Job Growth: SF Bay Area vs. United States 3-MMA Year-over-Year Percent Change 8% -2% -4% -6% -14%

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1 Economics Group Special Commentary Mark Vitner, Senior Economist (704) Misa Batcheller, Economic Analyst (704) What s Heating Up and Cooling Off in the San Francisco Bay Area California s economy has outpaced the nation for the past six years, and the San Francisco Bay Area has been the fastest growing part of the state by far (Figure 1). Annual real GDP growth in the greater Bay Area has averaged a strong 4.0 percent between 2010 and Growth in the local economy has been driven primarily by the strength of the region s technology sector and its impact on construction and supporting industries. The surge of economic growth at a time when the national economy has been growing only modestly is largely without precedent. Combined, the San Francisco-Oakland-Hayward and San Jose-Sunnyvale-Santa Clara metropolitan areas accounted for 8.0 percent of all U.S. real GDP growth from 2010 to 2015, despite comprising just 3.8 percent of the nation s economy. Bay Area employment growth continues to outpace the nation (Figure 2). Payroll gains have cooled relative to recent years, however, as late-cycle headwinds, including tighter labor market conditions and rising compensation costs, have created a more challenging business environment. Annual job growth in the Bay Area has slowed to between 2.5 percent and 3 percent compared to the 3.5 percent to 4 percent pace registered during the majority of 2013 to Notably, this slowdown has also been evident in the region s tech sector. Job growth in the professional, scientific & technical services and information sectors, which capture a significant portion of high-tech professions such as computer programmers, software developers and engineers, has decelerated over the past year. The number of initial public offerings (IPOs) has also slowed, as valuations have been stretched in the private markets, making IPOs appear less attractive. Figure 1 Figure 2 GDP Growth Comparison SF Bay Area: 5.7% California: 3. United States: 2. Year-over-Year Percent Change Job Growth: SF Bay Area vs. United States 3-MMA Year-over-Year Percent Change Bay Area employment growth continues to outpace the nation. Late-cycle headwinds have created a more challenging business environment SF Bay Area CSA: United States: San Jose MSA: San Francisco DMA: Oakland DMA: Source: U.S. Department of Commerce, U.S. Department of Labor and Wells Fargo Securities 1 The greater San Francisco Bay Area is comprised of the 12 counties that make up the San Jose-San Francisco-Oakland combined statistical area, which include Alameda, Contra Costa, Napa, Marin, San Francisco, San Mateo, Santa Clara, Sonoma, Solano, Santa Cruz, San Benito and San Joaquin. This report is available on wellsfargo.com/economics and on Bloomberg WFRE.

2 Labor costs have been edging higher as employers compete to attract and retain qualified workers. Many Bay Area cities have been at the forefront of local minimum wage increases. Tighter Labor Markets Are Restraining Growth The persistent tightening of the labor market has been a notable development across the country this past year, as the labor market has reached levels widely thought to be consistent with full employment. The U.S. unemployment rate stood at 4.7 percent in December and has been at or below 5 percent for the past year. In comparison, labor market conditions in the Bay Area have been tight for quite some time, as the jobless rate in the greater San Francisco Bay Area has been below 5 percent for nearly two years. The Bay Area s unemployment rate is trending near 4.3 percent and is just about even with its previous 2006 low, but remains a full percentage point above the low reached during the height of the dot-com era in Jobless rates among the Bay Area s counties range from a low of 3.1 percent in San Mateo to a high of 5.4 percent in Solano. With the pool of available workers continuing to diminish, labor costs have been edging higher as employers compete to attract and retain qualified workers. By a range of measures, wage growth has picked up across the country. Average hourly earnings in the United States were up 2.9 percent year over year in December after rising by an average of around 2 percent from 2010 to Wages have risen much faster in the Bay Area, and the region is home to some of the highest earning counties in the country. Santa Clara County ranks No. 1, with average weekly wages in the second quarter of 2016 at $2,252. That marks a significant $1,263 above the national average. Santa Clara s neighboring tech-centric counties, San Mateo and San Francisco, also placed among the top five. As shown in Figure 3, the majority of the Bay Area s localities have outpaced both the state and the national average wage growth. Napa County recorded a particularly strong increase, with average weekly wages rising more than 5 percent year over year. The strength in average hourly earnings is largely due to the preponderance of higher-paying jobs in information technology and life sciences. The rapid growth in these jobs has supported hiring in other industries, which has worsened income polarization within the region and made it much more difficult for a large proportion of Bay Area residents to find affordable housing. Wages in lower-paying parts of the economy have also been pulled higher in recent years, however. Adding to these building wage pressures, California s state minimum wage increased $0.50 to $10.50 an hour at the start of The state s minimum wage is scheduled to increase every year until it reaches $15 for all businesses by Jan. 1, Many Bay Area cities have been at the forefront of local wage increases, with some implementing changes as part of a plan to reach a $15 minimum wage ahead of the statewide mandate. San Jose s minimum wage is set to increase to $12 on July 1, 2017, before ultimately reaching $15 by Jan. 1, Palo Alto and Cupertino have also adopted legislation to reach $15 by Jan. 1, Meanwhile, Mountain View and Sunnyvale have laws in place to reach the $15 minimum a year sooner, by While the rise of the minimum wage is providing some relief to workers, it places an additional burden on many businesses and will likely slow job growth modestly in the affected sectors. Figure 3 Figure 4 Average Weekly Wage Growth by County 4-Quarter Moving Average, Year over Year Pct. Change Napa Sonoma 7% CPI: SF Bay Area vs. United States 6-MMA Year-over-Year Percent Change San Francisco-Oakland-San Jose: 3. United States: 1. 7% Santa Clara San Joaquin Marin Alameda San Francisco Solano California Contra Costa United States San Mateo June Source: U.S. Department of Labor and Wells Fargo Securities 2

3 The Cost of Living in the Bay Area Strong economic growth is pushing the Bay Area s already high cost of living up at a faster pace relative to the nation. The Consumer Price Index (CPI) for the San Francisco-San Jose-Oakland combined metropolitan region has risen 3.1 percent year over year compared to the national increase of just 1.3 percent (Figure 4). Higher energy prices have played a meaningful role in price increases this past year, as gasoline prices have rebounded. We note that energy prices are more volatile in California due to environmental restrictions on the blends of gasoline used in the state and initiatives to promote green energy. The core CPI, which strips out the more volatile food and energy components, is still up 3.8 percent in the Bay Area and 2.2 nationwide. Shelter costs, which account for roughly 40 percent of the core CPI and captures rental prices, are up a sizable 6.9 percent over the past year in the Bay Area. In comparison, shelter prices nationwide are up just 3.6 percent over the period. Skyrocketing home prices and rents continue to top the list of cost burdens for Bay Area residents. Higher housing costs are not a new development for the Bay Area, as the region s perennially tight housing market tends to support prices and rents even when the economy is growing slowly. When growth picks up, the high costs and considerable delays in bringing new properties to the market tend to cause prices and rents to surge. In economic terms, San Francisco has an incredibly inelastic supply of housing. Home prices have been rising steadily throughout the region since the end of the Great Recession as the Bay Area was one of the first major regions to see economic growth kick into higher gear. Home prices in San Francisco recovered back in April 2013 and currently stand nearly 40 percent higher than their previous 2007 peak. Despite the increases, home price appreciation across the Bay Area has largely decelerated (Figure 5). San Francisco County has seen a particularly notable slowdown in home price gains, with home price appreciation falling from an annual average increase of 12 percent in 2015 to a modest pickup of 1.3 percent year over year in November Much of this deceleration has occurred at the top of the market where price gains had been the greatest. Price increases for more modestly priced homes have actually accelerated in many parts of the Bay Area, as relatively little new supply has come on line. Effective apartment rents were $2,472 per month in San Francisco, $2,059 per month in San Jose and $1,719 per month in the East Bay in the third quarter, according to data from Reis. 2 Higher rents have brought about new supply, which has pushed the vacancy rate slightly higher and helped cool off the rise in apartment rents. San Francisco s apartment vacancy rate has risen about a percentage point over the past two years to 4.4 percent in the third quarter (Figure 6). Figure 5 Figure SF Bay Area Counties Home Price Growth Year-over-Year Percent Change CoreLogic HPI 3 2 7% San Francisco Apartment Supply & Demand Percent, Thousands of Units Apartment Completions: 463 Units (Right Axis) Apartment Net Absorption: 566 Units (Right Axis) Apartment Vacancy Rate: 4. (Left Axis) The Bay Area s already high cost of living is rising at a faster pace relative to the nation. Home price growth across the Bay Area has largely cooled Alameda: 5.7% -2 San Francisco: Santa Clara: 5. San Mateo: Source: CoreLogic, Reis, Inc. and Wells Fargo Securities 2 Reis metro area definitions are as follows: San Francisco includes San Francisco, Marin and San Mateo counties. San Jose includes Santa Clara County. East Bay includes Alameda and Contra Costa counties. 3

4 We estimate that the Bay Area s economy grew 5.9 percent in The moderation in employment growth and housing costs should continue in Summary and Outlook After five years of exceptionally solid economic growth, the Bay Area is beginning buckle on some of the strains generated from growing at such a rapid pace. Annual real GDP growth averaged a 4.0 percent pace in the Bay Area from 2010 to We estimate that the economy grew 5.9 percent in By contrast, real GDP growth has averaged just a 1.9 percent pace nationwide over this period, and the U.S. economy grew just 1.6 percent in Stronger economic growth has brought the unemployment rate back down to levels long considered to be near full employment and wage gains have accelerated. The cost of living has also ramped up in the region, where growth has been much stronger and impediments to development are much greater. Traffic congestion has also worsened considerably, raising the costs of commuting. The higher costs of doing business and increasing frustration with traffic congestion have contributed to the outmigration of some businesses away from the region. Growth has also shifted to lower-cost parts of the Bay Area, most notably Oakland and the East Bay in general. Growth in the region has shown some signs of moderation this past year. Nonfarm employment growth has decelerated. Job growth in the San Francisco metropolitan division was 3.1 percent in 2016, down from 4.8 percent the prior year. That still left payrolls some 32,400 jobs higher than the prior year, but the increase was down from a gain of 47,700 jobs in Much of the deceleration occurred during the second half of the year. Employment growth in Oakland followed a similar pattern, with nonfarm payrolls rising 2.5 percent in 2016, following a 3.1 percent rise the prior year. Oakland saw a net increase of 27,100 jobs in 2016, which is smaller than the 32,800 jobs added in Housing costs are also showing some tentative signs of cooling. Home price appreciation has moderated, following huge gains at the higher-end of the market. In addition to suffering from some indigestion from previous price spikes, demand for higher-priced homes also likely cooled off a bit as the IPO market slowed and interest from overseas buyers waned. Apartment rent growth has also lessened as development has increased significantly in recent years and the sudden onslaught of new units caused rents to rise more slowly this past year. The moderation in employment growth and housing costs should continue in Hiring has cooled off as employers have had a more difficult time filling vacant positions and rising compensation costs have raised the bar for many new hires. In addition, with the unemployment rate near 5 percent, many of the jobs being added are pulling workers from the ranks of the underemployed and involuntary part-time workers. The net result has been stronger wage and salary growth but less employment growth. The impact of the Trump presidency on the Bay Area remains uncertain but does create both upside and downside risks. Tax cuts would benefit high wage earners in the Bay Area, and the stock market rally since the election has helped reignite the IPO market. Regulatory reform would also likely benefit the region, possibly paving the way for more residential development. In addition, the Bay Area would benefit from an increase in infrastructure spending, although any growth on that front is likely years away. We also anticipate interest rates to be modestly higher, which will add to the region s housing affordability challenges. In addition, we look for the dollar to be stronger, which will likely impact corporate earnings for large multinational firms based in the region. The Trump administration s trade initiatives may also create some downside risks to the region, with threats of border taxes and tariffs potentially slowing trade with key trading partners such as Mexico and China. Increasing restrictions on immigration is another issue for employers and the Bay Area in general, which may adversely affect hiring in the region s technology, construction, hospitality and agriculture sectors is the latest data available. 4

5 San Francisco Bay Area Economic Outlook San Francisco-Oakland-Hay ward MSA Actual Forecast Real Gross Domestic Product, Millions 325, , , , , , , ,545 Annual Rate Population, Thousands 4,401 4,462 4,529 4,596 4,656 4,712 4,762 4,810 Change, Thousands Nonfarm Employment, Thousands 1,964 2,037 2,107 2,177 2,258 2,322 2,387 2,444 Change, Thousands Unemployment Rate, Annual Average Total Housing Permits 5,783 9,163 10,922 10,001 13,386 14,400 15,500 17,000 Single-Family Permits 1,923 3,095 3,659 3,716 4,804 4,900 5,540 6,000 Multifamily Permits 3,860 6,068 7,263 6,285 8,582 9,500 9,960 11,000 San Jose-Sunny vale-santa Clara MSA Real Gross Domestic Product, Millions 176, , , , , , , ,447 Annual Rate Population, Thousands 1,870 1,898 1,929 1,954 1,977 1,998 2,018 2,038 Change, Thousands Nonfarm Employment, Thousands ,002 1,043 1,080 1,112 1,140 Change, Thousands Unemployment Rate, Annual Average Total Housing Permits 3,097 5,532 7,764 10,037 5,788 5,900 6,600 6,700 Single-Family Permits 1,002 1,501 1,870 1,861 1,897 2,030 2,150 2,200 Multifamily Permits 2,095 4,031 5,894 8,176 3,891 3,870 4,450 4,500 Source: U.S. Department of Commerce, U.S. Department of Labor and Wells Fargo Securities Forecast as of: 5

6 San Francisco Bay Area Economic Conditions Job Growth: SF Bay Area vs. United States 3-MMA Year-over-Year Percent Change $25 $20 California Venture Capital In Billions of Dollars Silicon Valley: $3.9 Billion California: $5.1 Billion $25 $20 $15 $15 $10 $ $5 $ $ $0 - SF Bay Area CSA: 2. United States: Santa Clara Average Weekly Wages by County 4-Quarter Moving Average, USD - -1 Employment Cost Index: Wages & Salaries Private Industry Workers, Year-over-Year Percent Change Los Angeles-Long Beach-Riverside: 3. San Jose-San Francisco-Oakland: 3. United States: 2. San Mateo San Francisco Alameda Marin Contra Costa California Solano United States Napa Sonoma San Joaquin June $0 $500 $1,000 $1,500 $2,000 $2,500 San Francisco Apartment Effective Rent Percent Change Housing Affordability Percentage of Households That Can Afford Median Priced Home SF Bay Area: 22.9% US: 56.7% CA: % % Quarter-over-Quarter: -1. (Right Axis) Year-over-Year: 0. (Left Axis) Source: CAR, PwC/MoneyTree, Reis, Inc., U.S. Dept. of Labor and Wells Fargo Securities 6

7 Wells Fargo Securities Economics Group Diane Schumaker-Krieg Global Head of Research, Economics & Strategy (704) (212) John E. Silvia, Ph.D. Chief Economist (704) Mark Vitner Senior Economist (704) Jay H. Bryson, Ph.D. Global Economist (704) Sam Bullard Senior Economist (704) Nick Bennenbroek Currency Strategist (212) Anika R. Khan Senior Economist (212) Eugenio J. Alemán, Ph.D. Senior Economist (704) Azhar Iqbal Econometrician (704) Tim Quinlan Senior Economist (704) Eric Viloria, CFA Currency Strategist (212) Sarah House Economist (704) Michael A. Brown Economist (704) Jamie Feik Economist (704) Erik Nelson Currency Analyst (212) Misa Batcheller Economic Analyst (704) Michael Pugliese Economic Analyst (704) Julianne Causey Economic Analyst (704) E. Harry Pershing Economic Analyst (704) Donna LaFleur Executive Assistant (704) Dawne Howes Administrative Assistant (704) Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, LLC, a U.S. broker-dealer registered with the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and the Securities Investor Protection Corp. Wells Fargo Securities, LLC, distributes these publications directly and through subsidiaries including, but not limited to, Wells Fargo & Company, Wells Fargo Bank N.A., Wells Fargo Advisors, LLC, Wells Fargo Securities International Limited, Wells Fargo Securities Asia Limited and Wells Fargo Securities (Japan) Co. Limited. Wells Fargo Securities, LLC. is registered with the Commodities Futures Trading Commission as a futures commission merchant and is a member in good standing of the National Futures Association. Wells Fargo Bank, N.A. is registered with the Commodities Futures Trading Commission as a swap dealer and is a member in good standing of the National Futures Association. Wells Fargo Securities, LLC. and Wells Fargo Bank, N.A. are generally engaged in the trading of futures and derivative products, any of which may be discussed within this publication. Wells Fargo Securities, LLC does not compensate its research analysts based on specific investment banking transactions. Wells Fargo Securities, LLC s research analysts receive compensation that is based upon and impacted by the overall profitability and revenue of the firm which includes, but is not limited to investment banking revenue. The information and opinions herein are for general information use only. Wells Fargo Securities, LLC does not guarantee their accuracy or completeness, nor does Wells Fargo Securities, LLC assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. Wells Fargo Securities, LLC is a separate legal entity and distinct from affiliated banks and is a wholly owned subsidiary of Wells Fargo & Company 2017 Wells Fargo Securities, LLC. Important Information for Non-U.S. Recipients For recipients in the EEA, this report is distributed by Wells Fargo Securities International Limited ("WFSIL"). WFSIL is a U.K. incorporated investment firm authorized and regulated by the Financial Conduct Authority. The content of this report has been approved by WFSIL a regulated person under the Act. For purposes of the U.K. Financial Conduct Authority s rules, this report constitutes impartial investment research. WFSIL does not deal with retail clients as defined in the Markets in Financial Instruments Directive The FCA rules made under the Financial Services and Markets Act 2000 for the protection of retail clients will therefore not apply, nor will the Financial Services Compensation Scheme be available. This report is not intended for, and should not be relied upon by, retail clients. This document and any other materials accompanying this document (collectively, the "Materials") are provided for general informational purposes only. SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE