California legislature recently signed a bill into law on April 4, 2016 to raise the statewide minimum wage gradually until it reaches $15 in 2022. I will not be discussing the politics of increase in minimum wage. Instead, I will limit my discussion on possible effects on real estate in California.
The logic is simple for increasing minimum wage: more you get paid, more you can spend. However, the economics of minimum wage is not so clear-cut. Generally, rise in wages will also lead to increase in cost of services and goods produced by the laborer. If a coffee shop operates on a profit margin of 5% the owner will need to maintain that profit margin or they will be in risk of going out of business. To simplify the equation, we are going to assume the only cost to the coffee shop is labor.
If the laborer’s wage goes up by 50% then the price of goods sold (coffee price) will also need to increase proportionally by 50% to maintain the profit margin. This means that a cup of $3 coffee could be $4.50 after the 50% increase in minimum wage.
According to government data, roughly nine million people in California are paid with an hourly wage. Additionally, the social security administration data in 2013 show that roughly 53% of Americans make less than $30,000 a year. An increase of 50% to their wage will result in 50% boost to their purchase power. Like food, housing is a necessity of life. A person cannot live without food and shelter. No matter how much money a person makes, that person will spend a proportional amount of their income on housing. The law of supply and demand defines the effect that the availability of a particular product and the desire or demand for that product has on price. Generally, if there is low supply and a high demand, the price will be high. Assuming housing supply stays constant in a neighborhood, the boost in purchase power will allow more people to afford houses. Thus, demand will be proportionally greater than the existing supply of housing. Under law of supply and demand, the price of housing in that neighborhood will increase.
Investors will unlikely see much change in high price cities such as San Francisco. The median household income in San Francisco in 2014 is $83,222. This represents a wage of roughly $43 per hour. (assuming 40hour per week) Thus, it is more likely for an investor to see an increase in real estate price in cities with population making at or close to $10 per hour. Additionally, this will also affect cities without minimum wage laws. We should see a significant increase in home prices where the workers receive the most benefit from the new wage law.
According to sale’s data, the current median price of a home in San Francisco has exceeded a million dollars. A family making near minimum wage cannot afford a home in the million dollar range. Assuming the purchaser financed 80% of the purchase price of a million dollar home, the cost of the house will be close to $70,000 per year. The mortgage for a $250,000 loan at 4% is $1,193. This represents an affordable price for a family making $30,000 a year. An increase in household income from $30,000 to $45,000 a year will allow that family to afford homes in the $400,000 range. Under the law of supply and demand: if the housing inventory does not change in the city, median price of homes should increase with demand.
There are many opportunities for an investor in a real estate market. The increase in minimum wage is only one of the many factors that a prudent investor should consider. Some neighborhoods and cities with median home price of $250,000 represent a depressed labor market or over saturation of supply. An investor should still consider the traditional approach of calculating the capitalization rate on their investment along with their tolerance to risk. Please contact a real estate investment specialist near you before making significant investments in real estate.
The average asking rental rate per sq ft/year for Office properties in San Francisco, CA as of Feb 16 was $99.42. This represents an increase of 6.6% compared to the prior 3 months, with an increase of +102.4% year-over-year. County-wide, average rental rates in San Francisco are +6.7% higher at $97.67 per sq ft/year for Office properties currently for lease.