because they bought in 2003, but the '05 and '06 buyers are already well under water. But at The Palms and The Beacon, the condos depreciated the moment they were "driven off the lot", and since then the market has dropped from 10% to 20% or more.

I expect it will be close to 10 years before they get back to their levels they paid. If I am right, then EVERY sale in all three buildings will be some sort of "distress" sale. Either a Short Sale or an REO, and anyone who can afford not to sell will eventually become a stress sale, or will add to a growing number of rentals in these buildings which drive down rental rates, adding to the burden of those who always meant to use them as investments.

Finally, one distressed sale leads to another as the prices keep coming down until Buyers see them as deals. Current owners see the low sales prices and realize they are paying more on their loan then their condo is worth, and some will purposely short sell or allow themselves to be foreclosed upon to get out. If that happens, it becomes a snow ball effect of ever decreasing values. Devaluation happens when Buyers expect tomorrow's prices to be lower than today's, and if every buyer sits on the sidelines waiting, it will take enormous discounts to move any Condo. The lower the prices, the more likely home owners who paid higher prices will want to cut their losses. That is likely to eventually even impact the 2003 buyers at 140 South Van Ness.

At some point the prices will be so low that new buyers will snap up the condos, but that level is likely to be far lower than today's prices.

Could this be stopped? Well, there are possibilities. For one, all new construction is already coming to a halt thus limiting supply. The counter to this is that I estimate that there is probably about an 18 month supply of Condos in the area (what is on the MLS, what the new buildings are selling off the MLS, and those owners who are waiting for the Spring market hoping for a more robust market). So it will be a year and a half of downward price pressure which I think will keep the supply in the 18 month range until prices are so far down that investors and former renters jump in with both feet (ala Contra Costa and Solano counties today - prices down 40% while sales are up 100%).

The government could also step in with 4% 30 year fixed mortgages, or increase the new $15,000 tax credit to a far larger number, or force banks to do principal reduction in their loan modifications. But the government seems to be stuck as they always are. Of course the economy could do a dramtic turn around and the days of easy money could return... but don't hold your breath on any of the above.

One 2BR REO at 140 South Van Ness recently sold for $580,000, one at The Palms sold for $590,000. Expect these sales to just be the beginning, and if that ends up being true, the prices will be lower as time goes on.

1 comment:

  1. Anonymous4:06 PM

    I check out the Propertyshark.com foreclosure listings each week because it's free to look and really very few occur in San Francisco. http://www.propertyshark.com/mason/Foreclosures/index.html?lcl=san_francisco Santa Clara County is another story...