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January 31, 2017 Economics Group Special Commentary Mark Vitner, Senior Economist [email protected] ● (704) 410-3277 Misa Batcheller, Economic Analyst [email protected] ● (704) 410-3060 What’s Heating Up and Cooling Off in the San Francisco Bay Area California’s economy has outpaced the nation for the past six years, and the San Francisco Bay Area has been the fastest growing part of the state by far (Figure 1). Annual real GDP growth in the greater Bay Area has averaged a strong 4.0 percent between 2010 and 2015.1 Growth in the local economy has been driven primarily by the strength of the region’s technology sector and its impact on construction and supporting industries. The surge of economic growth at a time when the national economy has been growing only modestly is largely without precedent. Combined, the San Francisco-Oakland-Hayward and San Jose-Sunnyvale-Santa Clara metropolitan areas accounted for 8.0 percent of all U.S. real GDP growth from 2010 to 2015, despite comprising just 3.8 percent of the nation’s economy. Bay Area employment growth continues to outpace the nation (Figure 2). Payroll gains have cooled relative to recent years, however, as late-cycle headwinds, including tighter labor market conditions and rising compensation costs, have created a more challenging business environment. Annual job growth in the Bay Area has slowed to between 2.5 percent and 3 percent compared to the 3.5 percent to 4 percent pace registered during the majority of 2013 to 2015. Notably, this slowdown has also been evident in the region’s tech sector. Job growth in the professional, scientific & technical services and information sectors, which capture a significant portion of high-tech professions such as computer programmers, software developers and engineers, has decelerated over the past year. The number of initial public offerings (IPOs) has also slowed, as valuations have been stretched in the private markets, making IPOs appear less attractive. Figure 1 Figure 2 Job Growth: SF Bay Area vs. United States GDP Growth Comparison Year-over-Year Percent Change 8% 8% SF Bay Area: 2015 @ 5.7% California: 2015 @ 3.8% United States: 2015 @ 2.5% 6% 6% 4% 4% 2% 2% 0% 0% -2% -2% -4% -4% 3-MMA Year-over-Year Percent Change 8% 6% 4% 4% 2% 2% 0% 0% -2% -2% -4% -4% -6% -6% -8% -8% SF Bay Area CSA: Dec @ 2.5% United States: Dec @ 1.5% San Jose MSA: Dec @ 3.4% San Francisco DMA: Dec @ 2.2% Oakland DMA: Dec @ 2.3% -10% -12% -6% -6% 02 03 04 05 06 07 08 09 10 11 12 13 14 15 8% 6% -10% -12% -14% -14% 95 97 99 01 03 05 07 09 11 13 15 17 Source: U.S. Department of Commerce, U.S. Department of Labor and Wells Fargo Securities 1 The greater San Francisco Bay Area is comprised of the 12 counties that make up the San Jose-San Francisco-Oakland combined statistical area, which include Alameda, Contra Costa, Napa, Marin, San Francisco, San Mateo, Santa Clara, Sonoma, Solano, Santa Cruz, San Benito and San Joaquin. This report is available on wellsfargo.com/economics and on Bloomberg WFRE. Bay Area employment growth continues to outpace the nation. Late-cycle headwinds have created a more challenging business environment. What’s Heating Up and Cooling Off in the San Francisco Bay Area January 31, 2017 WELLS FARGO SECURITIES ECONOMICS GROUP Tighter Labor Markets Are Restraining Growth The persistent tightening of the labor market has been a notable development across the country this past year, as the labor market has reached levels widely thought to be consistent with full employment. The U.S. unemployment rate stood at 4.7 percent in December and has been at or below 5 percent for the past year. In comparison, labor market conditions in the Bay Area have been tight for quite some time, as the jobless rate in the greater San Francisco Bay Area has been below 5 percent for nearly two years. The Bay Area’s unemployment rate is trending near 4.3 percent and is just about even with its previous 2006 low, but remains a full percentage point above the low reached during the height of the dot-com era in 1999. Jobless rates among the Bay Area’s counties range from a low of 3.1 percent in San Mateo to a high of 5.4 percent in Solano. Labor costs have been edging higher as employers compete to attract and retain qualified workers. With the pool of available workers continuing to diminish, labor costs have been edging higher as employers compete to attract and retain qualified workers. By a range of measures, wage growth has picked up across the country. Average hourly earnings in the United States were up 2.9 percent year over year in December after rising by an average of around 2 percent from 2010 to 2015. Wages have risen much faster in the Bay Area, and the region is home to some of the highest earning counties in the country. Santa Clara County ranks No. 1, with average weekly wages in the second quarter of 2016 at $2,252. That marks a significant $1,263 above the national average. Santa Clara’s neighboring tech-centric counties, San Mateo and San Francisco, also placed among the top five. As shown in Figure 3, the majority of the Bay Area’s localities have outpaced both the state and the national average wage growth. Napa County recorded a particularly strong increase, with average weekly wages rising more than 5 percent year over year. The strength in average hourly earnings is largely due to the preponderance of higher-paying jobs in information technology and life sciences. The rapid growth in these jobs has supported hiring in other industries, which has worsened income polarization within the region and made it much more difficult for a large proportion of Bay Area residents to find affordable housing. Wages in lower-paying parts of the economy have also been pulled higher in recent years, however. Many Bay Area cities have been at the forefront of local minimum wage increases. Adding to these building wage pressures, California’s state minimum wage increased $0.50 to $10.50 an hour at the start of 2017. The state’s minimum wage is scheduled to increase every year until it reaches $15 for all businesses by Jan. 1, 2023. Many Bay Area cities have been at the forefront of local wage increases, with some implementing changes as part of a plan to reach a $15 minimum wage ahead of the statewide mandate. San Jose’s minimum wage is set to increase to $12 on July 1, 2017, before ultimately reaching $15 by Jan. 1, 2019. Palo Alto and Cupertino have also adopted legislation to reach $15 by Jan. 1, 2019. Meanwhile, Mountain View and Sunnyvale have laws in place to reach the $15 minimum a year sooner, by 2018. While the rise of the minimum wage is providing some relief to workers, it places an additional burden on many businesses and will likely slow job growth modestly in the affected sectors. Figure 3 Figure 4 Average Weekly Wage Growth by County CPI: SF Bay Area vs. United States 4-Quarter Moving Average, Year over Year Pct. Change 6-MMA Year-over-Year Percent Change 7% Napa Sonoma Santa Clara 7% San Francisco-Oakland-San Jose: Oct @ 3.1% United States: Nov @ 1.3% 6% 6% 5% 5% 4% 4% 3% 3% 2% 2% 1% 1% 0% 0% -1% -1% San Joaquin Marin Alameda San Francisco Solano California Contra Costa United States June 2016 San Mateo 0% 1% 2% 3% 4% 5% 6% -2% -2% 95 97 Source: U.S. Department of Labor and Wells Fargo Securities 2 99 01 03 05 07 09 11 13 15 17 What’s Heating Up and Cooling Off in the San Francisco Bay Area January 31, 2017 WELLS FARGO SECURITIES ECONOMICS GROUP The Cost of Living in the Bay Area Strong economic growth is pushing the Bay Area’s already high cost of living up at a faster pace relative to the nation. The Consumer Price Index (CPI) for the San Francisco-San Jose-Oakland combined metropolitan region has risen 3.1 percent year over year compared to the national increase of just 1.3 percent (Figure 4). Higher energy prices have played a meaningful role in price increases this past year, as gasoline prices have rebounded. We note that energy prices are more volatile in California due to environmental restrictions on the blends of gasoline used in the state and initiatives to promote green energy. The core CPI, which strips out the more volatile food and energy components, is still up 3.8 percent in the Bay Area and 2.2 nationwide. Shelter costs, which account for roughly 40 percent of the core CPI and captures rental prices, are up a sizable 6.9 percent over the past year in the Bay Area. In comparison, shelter prices nationwide are up just 3.6 percent over the period. The Bay Area’s already high cost of living is rising at a faster pace relative to the nation. Skyrocketing home prices and rents continue to top the list of cost burdens for Bay Area residents. Higher housing costs are not a new development for the Bay Area, as the region’s perennially tight housing market tends to support prices and rents even when the economy is growing slowly. When growth picks up, the high costs and considerable delays in bringing new properties to the market tend to cause prices and rents to surge. In economic terms, San Francisco has an incredibly inelastic supply of housing. Home prices have been rising steadily throughout the region since the end of the Great Recession as the Bay Area was one of the first major regions to see economic growth kick into higher gear. Home prices in San Francisco recovered back in April 2013 and currently stand nearly 40 percent higher than their previous 2007 peak. Despite the increases, home price appreciation across the Bay Area has largely decelerated (Figure 5). San Francisco County has seen a particularly notable slowdown in home price gains, with home price appreciation falling from an annual average increase of 12 percent in 2015 to a modest pickup of 1.3 percent year over year in November 2016. Much of this deceleration has occurred at the top of the market where price gains had been the greatest. Price increases for more modestly priced homes have actually accelerated in many parts of the Bay Area, as relatively little new supply has come on line. Home price growth across the Bay Area has largely cooled. Effective apartment rents were $2,472 per month in San Francisco, $2,059 per month in San Jose and $1,719 per month in the East Bay in the third quarter, according to data from Reis.2 Higher rents have brought about new supply, which has pushed the vacancy rate slightly higher and helped cool off the rise in apartment rents. San Francisco’s apartment vacancy rate has risen about a percentage point over the past two years to 4.4 percent in the third quarter (Figure 6). Figure 5 Figure 6 San Francisco Apartment Supply & Demand SF Bay Area Counties Home Price Growth Percent, Thousands of Units Year-over-Year Percent Change CoreLogic HPI 30% 7% 20% 20% 6% 10% 10% 5% 0.5 0% 4% 0.0 -10% 3% -0.5 -20% 2% -1.0 -30% 1% 30% 0% -10% Alameda: Nov @ 5.7% San Francisco: Nov @ 1.3% Santa Clara: Nov @ 5.1% San Mateo: Nov @ 5.3% -20% -30% 05 06 07 08 09 10 11 12 13 14 15 16 17 1.5 Apartment Completions: Q3 @ 463 Units (Right Axis) Apartment Net Absorption: Q3 @ 566 Units (Right Axis) Apartment Vacancy Rate: Q3 @ 4.4% (Left Axis) 1.0 -1.5 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: CoreLogic, Reis, Inc. and Wells Fargo Securities 2 Reis metro area definitions are as follows: San Francisco includes San Francisco, Marin and San Mateo counties. San Jose includes Santa Clara County. East Bay includes Alameda and Contra Costa counties. 3 What’s Heating Up and Cooling Off in the San Francisco Bay Area January 31, 2017 WELLS FARGO SECURITIES ECONOMICS GROUP Summary and Outlook We estimate that the Bay Area’s economy grew 5.9 percent in 2016. After five years of exceptionally solid economic growth, the Bay Area is beginning buckle on some of the strains generated from growing at such a rapid pace. Annual real GDP growth averaged a 4.0 percent pace in the Bay Area from 2010 to 2015.3 We estimate that the economy grew 5.9 percent in 2016. By contrast, real GDP growth has averaged just a 1.9 percent pace nationwide over this period, and the U.S. economy grew just 1.6 percent in 2016. Stronger economic growth has brought the unemployment rate back down to levels long considered to be near full employment and wage gains have accelerated. The cost of living has also ramped up in the region, where growth has been much stronger and impediments to development are much greater. Traffic congestion has also worsened considerably, raising the costs of commuting. The higher costs of doing business and increasing frustration with traffic congestion have contributed to the outmigration of some businesses away from the region. Growth has also shifted to lower-cost parts of the Bay Area, most notably Oakland and the East Bay in general. Growth in the region has shown some signs of moderation this past year. Nonfarm employment growth has decelerated. Job growth in the San Francisco metropolitan division was 3.1 percent in 2016, down from 4.8 percent the prior year. That still left payrolls some 32,400 jobs higher than the prior year, but the increase was down from a gain of 47,700 jobs in 2015. Much of the deceleration occurred during the second half of the year. Employment growth in Oakland followed a similar pattern, with nonfarm payrolls rising 2.5 percent in 2016, following a 3.1 percent rise the prior year. Oakland saw a net increase of 27,100 jobs in 2016, which is smaller than the 32,800 jobs added in 2015. Housing costs are also showing some tentative signs of cooling. Home price appreciation has moderated, following huge gains at the higher-end of the market. In addition to suffering from some indigestion from previous price spikes, demand for higher-priced homes also likely cooled off a bit as the IPO market slowed and interest from overseas buyers waned. Apartment rent growth has also lessened as development has increased significantly in recent years and the sudden onslaught of new units caused rents to rise more slowly this past year. The moderation in employment growth and housing costs should continue in 2017. The moderation in employment growth and housing costs should continue in 2017. Hiring has cooled off as employers have had a more difficult time filling vacant positions and rising compensation costs have raised the bar for many new hires. In addition, with the unemployment rate near 5 percent, many of the jobs being added are pulling workers from the ranks of the underemployed and involuntary part-time workers. The net result has been stronger wage and salary growth but less employment growth. The impact of the Trump presidency on the Bay Area remains uncertain but does create both upside and downside risks. Tax cuts would benefit high wage earners in the Bay Area, and the stock market rally since the election has helped reignite the IPO market. Regulatory reform would also likely benefit the region, possibly paving the way for more residential development. In addition, the Bay Area would benefit from an increase in infrastructure spending, although any growth on that front is likely years away. We also anticipate interest rates to be modestly higher, which will add to the region’s housing affordability challenges. In addition, we look for the dollar to be stronger, which will likely impact corporate earnings for large multinational firms based in the region. The Trump administration’s trade initiatives may also create some downside risks to the region, with threats of border taxes and tariffs potentially slowing trade with key trading partners such as Mexico and China. Increasing restrictions on immigration is another issue for employers and the Bay Area in general, which may adversely affect hiring in the region’s technology, construction, hospitality and agriculture sectors. 3 4 2015 is the latest data available. 5,783 1,923 3,860 Total Housing Permits Single-Family Permits Multifamily Permits 3,097 1,002 2,095 890 21 9.3 1,870 28 176,062 7.3 5,532 1,501 4,031 924 34 7.9 1,898 28 182,694 3.8 2012 9,163 3,095 6,068 2,037 73 7.7 4,462 62 343,656 5.6 2012 7,764 1,870 5,894 961 37 6.5 1,929 31 190,640 4.3 2013 10,922 3,659 7,263 2,107 70 6.3 4,529 67 349,283 1.6 2013 Actual Source: U.S. Department of Commerce, U.S. Department of Labor and Wells Fargo Securities Forecast as of: January 31, 2017 Total Housing Permits Single-Family Permits Multifamily Permits Nonfarm Employment, Thousands Change, Thousands Unemployment Rate, Annual Average Population, Thousands Change, Thousands Real Gross Domestic Product, Millions Annual Rate 2011 1,964 34 9.0 Nonfarm Employment, Thousands Change, Thousands Unemployment Rate, Annual Average San Jose-Sunny v ale-Santa Clara MSA 4,401 55 325,411 -0.1 2011 Population, Thousands Change, Thousands Real Gross Domestic Product, Millions Annual Rate San Francisco-Oakland-Hay ward MSA 10,037 1,861 8,176 1,002 41 5.2 1,954 26 204,783 7.4 2014 10,001 3,716 6,285 2,177 70 5.2 4,596 67 363,951 4.2 2014 San Francisco Bay Area Economic Outlook 5,788 1,897 3,891 1,043 41 4.3 1,977 22 223,088 8.9 2015 13,386 4,804 8,582 2,258 81 4.3 4,656 60 378,763 4.1 2015 5,900 2,030 3,870 1,080 37 3.8 1,998 21 236,919 6.2 2016 14,400 4,900 9,500 2,322 64 3.9 4,712 56 400,352 5.7 2016 6,600 2,150 4,450 1,112 32 3.5 2,018 20 250,661 5.8 2017 15,500 5,540 9,960 2,387 65 3.3 4,762 50 421,171 5.2 2017 Forecast 6,700 2,200 4,500 1,140 28 3.2 2,038 20 264,447 5.5 2018 17,000 6,000 11,000 2,444 57 3.1 4,810 48 440,545 4.6 2018 What’s Heating Up and Cooling Off in the San Francisco Bay Area January 31, 2017 WELLS FARGO SECURITIES ECONOMICS GROUP 5 What’s Heating Up and Cooling Off in the San Francisco Bay Area January 31, 2017 WELLS FARGO SECURITIES ECONOMICS GROUP California Venture Capital San Francisco Bay Area Economic Conditions In Billions of Dollars $25 $25 Silicon Valley: Oct @ $3.9 Billion Job Growth: SF Bay Area vs. United States California: Oct @ $5.1 Billion 3-MMA Year-over-Year Percent Change 6% 6% 4% 4% 2% 2% 0% 0% -2% -2% -4% -4% -6% -6% $20 $20 $15 $15 $10 $10 $5 $5 $0 $0 95 -8% -10% -10% 94 96 98 00 02 04 99 01 03 05 07 09 11 13 15 -8% SF Bay Area CSA: Dec @ 2.5% United States: Dec @ 1.5% 92 97 06 08 10 12 14 Employment Cost Index: Wages & Salaries 16 Private Industry Workers, Year-over-Year Percent Change 6% Average Weekly Wages by County 4-Quarter Moving Average, USD 6% Los Angeles-Long Beach-Riverside: Q3 @ 3.8% San Jose-San Francisco-Oakland: Q3 @ 3.0% United States: Q3 @ 2.4% 5% 5% Santa Clara San Mateo 4% 4% 3% 3% 2% 2% 1% 1% San Francisco Alameda Marin Contra Costa California Solano United States Napa 0% 2012 Sonoma 0% 2013 2014 2015 2016 June 2016 San Joaquin $0 $500 $1,000 $1,500 $2,000 $2,500 Housing Affordability Percentage of Households That Can Afford Median Priced Home 80% San Francisco Apartment Effective Rent Percent Change 12% 70% 4% 9% 3% 6% 2% 3% 1% 0% 0% -3% -1% -6% -2% Quarter-over-Quarter: Q3 @ -1.0% (Right Axis) 70% 60% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% 06 -9% 80% SF Bay Area: Jun @ 22.9% US: Jun @ 56.7% CA: Jun @ 29.8% 07 08 09 10 11 12 13 14 15 16 -3% Year-over-Year: Q3 @ 0.0% (Left Axis) -12% -4% 2007 6 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: CAR, PwC/MoneyTree, Reis, Inc., U.S. Dept. of Labor and Wells Fargo Securities Wells Fargo Securities Economics Group Diane Schumaker-Krieg Global Head of Research, Economics & Strategy (704) 410-1801 (212) 214-5070 [email protected] John E. Silvia, Ph.D. Chief Economist (704) 410-3275 [email protected] Mark Vitner Senior Economist (704) 410-3277 [email protected] Jay H. Bryson, Ph.D. Global Economist (704) 410-3274 [email protected] Sam Bullard Senior Economist (704) 410-3280 [email protected] Nick Bennenbroek Currency Strategist (212) 214-5636 [email protected] Anika R. Khan Senior Economist (212) 214-8543 [email protected] Eugenio J. Alemán, Ph.D. Senior Economist (704) 410-3273 [email protected] Azhar Iqbal Econometrician (704) 410-3270 [email protected] Tim Quinlan Senior Economist (704) 410-3283 [email protected] Eric Viloria, CFA Currency Strategist (212) 214-5637 [email protected] Sarah House Economist (704) 410-3282 [email protected] Michael A. Brown Economist (704) 410-3278 [email protected] Jamie Feik Economist (704) 410-3291 [email protected] Erik Nelson Currency Analyst (212) 214-5652 [email protected] Misa Batcheller Economic Analyst (704) 410-3060 [email protected] Michael Pugliese Economic Analyst (704) 410-3156 [email protected] Julianne Causey Economic Analyst (704) 410-3281 [email protected] E. Harry Pershing Economic Analyst (704) 410-3034 [email protected] Donna LaFleur Executive Assistant (704) 410-3279 [email protected] Dawne Howes Administrative Assistant (704) 410-3272 [email protected] Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, LLC, a U.S. broker-dealer registered with the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and the Securities Investor Protection Corp. 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