Tuesday, September 30, 2008

Credit Crisis: At Least One Great Thing Already Happening for Silicon Valley

The unfolding credit crisis may have severe implications for the region -- or the world -- a bit down the line. But it is already helping chip away at one of the Bay Area's biggest long-term problems: housing (un)affordability.

I'm going to keep with my narrow technology focus here and, fairly or not, make an analysis specifically of the region's viability as a technology and innovation hub, its ability to route investment into businesses that attract top engineers and churn out world-changing products.

Every year when the region's large business leaders meet, housing is at or near the top of their list of concerns. It's hard to hire in a place people cannot afford to live. Especially when potential employees are talented and often mobile, with a lot of options in front of them.

Owning a house in the Bay Area has been expensive for some time. But -- in the space of the last eight years or so -- it has crossed the line from "painful but affordable" to "not realistically affordable" for the technology professionals smart enough not to take one of those wild-'n'-wacky subprime loans with a handful of bogus low payments up front.

I'm going to be concrete here, and use specific numbers... numbers which may leave you gasping or slapping your head if you live elsewhere in the world, but numbers which are real.

In the wake of the dot-com crash, a large portion of the area's "starter house" stock was available for $350,000 to $500,000. These were often 2-bedroom tract homes, not always in the most desirable locations, but not in the worst either. They were no bargain, but they were affordable for the "senior software engineers" with a decent education, a half-dozen years of experience, and the willingness to save for a real down payment all that time instead of going wild with the Visa card. These engineers had seen their earning power top $100,000 (partly due to the dot-com boom), and if they avoided Aqua when the company wasn't paying, they could sock away some serious cash.

A widely held rule of thumb regarding housing affordability suggests that at most one-third -- perhaps a little more -- of gross income can go to housing. More than that, and the probability of the buyer experiencing financial hardship or outright defaulting goes up sharply.

So the senior engineer, with say six or seven years of professional experience, making a little over $100,000 -- exactly the "heart of the batting order" in a growing tech company's talent pool -- could afford a $400,000-$500,000 house, at around 6%, with the traditional 20% down payment. If they had a significant other who was also earning money, they could afford a little more. But not too much more if they didn't want to be dependent on those full dual incomes indefinitely.

Almost all of the folks in my "cohort" (say, within four years or so of my age) whom I know and who bought houses in the Bay Area did so in this way, at this time, and with this sort of cost.

Fast forward three years.

Easy money and bogus mortgages have caused prices to balloon. Those $400k-$500k houses become $700-$800k houses.

Salaries have drifted up a touch as the worst "crash" years pass, but not much beyond the rate of inflation, maybe $5k-$10k per year for these mid-level positions. Certainly not enough to cover the change in housing prices.

And -- just like that -- those engineers, the early-to-mid-career core of any tech company trying to scale, the folks who know enough to use a little process and not re-invent the wheel, while still working hard and willing to take chances to innovate and make something happen, have no access to the stock of starter homes.

Beyond the larger down payment, they discover that making a "real" (i.e., based on traditional mortgage terms) monthly payment on this $750,000 house means making over $150,000. And that's well beyond the typical salary for a senior engineer or even a lead engineer / architect type role.

And there's the story: that bubble cut off the up-and-coming generations of engineers from homeownership. Indefinitely if not permanently. If the Silicon Valley business leaders roundtable thought housing was an issue before, they are in a whole new landscape now.

But this is exactly where the credit crisis is starting to help. It was never practical to build our way out of the housing shortage because not only is buildable land scarce here, but ready credit meant each housing unit gets bid up based on what lenders are in the mood to invest.

Now that the brakes are on, we've already seen the median home price in the Bay Area drop by nearly a third from its high in '06. We need a couple more years of this -- together with lenders that want to see payments under that one-third of income mark, and a solid down payment.

When it all shakes out, perhaps some of my friends who missed that narrow window early in the decade and so, despite working hard, excelling, and making serious incomes, missed a chance to own any kind of house, will get their opportunity.

And, if it's too late for them -- after all, families grow, the kids get bigger, and that worn-down starter house won't look so attractive when we're all middle-aged -- at least the next generation of geeks and whiz kids will have a reason to work in Silicon Valley.

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