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Bay Area Economic Forecast 2023

Jan 20, 2023

During the Q1 Real Estate Principals Luncheon, co-hosted by EisnerAmper and Wells Fargo, Matt Regan of the Bay Area Council delivered a timely Bay Area economic forecast—taking a closer look at the projections for the real estate industry and beyond, and how the market outlook may impact business in the coming year.



So again, thank you to Michael and Elena and the team at EisnerAmper, and to the folks at Wells Fargo for the invite.

My primary work is on public policy, lobbying, and advocacy. I'm not an economist, but I will give you a macroeconomic overview of the region and the state's economy. And we are, as an organization, the Bay Area Council, we are a 75-year-old business-sponsored public policy and advocacy organization. You can see our mission statement here.

Most of the large employers in the nine county Bay Area are members, including Wells Fargo and EisnerAmper and a few others that are here at the table today. And we focus our attention on the big macro issues that drive our region's economy, that have made us the epicenter of the world's economy for so many years. We're the only people that have added any commercial real estate to San Francisco in the last couple of years.

This is our new office. The Klamath, come by and visit us anytime at Pier Nine. We bought 100-year-old a ferryboat a couple of years ago, which those of you who in the real estate investment business are laughing right now. "They bought a boat." But yes, so this is our new office and it's a phenomenal piece of real estate. Please come check us out.

So in that 75 years, some of the things that we've done, again to foster and grow economic activity and prosperity here in the region, BART. When we started the organization in the 1940s, our members got together and said, "In the post-war economy, if the Bay Area is going to compete with the New Yorks of the world, the Londons of the world, we need a regional transit system."

So we were the first people to talk about BART and we got a BART system. This is one you don't hear about anymore because we solved a problem. The sixth largest transit agency in the Bay Area are private tech shuttle buses. And you probably remember a few years ago there were people throwing stuff at these buses in protests. We sat the tech companies down with the city of San Francisco and negotiated a deal. They pay $1.50 a stop to use MUNI infrastructure.

Accessory dwelling units. I spent a lot of my time working on the housing shortage, the housing crisis, that's one of the biggest anchors on our economic growth in California in the Bay Area. We did a bill in 2015, SB1069. That makes it easier for homeowners to build a backyard cottage. In 2015, there were 200 accessory dwelling units permitted in the State of California. This year there will be 20,000.

So these are the sorts of solutions we as an organization have created to solve some of our big problems. Caltrain electrification is going to be part of high speed rail if that ever gets finished. But we were the organization to propose to Caltrain they need to electrify that line and we're seeing that slowly happen. Regional Measure Three, we passed a tax measure. We're a business group. We're not delirious about taxes, but sometimes we need to invest in our transit. And RM3 was one that we did.

Ferry expansion, we bear a little bit of the guilt for the lack of ferries on the Bay Area. We sponsored most of the bills to build the bridges across the Bay, which of course decommissioned the ferries. So when now we're bringing those back. For the banks at the table who underwrote the bonds for the bridges, they said, "You can't have the bridges with the ferries. We need the auto tolls to repay the bonds." But we're slowly working on bringing back ferry service to the Bay.

We also understand that this is a mega region, that the traditional borders of the nine counties have morphed into the Central Valley. A lot of our workforce comes from the Central Valley every day to their jobs in the Bay Area. And then Measure AA, wetland restoration we work on. Danielle talked about sustainability. It's a mission critical for our region's economic long-term longevity, is to make sure that our green and gray infrastructure around the Bay is in place for when the sea level rises.

If you look at this bar chart, this is sort of the Bay Area's economic growth compared to the national economic growth over the last number of cycles. And as you can see, we always outperform, except for I think one quarter. We always outperform the national economic data and we continue to do so. Even in today's period of contraction, we continue to outperform national numbers.

It's a knowledge-based economy and that comes with good thing, pluses and minuses. Our knowledge-based economy is also a keyboard economy, a very high work from home economy. So we've seen, as you've probably noticed, a lot of empty offices in downtown San Francisco because our workforce are not in factories making widgets or on farms growing crops. They're at home on their computers when they ordinarily should be downtown.

But we have a very, very highly educated workforce. 49% of our day daytime workforce has a bachelor's degree or more. I mean that's a pretty phenomenal statistic compared to the US average of just under a third of the workforce. Now, that ecosystem of highly educated workers, our national research labs, our universities, creates a real melting pot of innovation and entrepreneurialism.

And so you can see from this chart that Ivy Leagues have got nothing on Cal and Stanford in terms of the economic player that they generate. Our universities by far outrank the Ivies when it comes to the economic engines that they have become, the startup cultures that exist, the venture backed firms that are generated by our two major educational establishments.

And it's not just the universities, our national labs as well, we're fortunate to have Lawrence Livermore and Lawrence Berkeley National Labs and big research facility at Stanford. And just a couple of months ago, by way of example, Lawrence Livermore for the first time in human history fused two atoms in an energy positive environment. They've created nuclear fusion.

So that's in and of itself is going to, and 1000s of people for many years worked on that, that's going to become the next wave of innovation. Those people are here. The startup companies to sustain that idea and the next round of innovation are all here and they're going to stay here. So that's something that we're very bullish on, the continued innovation and the culture of innovation that exists here.

We were very heavily dependent upon tech, but not overly so. I mean if you look at the diverse types of companies that exist here in the Bay Area, we have retail, we have energy, obviously banking. And then you could see an embarrassment of riches on the tech side and then consumer products as well and life sciences.

So we're diverse. We need to be more diverse. Again, we've become very heavily dependent upon that fourth bucket of tech companies, but the ecosystem and support system around that tech industry is growing as well. And I think for every high paying tech job that's created, three additional jobs are created in the economy to support those tech jobs.

So we've stopped using the terminology of unicorn companies. Those are the pre IPO billion dollar valued companies, because there are just too many of them. It's statistically insignificant in the Bay Area, there are so many of those companies. We use pentacorn, pre IPO companies valued at more than five billion dollars. So in the Bay Area, we've got 45 such companies.

We have a long way to fall before any other market gets anywhere close to the level of innovation and investment that's taking place here in the Bay Area. So we're still, again, by orders of magnitude, the place where innovators and investors want to be.

Again, this shows 2022 GDP growth by region and we are the little dark blue patch on the far left. We are still outperforming the nation in terms of GDP growth. Again, the national rhetoric is that the Bay Area's in terminal decline and our best days are behind us. Not so. We are outperforming the rest of the country.

If the Bay Area, if the nine counties touching the Bay Area, were a state, our economy would be larger than 45 states. There are only five states that have a larger economy than the Bay Area. California, Texas, New York, Florida. Sorry, four, and we'd be the fifth. Just the little seven and a half million people in the Bay Area. And even within California, we are 20% of the state's population and we generate about 45% of the state's tax revenue that goes to Sacramento. It's a very, very productive, it's a very productive economy.

So that was going to happen on the natural, it was sped up a little bit by what happened with COVID, that black swan event. But we are still, again, the tales of our demise have been greatly exaggerated. We are still performing much better than a lot of our peer markets.

Again, non-farm employment growth, we're at four and a half percent growth for the first three quarters of 2022. Outstripping a lot of the rest of the country. Of course, we fell a little bit further in terms of job losses at the beginning of COVID, but we're certainly coming back faster than a lot of the other parts of the state and the nation.

So again, these are positive numbers. Again, you're looking at the two red bars, the beginning of COVID where we lost a lot of employment. But we've still, all the way through December 2022, we've been in positive territory in terms of job growth. And of course you're hearing a lot of news about layoffs. Tech is laying off. And that is happening, and I'll get into that in a second.

But a lot of those tech workers are immediately being rehired in other ventures. There's still a very high demand for labor across the whole industry spectrum. Tech, biotech, retail, hospitality. Ask anybody who runs a restaurant how difficult they're having a time finding labor. It's across all industry sectors. So those tech workers are being reemployed in large part. I think the numbers I saw recently, something like 60% of all tech workers are re-employed within 60 days. So it's a churn.

So WARN notices, these are the notices that large employers have to submit to the state when they're planning large layoffs. So as you can see, we're seeing a lot of our large employers announce big layoff numbers, but only a small percentage of those numbers are actually in the Bay Area. These are global companies. And when a global company announces 12,000 layoffs, they're not all going to be here.

I'm from Ireland, if you haven't picked up the accent. I was at an event last night at the Irish Consulate and they were talking with a lot of understandable concern about what these tech layoff impacts are going to have there? Because they have probably even more so than the Bay Area, a lot of eggs in the tech basket and are showing some concern. But as you can see, the actual raw numbers are not that great here in the Bay Area.

Now these are the economic performance numbers of our largest tech companies. And as you can see, 2021 was a very good year for tech and that was reflected in the NASDAQ .and a lot of these companies had rapidly expanding sales, rapidly expanding profits. And as a result, they rapidly expanded their employment bases. 2021 was a huge growth year for our largest tech companies.

2022 is a correction year. And as I mentioned, these companies are laying off. They're seeing for the first time in their history, they're starting to see contraction in growth. They're starting to see contraction in sales and obviously in profits, and they have been punished by the market. They've been the golden children of the stock market for a very, very long time.

And so we're seeing considerable contraction in their share values, probably a little bit not commensurate with the drawback in their actual profitability. They're being punished more than they should be it could be argued. So there might be some value there in the NASDAQ. So these numbers, we're still seeing moderate sales growth for most of them, but not anywhere near what they've been used to in previous years.

Now these are the total headcounts for two of the Bay Area's largest employers, I'm not going to name them. One's a search engine and one's a social media platform, but I'm not going to name them. But as you can see, and they've both been in the headlines recently for very large layoffs. And again, going back to my earlier comments about the national mantra that the Bay Area's over and that these companies are laying off massive amounts of people. And it's the end of times for the Bay Area.

As I said, 2021 was a massive growth year for these companies and they probably overshot their actual real need in terms of headcount growth. And I think what we're seeing this year with the layoffs is a naturally occurring contraction where they realized they got out over their skis and need to pull back a little bit. But we're still considerably ahead in terms of head count from where we were just a year and a half ago.

Nobody was saying that the Bay Area was over in 2021 as these companies were growing rapidly. But they're back to where they were in '21, still ahead of where they were obviously in 2020. So a natural contraction certainly. There are headwinds that I'll get into, that we need to be very, very mindful of.

So we have seen population decline and there are multiple drivers of why we've seen population decline. I mentioned the very, very high level of remote work eligible workers that we have in our region. So a lot of people when COVID hit, and we had the same, I'm sure in your own offices you experienced it, we did in ours. People were like, "you know what? It's really expensive in the Bay Area. I'm going to go plug in from Oregon. I'm going to plug in from Utah. I'm going to plug in from wherever."

So we definitely saw some of that. So we have seen a net loss of 91,000 people in 2020 and 2021. San Francisco actually saw quite a large net reduction in population, but that's starting to come back. We're starting to see that the latest data has shown that people are coming back to San Francisco and we're seeing a slight uptick now in population growth here. But as you can see, most of it is domestic.

What we as a region experienced for the better part of the last decade, decade and a half, was that we were pretty static in terms of the national, the domestic migration patterns. The same number of people were coming and going domestically, but we were a huge attractor for international migration, particularly from China and Asia. That all stopped as soon as COVID hit. The massive pipeline of people coming to go to school here from China, coming to invest in companies here, coming to start companies here. That all just ground to an absolute halt overnight as soon as COVID hit.

So we're starting to see that come back of obviously the Chinese government have reversed their policies on COVID. We still have obviously some geopolitical tensions with China that hopefully will resolve themselves. But we're starting to see, we actually had our first ... We have three offices in China that we help our member companies with sort of concierge service if they're trying to get into Chinese markets.

And for the last three years, we did not see our Chinese staff, our mainland Chinese staff visit us. They've come to visit us this last week for the first time in three years. And we had the first delegation of Chinese business people come visit us. We had 300 people on the boat just a week and a half ago for a Chinese New Year's celebration. So we're starting to see that come back.

With it, will come tourism. A large part of our tourism industry is driven by people coming from China and Asia. I saw something about revenge spending as something that Chinese nationals, they're talking about taking revenge on the government's very restrictive policies in COVID, by spending all of their discretionary income overseas. So hopefully we'll see some benefits from that.

Again, these are migration statistics and I've kind of got ahead of myself in terms of describing this. But as you can see, we've seen certainly contraction in our overall population. Most of the people we've lost have gone to other parts of California. So in the early days of COVID, you probably remember there was a massive spike in suburban, single family home prices.

This is my least favorite slide, and this is one, usually when I do a housing presentation, this is the one I always kick off with. The bulk of my work is on housing policy. And I'm the most boring guy at a dinner party when people go, "Oh, you work on housing policy. Well, let me tell you my theory on why home prices are so high here and why affordability is such a crisis. Well, it's Airbnb. I read a thing in the New Yorker that Airbnb have 25,000 short-term rentals. They're driving up the cost."

"No, no, no." Somebody else comes over. "It's not Airbnb, it's all cash investors from China. They're coming here with suitcases full of cash and they're buying." "No, no, no, it's Blackstone. Those are the guys, they're buying." It's none of those things. They're all marginal, tiny drivers of the overall cost of housing in the Bay Area. It's because we simply stopped building homes about 25 years ago.

As you can see, it's a cyclical industry and the peaks of the past cycles have been close to, if not above 300,000 homes a year. These are California wide numbers. Then sometime in the mid-80s, the peak got to a little over 300,000. The next peak in the next cycle that we went through, the 2005 peak, just got the 200,000. And then the last cycle that we went through.

When you're all investors, we went into a period of record high demand. People with more money in their pockets than ever before, record low interest rates. And so the macroeconomics for a housing boom were in place. Cheap money and lots of people with a high demand making high salaries. There should have been a massive building boom here in the last 15, 20 years.

But as you can see, our production is barely at the recessionary levels of previous cycles. So your Airbnbs and your Blackstones and your Chinese investors had nothing to do with it. We simply stopped building homes. And for a period in the Bay Area, we were creating eight new tech jobs for every new home we permitted.

And demographers will tell you that in order to maintain affordability, for every 1.5 jobs you create, you have to build a new home to maintain affordability. We were so far out of whack for so long. In 2015, San Mateo broke all national records. The County of San Mateo created 15 new jobs for every new home that they permitted.

So obviously when you have that kind of supply demand mismatch, prices go up, people get forced out of the region, you get gentrification. A word I don't like using because it's got very heavy political connotations. But we simply put existing workers, people that work in tourism, hotel, restaurants, teachers, firefighters, we put them into the same housing market to compete with tech workers, engineers making six and seven figures.

And who's going to win that every time? If you're in the land-lording business, it's the people with the most money. No matter how many rent control measures counties and cities pass, the people with the most money get the unit at the end of the day. That's just the way the world works.

So this is sort of the part of the presentation where I maybe have some bad news. So obviously you've all seen, and it's no great secret, that there's a lot of empty commercial space in San Francisco. So you're looking at in South Market, Yerba Buena, Civic Center. Close to a third if not above a third of existing office space is vacant. And projections are that number's going to go up when a lot of these five year leases come due in the next couple of years. So we're seeing a considerable correction in commercial real estate.

We haven't seen from the folks that I've talked to that are in the class A office space, we haven't seen a lot of attrition and rent. There's not a lot of renegotiation going on. There's some sublease markets taking place.

So the new normal is fewer people are going to be coming into downtown San Francisco every day. We're not going to get, we're never going back to everybody coming to work 9:00 to 5:00, Monday to Friday. It's not going to happen. So we've got to reimagine what we're going to do with all of this empty space. And there are things that are feasible, things that are infeasible. There are cockamamie ideas like, "Well, let's turn the Salesforce building into a big residential tower." Not possible. Floor plates, windows, building codes, you can't do it. But you can turn a lot of class C and B of older office space, that's more feasible to convert to residential.

If we can find a way to create the right incentives, tax breaks to convert older, sort of the medical offices and stuff. The offices that are on Union Square that are currently the homes for non-profits and doctors, that sort of stuff. We can convert that. But modern class A office space, not going to happen. So how do we repurpose those? There are a lot of on ongoing conversations about how best to do that.

So getting people back to work. The lowest hanging piece of fruit to get people back into San Francisco is to get the people who want to come back but are too afraid. They're afraid of the crime and mostly they're afraid of the state of public transit, BART in particular. So we've seen obviously a lot of attrition in terms of people riding BART. Commuters, the Bay Bridge traffic is back to pre COVID levels.

People are driving to work because they feel safe in their cars, but they're obviously not getting on BART. They're not getting on Caltrain. Some of the local commute systems like MUNI and AC Transit, they're getting somewhat back to normal. But the commuter, the regional commuter systems are in big trouble. And that's something we've got to solve for.

So recession, someone said the R word at the beginning of the conversation. The large macro indicators are not telling us that we're headed towards a recession. But we can certainly talk ourselves into one if we want to be in one. And we do a really good job of it here in the Bay Area. And I mean if you remember the dot com bust. Back in the early when the dot com economy crashed here in the Bay Area, we dragged the State of California into a recession.

The rest of the state was experiencing economic growth. The Bay Area, again, because we're such a large piece of the region's economy, we dragged the whole state of California into a recession. And as a result, the national economy had I think two quarters of negative growth. So if we talk ourselves into a recession, it has ramifications beyond the Bay Area. We could quite feasibly drag the state and the nation into a recession as well.

This slide shows, as I mentioned earlier, the challenge that employers have finding labor. Openings still far outstrip hires. There are more vacancies than layoffs. There are more companies looking for talent than exists in the marketplace. So we actually have a workforce challenge. We need to retrain a lot of people. We need to make sure that our kids coming out of college are ready to work.

As I like to say, workforce development is economic development. The biggest anchor currently existing in our ability to grow is the lack of talent. So we need to make sure that our kids and young people are being trained. And that we're making sure that everybody that wants to be in the workforce and can be in the workforce, is in the workforce and trained to do the jobs that we need them for.

Again, the labor market is in large part driving, the labor shortage is driving, sorry, inflationary pressure. So we're seeing CPI increases in the last couple of years. So bright spots, again, we are in a pretty good place in terms of the talent that's here, the companies that are here. We are diversifying. We're the global leader in biotech.

It's just that our biotech is overshadowed by our traditional tech because it's so much larger, but we're still leading the world there. FinTech, Stripe, two kids from Ireland came here a decade ago and started a financial services company called Stripe. It's now worth $100 billion. I mean that's more than every other pre IPO company in the country combined. And it's here, it's in inside ... They left San Francisco because San Francisco's a tough place to do business. They're inside San Francisco now.

But then obviously Tesla, still here. They're manufacturing plant is still here. All of the major auto manufacturers on the planet have their autonomous vehicle research facilities here in the Bay Area. Concord Naval Weapon Station is a big dedicated vehicle test center for autonomous vehicles.

And then of course, housing affordability. You saw the slides about production. This is basic supply and demand. We've got to find it easier to build more housing. So thank you.

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