News & Research Archive

Pulse Of The Market (Pulse 59 - Quality Wins Out)

Apr 23, 2008

A friend of mine sent me a client newsletter from an investment manager. I would like to share a few excerpts…

"We don't invest based on expectations of what the market will do next month or even next quarter. We invest based on expectations about future earnings and cash flows, factors that reflect the real value of a company beyond the short-term emotion-driven ebbs and flows of the market."

"Trying to time the market for possible short-term advantages is inconsistent with a focused strategy designed for the long haul where selecting quality stocks becomes the crucial variable."

"In the last 12 months ending January, producer prices climbed the largest increase since October 1981. In the future companies will be forced to more fully pass these costs along to consumers…..In simple English, all of this means that you can expect higher prices for almost everything; it is going to cost you more to live in the future."

As I read the above, two words jumped out at me: quality and costs.


It's expensive to live in San Francisco, it always has been, and it is not going to get any cheaper, notwithstanding that some of my clients and friends are waiting for prices to fall, convinced that San Francisco real estate will crater just like the rest of the county.

I can't cite statistics on the last few years’ increased cost of basic residential building materials – concrete, steel, and copper, not to mention labor and soft development costs. Nonetheless, I have not met a developer who has not bemoaned the rapid rise in all them. I recall talking with a major developer in 2005 when his firm was getting ready to excavate for a new high-rise residential tower. The original budget was $450.00/sq. ft. cost-to-build. As they neared completion, the new reality looked more like $650/sq. ft. I am not sure where it ended up, but I would bet it exceeded $650+/sq. ft. Today it would probably be north of $800/sq.ft.!

It's going to be more expensive in the future!

Another fact is that the land is getting scarcer and more costly, whether it is in The Financial District, South Beach, SOMA or Mission Bay. The availability of parking lots is diminishing.

Building in an environmentally friendly way is yet another challenge. This requires new technologies, new materials, and new skills to pull it off, all of which are adding to the cost.

So while some people develop heart palpitations as new-condo sale prices near an average of $1,000/sq. ft., they will no doubt have a total coronary when homes approach $1,500/sq. ft. (unless they bought homes at $1,000/$1,200 sq. ft. and are selling). For those who wish to avoid heart medicine, I recommend Tulsa, Oklahoma where there are good steaks and you don't have to make excuses for the Giants or the Forty Niners.


The above investment manager focuses on quality companies, those with fundamentally sound balance sheets and quality earnings. So too with real estate. When it comes to single-family homes, buyers want to live in the better neighborhoods in a quality home. The concept of progression and regression are two basic concepts that persist throughout the residential real estate industry. Simply stated, progression is when the better homes on a block typically raise the value of the lesser homes, while regression implies a tendency for a neighborhood of low valued homes to pull down the value of the most expensive home.

In other words, savvy buyers would rather buy and own the least expensive home on a block of expensive, higher quality homes, than the most expensive home on a block of inexpensive or average quality homes.

The same thing holds true with high-rises in the south of Market neighborhoods. Relatively speaking, there are better quality neighborhoods and better quality buildings. What determines the quality of the buildings is location and amenities. I would much rather own a lesser unit in a quality building than an expensive unit in a lesser quality building. In the longterm, as with the stock market, quality will win out.

Every real estate junkie knows that location is important, but it takes work to distinguish the better buildings within the same neighborhood. When comparing buildings in the south of Market neighborhoods, the better location is evaluated by how close it is to major and minor shopping venues, restaurants, parks, grocery stores, public transportation, as well as the configuration of the street – one way or two way and how busy it is. Buyers familiar with a particular area may have a good gut feeling about these, but to really understand them and their relative values, these factors need to be put into a matrix and compared. Naturally, I have done this and would be glad to share.

The other determinate of building quality is the composition of a building’s amenities, i.e. those attributes that are appurtenant to all the units in a building. They include doorman, concierge (and there are even different levels of service), deeded or non-deeded parking, air conditioning, fitness center, pool, media room, business center, deck or common outdoor space, BBQ, and, of course, the quality of the construction.

Bottom line: each building has a value, which either adds to or subtracts from the value of an individual unit.

Summing Up

As with the stock market, the emotions of residential buyers and sellers ebb and flow. Right now, some buyers are concerned about the credit markets, their jobs, etc. Historically, San Francisco has weathered similar storms, both because of the scarcity of land, the difficulty of the entitlement process, and constant escalation of development/building costs, all of which contribute to higher prices of new construction. Unlike most other cities in the country, San Francisco demand is supported by five legs of the "buyer stool." We have buyers who need a primary residence because they work here, empty nesters and pied a terre buyers who most likely reside within a 150+ mile radius of San Francisco, investors who are willing to buy to rent for the next 5 - 15 years, and ‘home collectors’ who are wealthy and comfortable in placing some of their assets in the San Francisco real estate market. When one or two legs weaken, the others support overall demand.

Not all developers will win in this market. Those with lesser quality buildings (combined location and/or amenity package), coupled with less than deep (marketing) pockets, may already be having trouble. As a Buyer, you need to beware, for it is easy to be enticed by a price discount, free HOA dues, subsidized mortgages, and other incentives. Yet long after the deal is closed, you are left with what you own, and how much you paid is a distant memory. What will be in your face every day is the quality you now have, not the old price tag. And down the road, it’s going to be more difficult to sell a unit in a lesser quality building.

While there are always sound reasons for a particular buyer to buy a particular property, of any quality or price, it requires an educated consumer to make the better decisions.

Written by: Malcolm E.A. Kaufman


Starboard TCN is posting this article on its website and blog with Malcolm E.A. Kaufman's approval.

Malcolm E.A. Kaufman is Top Producer at McGuire Partner. He refers you to his website,, where you can see recent issues of Pulse of the Market© and learn more about him. He invites your comments, suggestions, and questions.

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