How the Surge of Hot Money Pushes San Francisco to the Brink

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Wolf Richter   www.wolfstreet.com   www.amazon.com/author/wolfrichter

The median home price in my beloved and crazy San Francisco – that’s for a no-view two-bedroom apartment in an older building in a so-so area – after rising 13.3% from a year ago, hit an ultra-cool, slick  $1,000,000.

It made a splash in our conversations. People figured that nothing could to take down the housing market. Yet, as before, there will be a devastating event: the moment when the billions from all over the world suddenly stop raining down on San Francisco.

Every real-estate data provider has its own numbers. The Case-Shiller placed the peak of the prior bubble in “San Francisco” in June 2006 with an index value of 218, well above the current index value of 191. Though named “San Francisco,” the index covers five Bay Area counties that include cities like Oakland and Richmond where home prices, though soaring, haven’t gone back to previous bubble peaks.

The $1,000,000 that DataQuick, now part of CoreLogic, came up with is for the actual city of San Francisco. In the data series, San Francisco’s prior housing bubble peaked in November 2007 when the median home price hit $814,750. People thought this would go on forever, that San Francisco was special, that the national housing bust would pass it by. A month later, the median home price plunged 10%.

It was the beginning of a terrible bust – the moment when money from all over the world stopped raining down on San Francisco. Real estate here lives and dies with the periodic storm surges of moolah from venture capital investors, IPOs, and corporate buyouts.

Now we’re in another storm surge. The Twitter IPO transferred billions from around the world to Twitter investors and employees in the city and the Bay Area. When Facebook acquired Whatsapp for $19 billion, its 55 employees and some investors started plowing some of this money into the local economy, money that didn’t come from heaven but indirectly from Facebook shareholders. In the current climate, hundreds of transactions, large and small, take place every month, including a slew of IPOs. That’s the great hot-money-transfer machine. And San Francisco sits at the receiving end.

There are some drawbacks, however. Number one, it won’t last. It just prepares the way for the next bust. Number two (and in the interim), it forces out real businesses with real revenues and profits. And it drives out people who find themselves – though well-employed – financially unable to live here any longer.

Take the story of Bloodhound that was catapulted into the limelight by ValleyWag. In January 2013, a Series A round brought its total funding to $4.8 million, based on its conference app, an “ambitious vision to fundamentally change how buyers meet sellers,” as TechCrunch put it. “Its hardcore dedication to product and the fact that it can reuse everything it builds puts it leagues ahead of….” Etc. etc. The article was dripping with startup hype.

Companies like Bloodhound are flush with money from investors and have no need to make revenues or profits, and they have no clue how to manage expenses, or that expenses even need to be managed, and there’s nothing to constrain them in any way and force them to be prudent with investors’ money. Armed to the teeth this way, they dive into the local real estate market.

As the startup bubble in San Francisco was coming to a boil, and billions started showing up in bits and pieces, landlords began lusting after this money. And so in October 2012, the Million Fishes Art Collective – “an incubation program” for artists – was not able to renew its lease on a 10,000 square-foot space on Bryant Street at 23rd Street, in the Mission, which had been an iffy area and therefore affordable. After ten years, Million Fishes was gone, and so were the artists and the shows that had been open to the public. It reportedly had been paying over $13,000 per month.

The space was prepared for a startup armed with hype, hoopla, and Series-A money piped in from VC-fund investors around the world. Along come Bloodhound with whatever remained of its $4.8 million in funding. It signed a 5-year lease for $31,667 a month in rent and $564 in fees, or nearly 150% more than Million Fishes had paid. The neighborhood wasn’t amused, but hey, big money rules, and it was a done deal.

So Bloodhound was blowing $387,000 a year on rent, and it didn’t care because expenses were no objective because profits weren’t even on the horizon. It was just building a thingy that would forever change the world. But now Bloodhound is gone as well. Stopped paying rent, ran out of money, just packed up and disappeared. ValleyWag reported:

When emailed for comment, Bloodhound co-founder Anthony Krumeich simply stated “We moved out of the office. No longer fit our needs.” However court documents indicate Bloodhound has gone AWOL and abandoned their office. The landlord’s attorney has not been able to issue the company or its founders a summons….

Bloodhound didn’t change the world. But its hot money changed San Francisco. It helped drive up rents. Each transaction impacts a number of future transactions via the multiplier effect. This scenario is repeated over and over. Enterprises with real cash flows are pushed out because they can’t compete with the hot money that briefly comes into town looking to multiply itself.

But occasionally, it goes too far, even for San Francisco. A little while ago, Pinterest jumped into the fray. It has raised $800 million so far, and sports a valuation of $5 billion, but has no noticeable revenues, doesn’t even dream of profits, and has no idea how to control expenses – and no need to. Armed with this distorted attitude and hundreds of millions of dollars in global hot money, it set its sights on the beautiful, historic 600,000 square-foot San Francisco Design Center at 2 Henry Adams St., where 77 design businesses were plying their trade the hard way by generating the cash flow necessary to sustain themselves.

The Design Center’s owner, according to the SFGate, “had sought to take advantage of a city zoning ordinance that allows owners of designated historic landmarks to change zoning from so-called PDR – production, distribution and repair – to traditional office space. That would have allowed Pinterest to locate its offices there.” The tenants would have been booted out in favor of a company that had no reason to care about how much money it blew on office space. Alas, after an uproar, the Board of Supervisors Land Use & Economic Development Committee voted to table the matter indefinitely.

The ratchet effect continues as each transaction impacts future transactions, pumped up by hot money that doesn’t care about actual expenses and profits. And the space Million Fishes had leased for $13,000 a month, and that Bloodhound had leased for $31,667 a month, went back on the market, ValleyWag reported, at $37,500 a month.

This too is happening to homes where one sale price of one home impacts the price on average of 60 others via the multiplier effect [How Wall Street Manipulates The Buy-to-Rent Housing Racket]. That’s how the median home price of $1,000,000 came about: powered by hot money that follows hope and hype about the next big thingy that will change the world. As before, someday the hot money will suddenly evaporate, with devastating effect. To pinpoint that moment, we just have to watch the IPO market. When it blows off its top, so will San Francisco.

UBS is already preparing for that moment. The world’s largest wealth manager is “very worried” about “the lack of liquidity” that could wreak havoc during the expected sell-off. So UBS reduces risk “over the full spectrum of assets.” Read…. UBS Warns Everything Is Overpriced, Prepares For Sell-Off