The height of the California Gold Rush in 1849 was no time to fancy a greasy-spoon breakfast. Back then, according to this Smithsonian.com article, a dozen eggs cost $90 (£63) at today’s prices, a pound of coffee $1,200 (£849) and even a slice of buttered bread $56 (£39). Should someone have stolen your pickaxe after you passed out on receiving your bill, a new one would have set you back the equivalent of $1,500 (£1,061).
Fast-forward to modern-day California and echoes of this kind of localised inflation can be identified in San Francisco’s property market, where the average house price is now $1.2m (£849,364). Calculations made by a local property manager meanwhile suggest that just 11% of the city’s population can actually afford the 20% deposit, taxes and insurance costs associated with moving to such a property.
This strong rise in the San Franciscan property market can of course be largely attributed to the ongoing ‘California Tech Rush’. Here on The Value Perspective then, we thought it would be interesting to do some calculations of our own as to how a young employee at a large technology company – let us call her Fay Zbuk – might try to get a foot on the property ladder in the area.
Let’s say Fay has managed to save a bit of money but not enough to cover the $254,000 (£179,782) she needs for the deposit, taxes and insurance costs on that average $1.2m (£849,364) house. She does, however, have some stock units and it just so happens that there is now a financial product available that enables her to borrow up to 80% of the value of these units as ‘collateralised equity’ (also known as ‘debt’).
So we have Fay looking to buy into a property market that, while we cannot know for sure, certainly looks pretty highly valued and then, on top of that, she is planning to help fund her purchase with stock units that have gone up a long way over the last few years. All things considered, Fay’s finances are starting to feel precarious but, still, let’s crunch the numbers.
Say Fay has so far been thrifty and saved $100,000 (£70,771), while her stock units are worth $200,000 (£141,537). She decides to borrow the maximum possible $160,000 (£113,229) against these – $154,000 (£108,983) to bring her up to that $254,000 (£179,782) costs figure, plus an extra $6,000 (£4,246) to help fund some initial DIY. Her total assets thus stand at $1.4m ($1.2m for the house plus $200,000 (£141,537) of stock).
At the same time, her total debt is $1.16m (£1,132,626) ($1m of mortgage debt plus $160,000 of collateralised equity), meaning her net wealth at this point is $240,000. Now let’s say the value of her employer –FaceBook seems appropriate – falls back to the level it was, respectively, one and two years ago. What does that mean for Fay’s finances?
Those scenarios would see her net wealth fall to $190,000 (£134,510) and $130,000 (£92,033) – so no cause for alarm just yet. If we then add on the not-unrelated impact of taking San Franciscan house prices back one and two years, however, we find Fay’s net wealth now falling to $65,000 (£46,016) and minus $145,000 (£102,659) respectively – the latter scenario, in other words, wiping out her net wealth and putting her well into negative equity.
We are not, this time, picking on the valuations of the so-called ‘FANG’ generation of tech stocks – for that you should read Video nasty – or even of San Franciscan property. Rather, we wanted to highlight the folly of financial products that spring up to continue inflating a bubble and so can prove very dangerous indeed to the unwary should the future not pan out in the way they might expect or hope.