Rising Interest Rates & Bay Area Housing Affordability

Changes in interest rates affect local, national and international economies in a bewildering variety of positive and negative ways depending on the segment, and there is vehement disagreement as to what rate or rate movement is best, or most dangerous, for whom.


As of Friday, November 18, mortgage interest rates have jumped about 15% since the election, with many economists and analysts predicting more to come in the not too distant future. Federal Reserve Bank Chair Janet Yellen recently suggested that the Fed is close to lifting its benchmark interest rate. However, predicting interest rate changes; what factors might arise to cause movements up or down; as well as the direction, scale and speed of changes; is enormously difficult. Witness the thousands of incorrect expert predictions over the past 10 years. For that matter, rates actually went downafter the Fed last raised rates in December 2015.

This report will focus on a single issue: Increases in interest rates raise the ongoing cost of housing and reduce housing affordability (unless there is a concurrent drop in prices). In the Bay Area, already experiencing significant social and economic ramifications from the high cost of housing at a time of historically low interest rates, this is a big concern, including how it might affect our real estate markets.

The degree of the effect of any interest rate changes will, of course, depend on what actually occurs at what speed, which is beyond our ability to predict. The possible scenarios in this report do not imply any predictions on our part. The first charts below provide some useful context.

Bay Area Home Price & Affordability Trends by County

From 2012 through Q3 2016, Bay Area home prices in most counties soared to new peaks. Affordability percentages dropped dramatically since 2012, but without quite reaching the lows of 2006-2007.

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In this report, affordability is calculated, under the C.A.R. Housing Affordability Index methodology, using 3 main criteria: 1) the county median house sales price, 2) the prevailing mortgage interest rate, and 3) county household income distribution percentages.

Long-Term Interest Rate Movements

The drop in interest rates from 2007, the last peak of market before the 2008 crash, through early November 2016 has been incredible. And the rates prevailing prior to the 2008 crash, in the 6% range, were themselves quite low by prior historical standards. The average annual rate from 1990 through 2007 was 7.4%. Just prior to the recent 2016 election, rates were between 3.5% and 3.6% (with an all-time low of 3.3% hit in 2013). The chart at the top of this report illustrates the sudden post-election pop in rates to 4.125% (11/18/16).

Interest Rate & San Francisco Median Price Changes since 2007

Home prices and interest rates dropped precipitately after the financial markets crisis of September 2008. Once the real estate recovery began in 2012, home prices skyrocketed while interest rates generally continued to bump along at or near all-time lows.

In effect, the big reductions in interest rates subsidized much of the surge in Bay Area home prices: Since the last peak of the market prior to the 2008 crash, to just before the 2016 presidential election, the interest rate for 30-year, conforming, fixed-rate home loans, fell about 43%, from roughly 6.3% to 3.6%.According to the S&P Case-Shiller Home Price Index, overall Bay Area home prices have appreciated approximately 82% since 2012, though, please note, appreciation rates vary widely by specific location and home-price segment. The above chart shows SF median price changes only.

The decline in interest rates was not the only or even the primary factor in the appreciation of Bay Area home prices. The massive increase in employment, much of it high-paid, and the resultant surge in population (without a parallel increase in housing supply), along with the local explosion of new wealth from our high-tech boom, were the primary factors. Still, there is no arguing that plunging interest rates made increasing home prices much more affordable.

These interest rate rise scenarios below do not imply predictions on our part: A top interest rate scenario of 6.3% was chosen simply because that was the rate in 2007, the peak of the last cycle.

Short-Term Interest Rate Movements since December 2015
The same chart that began this report

Post-election increase: Short-term spike
or beginning of a longer-term ascent?

Monthly Housing Cost Scenarios
Illustrated Using the San Francisco Median House Price

Approximate monthly principal, interest, taxes and insurance costs for the purchase of a Q3 2016, median-priced San Francisco house at $1,300,000, using an 80%, 30-year fixed rate loan, at a number of interest rate scenarios.

As seen below, the 15% increase in interest rate from 11/10/16 to 11/18/16 added almost $4000 to the annual housing cost of purchasing a $1,300,000 home. If the rate goes to 4.5%, the increase is about $6700, and if it goes up to 5%, the additional annual cost of housing is over $10,000. Illustrating how declining interest rates help subsidize increasing home prices, the Q3 2016 SF median home price was 45% higher than the previous peak price in 2007, however the increase in monthly housing costs (PITI) was only 14% higher than in 2007 due the big drop in mortgage rates.

Minimum Qualifying Household Income

The below chart tracks approximate household income needed to qualify for the purchase of a Q3 2016, median-priced San Francisco house at $1,300,000, using an 80%, 30-year fixed rate loan, per associated PITI costs, at various interest rates.

As interest rates increase, household income requirements increase. Before the election, buyers needed an approximate income of $251,000 to qualify for financing their purchase of a median priced SF house, with a 20% down-payment. By Friday, November 18, the income requirement increased by $13,000. And if the interest rate goes up to 5% (and again, we are not saying it will), an additional $35,000 in annual income would be required.

Housing Affordability Trends for San Francisco

If housing costs increase, then housing affordability declines. In Q3 2016, the percentage of San Francisco households who could afford to purchase a median priced house, at 14%, was 6 points higher than the all-time low of 8% in Q3 2007. The recent interest rate increase through 11/18/16 drops that another percentage point. If additional rate increases occur, then, all things being equal, San Francisco will continue to move closer to the historic low hit at the peak of the last market cycle. And, of course, the affordability percentages of other Bay Area counties will also drop. (San Francisco, San Mateo and Marin have the 3 lowest percentages in the state, and must be in the running for lowest percentages in the country.)

To what exact degree interest rate changes would affect local real estate markets is unknown. Much would depend on the scale and speed of change as well as other economic trends in the Bay Area – such as high-tech hiring and IPOs coming to market – as well as macro-economic trends in the nation. But it could include a slowing of transaction activity and new construction projects, possible adjustments to home prices, or the continued pushing of buyers from more expensive areas to less expensive ones (including, possibly, those outside the Bay Area). High housing costs are not an easy problem to fix, and increasing interest rates, if they continue, are unlikely to help.
All the statistics and numbers used in this analysis are based on data deemed reliable but should be considered approximations and generalities, most useful in illustrating comparative values and broad trend lines. By definition, half of the homes sold cost less than the median sales price, and greater percentages of households could afford their purchase. Also other property types such as condos are typically significantly less expensive than houses, so they would be more affordable as well. Our gratitude to the California Association of Realtors, and in particular, its analyst Azad Amir-Ghassemi, for all their work on the Housing Affordability Index (HAI). For analyses and scenarios after Q3 2016, the numbers reflect our best estimates based upon our understanding of the CAR HAI methodology, and/or housing cost calculators. None of the interest rate increase scenarios included imply any predictions on our part that such increases will occur. Anyone contemplating purchasing a home with financing should confer with a qualified loan agent and their own financial planners. This report was written in good faith, but may contain errors and is subject to revision.

© 2016 Paragon Real Estate Group

Multiple Angles on a Changing San Francisco Market

Median sales prices usually jump in autumn, to a large degree because of the seasonal increase in luxury home sales, and that is what happened in October. The combined house and condo median sales price was up 6% from October 2015, but substantially unchanged from the previous peak median prices achieved in spring 2015 and spring 2016.

San Francisco Median Home Sales Prices


Median sales prices usually jump in autumn, to a large degree because of the seasonal increase in luxury home sales, and that is what happened in October. The combined house and condo median sales price was up 6% from October 2015, but substantially unchanged from the previous peak median prices achieved in spring 2015 and spring 2016.

Click on the map below to access our updated Bay Area & SF home price maps


The six weeks from mid-September to Halloween constitute the heart of the relatively short autumn selling season, with the market typically going into semi-hibernation from Thanksgiving through mid-January. (Sales still occur during this period and it can be an excellent time to buy with the big drop in competition.) Generally speaking, this autumn experienced further cooling in SF market conditions: October saw significant year-over-year declines in accepted-offer and closed-sale activity, and significant increases in price reductions and listings expiring without selling. Condos appear to be most affected on all these counts, with some decline in condo values: This situation is certainly being exacerbated by new condo projects coming on market at the same time that buyer demand has been softening.

The house market has continued to see declines in listing inventory and to shrink as a percentage of total home sales, thus becoming a scarcer commodity. It has performed much better, especially in more affordable neighborhoods. And sales of luxury houses suddenly spiked dramatically in October, though this appears to have been mostly driven by a huge surge in such listings in September. This jump in expensive house sales drove the median house sales price to its highest point ever in October, to just over $1.4 million. The condo median sales price in October, at $1,150,000 was above that of October 2015, but a tad below its all-time high in June. Please note that median sales prices are not perfect measures of changes in fair market value, since they fluctuate for a number of reasons, including seasonality and significant changes in the inventory of homes for sale.

Bay Area Case-Shiller Home Price Index
Recent price changes by property type and price segment

Case-Shiller Index numbers all refer to a January 2000 price of 100, and track appreciation since then. Thus 243 on the chart signifies a price 143% above that of January 2000.


As mentioned in earlier reports, the highest pressure of buyer demand has shifted in the past year toward more affordable homes, and that is now showing up in the different price movements of low, middle and high-price tier houses. The Case-Shiller Index does not measure median sales price changes, but has its own special algorithm to determine same-home appreciation. This short-term chart illustrates how lower-priced houses have continued to appreciate rapidly, while mid-price and high-price houses have recently more or less plateaued, and condo prices have declined. The Bay Area Index for August 2016 was published in late October.

Chart: Long-Term, Case-Shiller Bay Area Home Price Trends

Link to our complete S&P Case-Shiller Index report

San Francisco Luxury Home Sales
Houses of $3 million+/ Condos, Co-ops & TICs of $2 million+


This report will generally consider houses selling for $3m or more, and condos, co-ops and TICs selling for $2m or more, as constituting the luxury home segment in the city. They total just under 10% of total home sales. For the ultra-luxury designation, houses are bumped up to $5m or more, and condos, co-ops and TICs to $3m or more. These price segments total 2.6% of total home sales.

Pursuant to a big jump in new high-end home listings in September, luxury house sales in October, suddenly hit their highest point in many years, if not ever. This is illustrated in the red line in the chart above. Luxury condo sales reported to MLS, as seen in the blue line, were higher than in October 2015, but far below peaks hit in previous spring selling seasons. However, this does not count new-project luxury condo listings unreported to MLS, which are playing an increasingly large role in the market and creating substantial competition for resale luxury-condo listings.

Below are 2 charts breaking out luxury home sales by city district.



Additional Chart: New high-end listings coming on market

Further Perspective

The past 14 months has seen the Chinese stock market crash, the oil price crash, Brexit, high U.S. financial market volatility, a slowdown in the Bay Area high-tech boom, and enormous election-related anxiety. It is difficult to tell exactly how these events may have affected real estate markets. However, despite significant affordability issues and the transition to less heated market conditions – as illustrated in the analyses of this report – so far, we have seen no sign of anything approaching an impending crash in our local market.

Selected Real Estate Market Statistics
Year-over-year changes by property type and price segment

Listings vs. Sales: The overall inventory of house listings has persisted in declining, while house sales are basically even year-over-year. Condo inventory continues to climb (without including new project condos not listed in MLS), while sales have been dropping.


Percentage of Sales over Asking Price: Condos saw dramatic drops in this metric, illustrating a significant decline in buyer demand and competition. Overall, houses have seen a negligible decline, maintaining a very high percentage of sales over asking price. Luxury houses, as mentioned before, experienced a stronger October market than last year.


Median Percentage of Sales Price over Final List Price: All market segments saw year-over-year drops as buyers refused to overbid list prices on the scale of previous years. However, the general house segment still saw a 9.3% median overbid of list price, which is huge, even considering that some agents are consciously underpricing their listings. The other segments, with overbid percentages shrinking toward zero, are seeing a much greater quantity of sales negotiated below list price. And this does not include the increasing number of listings that are simply expiring, i.e. with no sale taking place.


Sales Price to Original List Price Percentage Overview
All San Francisco residential sales


Months Supply of Inventory (MSI): MSI measures how long it would take to sell the current inventory of listings for sale at the average annual rate of sale. All segments ticked up, indicating some market softening, but the general house market is still well within seller market territory. The biggest change is in the luxury condo market, where inventory has been hitting new highs, while sales have generally been declining, thus putting the segment in buyer market territory. Again, these figures do not include the large number of new-project listings and sales unreported to MLS, which would probably increase the condo MSI readings.


Average Condo Dollar per Square Foot Values by Era of Construction: Newer condos sell for higher average dollar per square foot values than older condos. Generally speaking, in 2016 there has been a tick down in this measure of value, which, as seen in the chart at the beginning of this report, correlates with the conclusion of the Case-Shiller Index as well. According to The Mark Company, which specializes in the marketing of new-construction condo projects (for which statistics are usually not available), average dollar per square foot values for brand new condos have dropped about 8% over the past year. This would presumably reflect the fierce competition between projects to sell out their inventories of units.


The two following charts are from our recent report on the Bay Area Apartment Building market, mostly focusing on San Francisco, Alameda and Marin Counties.

Median Sales Prices for Multi-Unit Properties
by building size and submarket


Average Asking Rents by Bay Area County


Rent rates in San Francisco have been dropping in 2016 after peaking in 2015, with estimates of the decline generally running in the range of 3% to 6.5%, but with some city rental agents saying that certain districts have seen slumps of more than 10%. We believe there are 3 big factors at work: a rush of large, newly built apartment buildings coming on market; a softening of demand as hiring trends have fluctuated; and affordability issues that have caused more prospective renters to simply turn away from living in the city, their first choice, and look elsewhere. However, even with the recent decline, the city still has the highest rents in the country.

Link to our full Apartment Building Market report

Link to our full Rent Trends report

Our Best Autumn Ever

We hope you will forgive our celebrating the fact that Paragon, which opened its doors in 2004, represented buyers and sellers in closing more in San Francisco home sales in October than any other brokerage. [Total dollar volume residential sales reported to MLS, per Broker Metrics.]

These analyses were made in good faith with data from sources deemed reliable, but may contain errors and are subject to revision. It is not our intent to convince you of a particular position, but to attempt to provide straightforward data and analysis, so you can make your own informed decisions. Median and average statistics are enormous generalities: There are hundreds of different markets in the Bay Area, each with its own unique dynamics. Median prices can be and often are affected by other factors besides changes in fair market value, and longer term trends are much more meaningful than short-term. It is impossible to know how value statistics apply to any particular home without a specific comparative market analysis.

© 2016 Paragon Real Estate Group