San Francisco homeowners shouldn’t expect to get rich from tech IPOs. There seems to be blockbuster tech IPOs every year. But it’s good not to expect to get rich from them.
The default assumption is that these tech IPOs will bring in huge demand and drive SF Bay Area real estate prices up. After all, these soon-to-be public companies are worth billions and employ tens of thousands of sub-35 year-old-employees looking to finally buy a piece of the American dream.
As an owner of three properties in San Francisco and one property in Lake Tahoe, I’m pretty excited about seeing money from from the sky as well!
Alas, I’m afraid the tech IPOs are being overhyped, and we’re in the classic top of the market mania. Why else are so many companies trying to rush to IPO all at once?
So many people thought they couldn’t lose in 2007 and lost BIG TIME. Let’s see if we can tame the mania and look at the downside of all the new tech IPO demand.
For San Francisco Homeowners, New Demand Is Overrated
Demand for new housing won’t be as high as the mass media claims it to be (tens of thousands of new tech millionaires wanting to buy homes).
Let’s go through an exercise to ascertain what the realistic incremental demand is for housing from tech IPOs.
- The median home price in San Francisco is about $1.5 million. In the SF Bay Area, the median ranges from around $800K in the East Bay up to $3.1 million in places like Palo Alto.
- To feel wealthy enough to buy an above average/median home and have money left over to pay for life, let’s assume a $1 million after-tax windfall from the IPO.
- 99% of the employees are not highly-comped execs, but 35 and under employees making less than $300,000 a year all-in, a middle class lifestyle for the Bay Area.
- The average employee has been with the company for two years.
- Given the average startup employee is underpaid on salary due to stock compensation, the average startup employee does not already have a 20% downpayment for a median-priced home.
- The average employee’s option strike price is higher than zero since the vast majority of employees didn’t join at the beginning.
- The tax rate on the exercise of options after the IPO lockup period will be approximately 50% total to account for state and federal taxes. For them to become windfall millionaires, they would have to sell at least $2M in options. Of those with this optionality, I suspect only a small percentage will enter the housing market. Let me explain.
Tech IPO Influx Example
Let’s say the company IPOs at a $20B valuation like Lyft. To get $2M in proceeds the employee must liquidate 0.01% (1 basis point) ownership in the company.
Now let’s go back to our assumptions. If they’ve been there two years at IPO time and they want their money within a year of IPO, they’ll only have vested 3/4 of their initial 4-year grant, which means they must have been granted 1.33 basis points ownership.
Further, given their strike price isn’t zero, even with ballistic growth since joining two years ago, they’ll need an even higher grant than 1.33 bp. Let’s call it 1.5 bp (0.015%).
The employee option pool size at this stage is typically around 15%. And of course, they’re not distributed evenly. At a $20B company there are probably 500 – 1000 employees who could end up owning 1-1.5bp on average.
So at a $20 billion valuation post IPO, if its value holds in time for employees to sell usually 6 months after IPO, the IPO may yield 1,000 eligible buyers with $2-3 million gross / $1-1.5 million after-tax, assuming they sell ALL their stock. But most employees don’t sell all their stock.
What Is The Real Demand For San Francisco Homeowners
Now multiply these 1,000 people by the percentage of how many will actually enter the real estate market with this money in the ensuing year. If 50% want to buy property, that’s 500 eligible buyers. If 20% want to buy property, that’s only 200 eligible buyers.
If we add up the total projected public values of Uber, Lyft, Airbnb, Palantir, Pinterest, and Slack, we’re talking about a total public value of roughly $200B from 2019 – 2020.
Therefore, one can make an educated guess there will be roughly 10,000 eligible buyers and anywhere between 2,000 – 5,000 high intent buyers,resulting from all these IPOs over a two year period.
These 2,000 – 5,000 high intent buyers with $1 – $1.5 million in cash after tax are therefore looking for properties worth between $1 million – $7.5 million based on a 20% – 100% downpayment.
But how does 2,000 – 5,000 new buyers compare to supply? Supply is the key to all the hoopla, which the mass media and realtors conveniently don’t mention.
Housing Inventory Could Surge Further
The SF Bay Area real estate market cooled off in 2018. Some tech companies like Nvidia, Facebook, and Apple lost 20% – 40% of their value, even though the S&P 500 was only down about 6.4%.
A correction was bound to happen as price growth outstripped wage growth for so many years.
Check out this price chart by Compass, the largest real estate broker in SF. Notice how the median price peaked in early 2018 and is down 11.5%.
At any given time, there are between 6,000 – 8,000 homes for sale in the San Francisco Bay Area. In March 2019 there were 7,792 homes for sale in the Bay Area, up from 6,233 a year before according to Zillow, +25% YoY.
In the San Jose sub area, there were 3,011 homes for sale in March 2019, up from 2,102 the same time a year before. That’s an almost 50% YoY increase in inventory folks.
San Francisco Real Estate Inventory Increased
Check out this chart below that shows how the inventory of homes for sale is spiking in the Bay Area. We’re at 7-year highs, and the number looks to be going higher as sellers try to cash in.
Supply is surging higher because more homeowners are cashing out after a 10 year bull run. The SF Bay Area population is aging and the area is becoming congested, homogenous, and unaffordable, even for most tech workers.
Further, there is a demographic shift away from the SF Bay Area to the heartland of America because costs there are much lower. Cities like Austin, Houston, Dallas, Salt Lake City and Memphis have thriving tech and startup scenes now. There is no monopoly on innovation.
When you can get a house 3X as big for 70% less in Austin, Texas, while also earning a similar amount of money, it’s go time!
Massive Potential Increase In Supply
Sure, all these new tech company IPOs over the next couple years employ ~35,000 people (Uber ~13K, Airbnb ~11K, Lyft 2K, Palantir ~3K, Slack ~1K, Pinterest ~1K, etc), some of whom will want to buy real estate.
But the SF Bay Area has 7.6 million residents, some of whom will want to take advantage of the new tech IPOs and sell their real estate.
Let’s say only 20% of the 7.6 million people own their homes since ~15% of the population are kids and there are dual adult households. That’s still 1.52 million homeowners who might want to consider cashing out versus 35,000 new tech IPO employees who might be able to buy.
And frankly, closer to 44% of Bay Area residents own homes. I’m just trying to be conservative.
In other words, the ratio of potential sellers to potential buyers is 43:1 in this scenario (1.52M to 35K).
Crunching The Numbers
Even if we more conservatively assume only 10% of the 7.6 million Bay Area residents own their homes, and there are 100,000 tech company IPO employees all living in the Bay Area, the ratio of potential sellers to potential buyers is still 7.6:1 (760K to 100K).
We can drill down further and estimate the high intent to sell sellers out of the 760,000 – 1,520,000 estimated homeowners in the SF Bay Area, which is already a conservative figure.
Even if just an additional 5% of SF Bay Area homeowners decide to list their homes over the next couple of years, that’s an extra 38,000 – 76,000 in new supply flooding the market compared to 2,000 – 5,000 high intent buyers based on $200 billion worth of tech company IPO value.
Therefore, the ratio of potential sellers to potential buyers still ranges from 7.6:1 to 38:1. Even if we double the high intent buyer count to 10,000, supply still far outweighs demand.
Supply Overwhelms Demand
If you still can’t see how supply can overwhelm demand, here is a classic supply and demand chart for your review. I was an economics major at The College of William & Mary and got my MBA from Berkeley for what it’s worth.
The initial price point equilibrium is where S1 (supply) intersects D2 (demand) to get P1 (price). With all the tech company IPO hoopla, the default assumption is that demand shifts up from D1 to D2. As a result, real estate prices increase in the short-run to P2 as FOMO buyers go all-in at or close to the peak of the market. Time frame: next 12 months
But as prices rise, supply rises to match demand as more homeowners get tempted to cash in. With more listings on the market, S1 shifts down to S2 and prices temporarily get back to even. Time frame: in 12-24 months
However, what I’m arguing is that there’s a good chance the tech IPO hoopla will awaken a slumbering bear of 760,000 – 1,520,000 homeowners in the SF Bay Area who flood the market with new supply. In such a scenario, the supply curve shifts from S1 to S3. Time frame: in 12 – 30 months
When D2 intersects S3, real estate prices end up lower than during the initial D1 and S1 intersection equilibrium.
Things Could Get Worse
But things could get even worse given how slowly it usually takes for homeowners to read headlines, contact an agent, prepare their home for sale, and then list their home on the Multiple Listing Service.
The Johnny-come-latelies would create even more supply past the new equilibrium, thoroughly overwhelming demand. As the inventory of homes piles up, more price cuts are an inevitability.
As prices decline to P4, homeowners, home sellers, and the mass media start to panic, causing even more pricing pressure. This is how real estate cycles form, and partly why a recession might appear by 2021. Time frame: in 20 – 36 months.
San Francisco Homeowners Are Getting Wealthier Again
Post-pandemic, the San Francisco real estate market held up well. I’ve been tracking single family homes on the west side of San Francisco since the pandemic began.
With San Francisco opening up as we reach herd immunity, people are rushing back to the city in droves. Rental prices are ticking up as well.
The median San Francisco home price is now at a record $1.86 million. It’s good to get neutral San Francisco real estate by owning your primary residence at least. Then, consider investing in the heartland.
Buy A San Francisco Home, But Invest Elsewhere
Buy a property to enjoy life and make great new memories. If you foresee owning your home for at least 10 years and the cost makes sense after putting at least 20% down, then go ahead and buy. Just don’t expect to get rich buying at this point in the cycle.
If you want to buy in San Francisco, I believe Golden Gate Heights is the best area to buy property right now. It’s all about buying a home with panoramic ocean views, which trade at massive premiums everywhere else in the world, except for in San Francisco, at the moment.
If you want to make money investing in real estate, you should invest in areas outside the SF Bay Area where the cap rates are 3-5X higher and valuations are 70%+ cheaper.
Best Real Estate Investing Platforms
The easiest was to invest passively in non-coastal city real estate is through real estate crowdfunding site Fundrise, if you are not an accredited investor. They’ve got a great platform with many pre-vetted properties where you can invest as little as $500. Fundrise is the creator of the eREIT asset class to gain real estate exposure.
My other favorite platform is CrowdStreet, largely for accredited investors with more than $1 million net worth outside their primary residence. CrowdStreet primarily focuses on deals in 18-hour cities where valuations are lower and cap rates are higher.
I’ve personally invested $810,000 in real estate crowdfunding with a target return of between 10% – 15% after selling one of my SF rental properties recently. It feels great to be diversified and not have to manage tenants.
I plan to hold my other two SF rentals and my primary residence given I have to live somewhere. I just don’t expected to see a significant boost to my net worth thanks to the tech IPOs. It would be nice, but I’m not counting on it.
Please buy responsibly! If you don’t have at least 20% down and a 10% cash buffer, you cannot afford to buy a house in the SF Bay Area.
Don’t Forget To Refinance Your Mortgage
Check Credible for the latest mortgage rates and refinance if you can! I did, at 2.625% for a 7/1 ARM with no fees. I’m a buyer of San Francisco property here. The S&P 500 has come back and there are deals to be had from scared sellers.
About the Author: Sam worked in investing banking for 13 years at GS and CS. He received his undergraduate degree in Economics from The College of William & Mary and got his MBA from UC Berkeley. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $250,000 a year in passive income. He spends most of his time playing tennis and taking care of his family. Financial Samurai was started in 2009 and is one of the most trusted personal finance sites on the web with over 1.5 million pageviews a month.