Tenderloin Heights

Tax Cuts and the San Francisco Real Estate Market

by Jim Forbes

President Bush recently signed into law his third tax cut in two-and-half-years. The latest one, like the first one he enacted, is one of the top three tax cuts in history. Many of us here in San Francisco wonder, will it help the rental market here? Maybe�but I doubt it.

As I've written before, rental rates in San Francisco are determined primarily by demand. Supply is a relative constant, growing, but rarely fast enough to single-handedly push rental rates down. Demand, however, fluctuates from flat to overheated, depending primarily on how much money apartment seekers have in their pockets. How much money they have depends on their jobs, or the jobs of their parents. Thus, in slow economic times such as now, demand for rental housing drops off, as it has here in San Francisco, with market rents off some 40 percent from their dot-com peak.

So the question is will the tax cut create jobs? The president claims it should add one million new jobs by the end of the year. But might this not have happened anyway? Because the labor force and the size of the economy is constantly expanding, nearly every year there are new jobs, even at times when there is rising unemployment. Since this kind of normal annual growth is usually in areas of rising population, San Francisco is not affected by it. Until recently, we had decades of a more or less constant population, with years of immigration often followed by years of emigration. In fact, our current population, at nearly 800,000, is at its highest level since the fifties and will most likely decline.

But if the one million jobs are in addition to the normal growth in employment, then arguably these jobs should occur in an area of unusually high unemployment such as here. So, how will the tax cuts create jobs in San Francisco or the Bay Area?

For this question, I am not sure. One of the arguments for the lion's share of the tax cut�reduction of the rate on dividends and capital gains�is that it will give people more cash to invest in new businesses. But in my opinion, there is already too much cash out there, seeking investments, driving down returns and basically keeping assets in a bubble, despite weak demand for goods and services. Just look at the ridiculously high prices people are paying for homes�from $600,000 in the foggy outer Richmond to millions and millions elsewhere�to show that a dearth of cash is not what we suffer from.

Nor do we suffer form a lack of creativity or entrepreneurial spirit. If there is a good idea, even a marginal one, Bay Area people will try it and I know plenty of venture capitalists who will finance it. This tax cut is not going to make a difference.

There are, however, bits and pieces in the legislation that could help San Francisco businesses and therefore create jobs. For instance, the tax bill does increase the investment tax credit a business can take on new purchases from $25,000 per year to $100,000. Since restaurants are one sector hard hit by the slowdown here (nearly 150 shut down last year alone) entrepreneurs and investors could get a significant write-off on new furniture and equipment with this new tax bill.

The overall cash in everyone's pocket may also provide a boost because some people are going to be willing to spend it on things we offer, such as hotel rooms and retail goods. If the tax cut is enough to sway the skeptical tourist into action, this boost will also create a need for new employees. But much like the $400 rebate most people got in 2001, it�s dubious it will be enough. Most likely, taxpayers are going to pay down debt and sock it away for a rainy day, especially when rain is apparently around the corner for many job holders, and is already coming down for many others.

What about the $20 billion earmarked in the tax bill to help out the states? As we all know California by far has the worst budget deficit in the nation and could definitely use the money. We doubt, however, that we will see much. It will likely go to Medicare, and possibly some homeland security, but California's needs are not high priorities right now for the White House and the Republican-controlled Congress. Fact is, we probably rank next to France in that regard.

No, the way I see it there is little chance that this tax bill will directly improve our economy in San Francisco and, therefore, create more than a token number of jobs. The best we can hope for is if the whole country starts moving forward, and/or the stock market starts rising convincingly.

Let's start with the stock market. Even though many economists argue the cut in dividends will only add some 2.5 percent to the value of stocks, San Franciscans are a stock-holding population, at least compared to most other places. Human nature being what it is, most people have reconciled themselves to their new depressed portfolio values. Getting into a bull market, regardless of what caused it, will allow people to feel richer and, therefore, to spend. This phenomenon may not be universal, but it should impact a wealthy population such as ours here in the Bay Area.

The issue of the wider economy is a different matter however. Chances are, the economy was going to move forward slowly with or without the tax cut because, by and large, things are not as bad as when the first President Bush took office in 1989. Our slow down today is almost exclusively because of the excesses of the prior six years. Sure, a bit of deflation was warranted when we took it beyond an intrinsically sound level. But, more or less, money making or increasing wealth is not a bad thing.

When the first President Bush came into office in 1989, albeit also after six years of prosperity, it was prosperity with a cost. The costs included the largest budget deficits in history, in absolute number and as a percentage of GDP, and a tax structure that encouraged investment in supply and other under-utilized products like real estate without any regard to demand. The consequence was a recession that in some regions lasted as long as the prosperity did.

This time round we have low inflation, low interest rates, high productivity and until recently, government surpluses to ease the weight on the economy. This was a downturn that just needed to run its course, and little tinkering was needed, such as tax cuts at the bottom of the tax scales or the lowest payroll-tax levels. By moving large amounts of resources into the hands of those who already have large amounts of resources is a mistake that could make matters much worse than they would have otherwise been.

Let me put it this way: not a single one of my residential tenants will likely receive a dollar of this tax cut, and without one they will not be willing to pay me any more in rent.

The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of the SFAA or the San Francisco Apartment Magazine. Jim Forbes is president of Urban Properties, a real estate investment and brokerage firm. He can be reached at 415.922.8998 or at his Web site.