It may be hard to believe, but we’re nearing the 10-year anniversary of the Great Recession.
And as you know, much of carnage was due to the bursting of a real estate bubble — fueled by subprime loans.
In the wake of the crisis, lawmakers swiftly passed the Dodd-Frank Act — which placed tighter rules on lending and the trading of real estate securities.
But on the West Coast, another housing bubble has formed in one of America’s most vibrant cities.
A bubble that not even Dodd-Frank could save.
And as senior analyst Jonathan Rodriguez outlines below, there’s a way for early speculators to capitalize on the downside.
Ahead of the tape,
Chief Investment Strategist, Wall Street Daily
Bay Area Breakdown
The Bay Area of California is home to some of America’s brightest minds and a number of the world’s most valuable tech companies.
This metropolis includes the cities of San Francisco, Oakland and San Jose and nine counties — a total population of nearly 8 million people.
Now, over the last 20 years, the tech-driven economic boom has dramatically improved the economic status of many people who live and work in the area.
But herein lies the problem…
Not everyone who lives in San Francisco is a high-paid tech-sector employee.
And the skyrocketing housing costs are pricing many folks — like teachers and service workers — right out of the city.
Data from the National Association of Realtors show that the median existing home price in the U.S. is $229,900.
In San Francisco, the median home price is $837,500, according to a study from mortgage research firm HSH.
That’s more than three times the national median. It’s also higher than the peak set for the Bay Area before the last housing crisis.
The study also showed that a prospective buyer of a house at the median price would need to earn $160,589.84 to afford it — using a 30-year fixed mortgage rate of 4.1%.
Unfortunately, the median salary in San Francisco isn’t nearly that high…
The Struggle Is Real
According to the latest figures from the U.S. Census Bureau, the median Bay Area household pulls in just $88,518 annually.
To be fair, that’s $30,000 higher than the national average. But a dual-earner household, with each member earning the median, spends nearly half of their monthly gross pay on housing costs (when you include interest, taxes and insurance).
Renters don’t have it much better, either.
The median rent on a one-bedroom apartment in one of American’s 50 largest cities last year was $1,234.43, according to GOBankingRates.
The median rent for a one-bedroom apartment in San Francisco dwarfs that figure at $3,270, according to data from housing site Zumper.
That’s down slightly from 2016. But it still represents the second-highest rent among all cities in America — coming in just behind New York City.
As you can imagine, tech workers — the breadwinners of the Bay Area — can earn far more than the median salary.
But a “median” earner would spend 44% of their gross earnings on a typical single-bedroom apartment in ’Frisco.
A little sobering, no?
The notion is sinking in for many of the wide-eyed young folks who descend upon the area’s universities and companies — attempting to claim their share of the red-hot tech market.
In fact, a recent study of by the Bay Area Council found that nearly half of millennials are considering relocation because of the high cost of living and traffic.
Prepare Your Portfolio for the Apocalypse
What does all this mean for investors?
Well, for one… an exodus of young, productive talent would be catastrophic for the Bay Area’s inflated housing market — especially the rental market.
And all it could take is a downtrend in the tech sector to set off this ticking time bomb.
The easiest way to play the bubble burst? Short a residential real estate investment trust (REIT) with holdings in San Francisco.
AvalonBay Communities Inc. (NYSE: AVB) is one of the nation’s largest apartment REITs, sporting a market cap of $20 billion.
Sixteen percent of its portfolio is located in the Bay Area. And another 41% of its portfolio consists of units in two other pricey metropolitan areas: New York and Los Angeles.
Even before factoring in a massive deflation of apartment prices, the fund trades at 40 times forward earnings — twice the earnings multiple of the S&P 500.
And as interest rates rise, the fund — along with other REITs — will also likely see outflows from income investors who rotate into risk-free bonds.
Speculators looking for an even larger pop on the downside could even buy puts on the fund, rather than short the REIT outright.
Bottom line: The high-priced rents in California’s Bay Area aren’t sustainable without massive increases in salaries outside of the tech sector or a drastic increase in rental supply. And shorting a REIT like AvalonBay allows investors to cash in on the downside.
On the hunt,
Senior Analyst, Wall Street Daily