Is Bay Area Real Estate in a Bubble?

I experienced the “Dotcom Bubble” during my days as a university student. Everyone—from faculty to classmates to the janitors—day traded and gave investment advice. Professors even gave stock tips during Econ lectures.

 The new economy made euphoric promises of endless profits because, as everyone was just starting to figure out, the Internet would change the game forever. Days after making my initial wire transfer to ETRADE, my portfolio doubled off a biotech stock I identified on Yahoo Finance. While speculative bubbles like the Dotcom are inevitable and unpreventable, the crashes that follow serve as lessons to protect investors and prevent the same thing happening again to rookie investors.

What the hell is happening to apartment valuations?

We all use different measures to value apartments. You can find the main apartment valuation models described in more detail in my previous post where I discuss multifamily valuation models for Oakland apartments. Despite the variety of approaches different investors may take, we know that bubbles occur in well established markets when a large group of investors depart from traditional valuation methods. In the Dotcom Bubble, for example, interest shifted from profits to eyeballs. Ten years later, the housing bubble happened as investors shifted focus from yields to leveraged appreciation.

Despite the variety of approaches different investors may take, we know that bubbles occur in well established markets when a large group of investors depart from traditional valuation methods.

In today’s real estate market, I see some similarities—there’s a clear shift away from historical methods of valuing property. In my recent conversations with owners and other brokers, the community is starting to base property values on Oakland area developments—such as Blackstone’s project on Broadway, rumors of Uber’s arrival, and Chinese investments in the Brooklyn Basin project. While new developments, new employers, and foreign investments may or may not happen five plus years down the road, the reality is the hype has been already priced into most of the listings we see in today’s market.

In the same way that the Dotcom companies IPO’d without any revenue model, and metrics were based on potential profits and fortunes made sometime in the future, we can’t be certain that the values currently priced in to the Oakland market will materialize in the actual economy.

The Exception that Proves the Rule

Nobody knows if and when the Bay Area real estate correction will come. We can only learn from past events to help guide us to identify the cracks in the foundation.

CNBC served as the background music to the Dotcom era. Everywhere you went—from offices, to restaurants, to your regular dentist visits—you could not avoid CNBC’s coverage fueling the market hype cycle. Today, we have similar endorsements from local news, x entities, and y entities. I recently came across a typical piece that exploits the typical Silicon Valley hype, where real estate mongers are now using a “Hotness Index” to find the best real estate opportunities in the Bay Area.  This is exactly the same sort of hype that influenced a younger version of myself in the Dotcom, and might influence the novice investor today.

Every market I’ve seen punishes crafty investors and rewards patience. Real estate in Oakland will be no different.

It’s natural for investors to see upside. After all, that’s why we do what we do—take calculated risks. But it can sometimes be a tricky business to separate instinctive optimism and opportunism from our self-gratifying needs to confirm our biases. There’s always a danger in seeing any given market as an exception. It is both a weakness and magical quality of the human mind to seek out the exception to the rules.  The danger for investors is that we allow this quirk of imagination to convince us that, despite the history, despite tradition, despite all the sage advice of our elders, we contrive a way to convince ourselves: this time is different.

Every market I’ve seen punishes crafty investors and rewards patience. Real estate in Oakland will be no different. No matter what articles you read, no matter what thought leaders are saying, it is more than likely the case that the patterns that we see throughout economic history will hold true.

The markets are being transformed

The beginnings of the Dotcom bubble were rooted with rational thinking. As an unarguable matter of fact, the internet did change the world. The crash only occurred because the real world impact of those early visions took much longer than people expected.

Irrational Euphoria occurs when investors forget it may take ten, twenty, even thirty years for value to be realized. Looking back at the epic failure of pets.com, it’s hard to understand what went wrong now that nearly all of us have an Amazon Prime account and personally understand the value of the on-demand delivery economy.

The consensus among real estate professionals is that Oakland has turned the corner and is now home to one of the most educated and diverse workforces in the nation. Granted, as an Oakland native, I welcome the prospects of new developments, employment and institutional investments and how it will contribute to the long-term price appreciation of apartments in this area. But we must remember sound investment decisions should not be based on the speculative news cycle. It’s important that we exercise rational thinking and not ditch tried-and-true methods in valuing property.

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