San Francisco Insights

Charting gentrification in San Francisco

Using metrics, not punditry.
By Constantine A. Valhouli  |  July 19, 2017 12:05 PM

Lumina (201 Folsom St.) via Tishman Speyer

It's a given that rising prices and rents have been changing the face and character of San Francisco's neighborhoods. And each year, pricing pressures force people further out in search of (comparative) bargains or more space. With that, transitional neighborhoods become emerging, while emerging neighborhoods become established - and established neighborhoods become aspirational.

Our San Francisco team did an extensive analysis to see, using a quantitative rather than qualitative approach, how the neighborhoods are changing.

When we analyze most neighborhoods, we typically only consider a single metric such as purchase price per square foot or rent per square foot. However, for this analysis we looked at both metrics - as well as the relationship between those two metrics, to see if it would give us additional insight.

On one hand, purchase price per square foot gives a sense of what someone is willing to pay to own in a neighborhood. If people are willing to pay more to live in a neighborhood, it suggests that it is either simply a very desirable place for an owner-occupant to live - or that there is potential for housing prices, rents, or quality of life to increase.

On the other hand, rent per square foot reflects current conditions for which someone is willing to pay for one year. A renter does not care if the neighborhood will improve in two or three years, if their lease will be up in twelve months. Higher rents imply that an area is more desirable now; lower rents imply that a particular neighborhood may be, for now, a destination of necessity rather than choice.

For example, if a neighborhood looks like it might be improving, but it's not there yet, there may be a gap between rents and purchase prices. The upside goes to the owner, who is in it for a longer haul than a renter, whose lease might be up before there's a coffee shop, boutique, or gallery nearby.

The ratio of purchase price to annual rent

The relationship (ratio) between the purchase price and the annual rent gives a sense of how many times the annual rent is someone willing to pay to own in this neighborhood.

When that ratio is low (like in Excelsior and Bayview), the neighborhood is often still under the radar or emerging. At this point, it may be a bargain in absolute dollar terms, but it also offers a relatively compelling gross rental yield.

This suggests that it is priced in a way that is more desirable to landlords, or to those willing to hold it as a long-term investment in hopes that the neighborhood will improve. (Low rents suggests that it might not offer as desirable of a lifestyle right now as more established neighborhoods).

When the purchase price is a high multiple of the annual rent (like in Pacific Heights, Russian Hill, and Potrero Hill), then the rental yield will often be low - even if the rent in dollar terms seems high, the purchase price is *much* higher). This suggests that the properties make less sense as investments (the money could likely return more elsewhere) but make more sense as desirable neighborhoods where residents are willing to pay a significant premium to live their now.

The chart below compares the purchase prices and annual rents across San Francisco. Readers can mouse over chart bars for more detailed information on each neighborhood.

From the chart above, the emerging neighborhoods of San Francisco are trading at a lower multiple of annual rent than at the upper end. For example, Bayview is priced at just 13.02x annual rent, and Excelsior is priced at 14.16x.

On the other hand, the more established neighborhoods are trading at 23-23x annual rent. This reflects that, at these prices, they are less desirable as rental properties but more as owner-occupied residences. The premium paid reflects the lifestyle and convenience of living in these neighborhoods.

What does all of this suggest for the future of San Francisco neighborhoods?

If fundamentals remain intact, transitional neighborhoods will continue to emerge (and as restaurants, bars, and lifestyle retail options proliferate) and these will begin trading at ratios closer to more established neighborhoods. In other words, while both rents and purchase prices will continue to rise, the purchase prices will likely rise faster than rents.