Why recession might hit San Francisco tougher than different cities

A potential recession could hit San Francisco’s tech-centered economy hard.

Though the city’s record low unemployment figure of 1.9% in May is “a pretty clear sign that we’re not in a recession at the moment,” there are potential risks, said Ted Egan, San Francisco’s chief economist.

Egan sees the Federal Reserve’s plan to raise interest rates as the likeliest trigger for a recession.

“Tech is probably the sector of the economy that’s more sensitive to interest rates,” Egan said. “That places us at greater risk.”

Higher interest rates could discourage venture capitalists from investing in startups, dampening job growth and demand for other services. Global venture capital fundraising dropped around 27% in the second quarter compared with the first, according to preliminary data last week from research firm CB Insights.

A prolonged downturn would be a major setback for San Francisco’s nascent economic recovery from the pandemic, which has already lagged other major cities, Egan said. “The tech industry has been the strongest hirer of people since the start of the pandemic, even if most of them are working from home,” Egan said. “A downturn in tech would hit us worse than other places.”

A 2012 Bay Area Council Economic Institute study found that each high-tech job supports the creation of 4.3 additional jobs, though that number is lower if many tech workers are remote, Egan said.

San Francisco’s percentage of workers back in the office has been consistently among the lowest among major US cities at around 35%, according to security firm Kastle. Office vacancy, or the amount of space available for lease, is more than 20%. Those figures could get worse during a recession, as companies seek to cut more real estate costs and workers are discouraged from paying for a commute and lunch at the office.

Commuters make their way to work down Sutter Street in San Francisco. Though the city had a record low unemployment rate in May, a recession could hurt the city’s economy.

Jessica Christian/The Chronicle

In May, the storied Menlo Park venture capital firm Sequoia Capital told startup founders that it funds that it was at a “crucible moment,” with a market downturn and longer recovery period compared with 2020. The stock market had its worst first half of the year since 1970, with the tech-heavy Nasdaq Composite falling more than 30% from its all-time high in November.

“Capital was free. Now it’s expensive,” Sequoia’s team said in a presentation. “Growth at all costs is no longer being rewarded.”

The venture firm encouraged startups to increase revenue from customers if possible, cut costs and, if necessary, raise equity or debt.

In the past two months, tech layoffs have totaled around 32,000 people globally, according to tracker layoffs.fyi — the highest number in two years, when the pandemic started.

In the Bay Area, electric car firm Tesla, video game company Unity and e-commerce firm Bolt have each laid off hundreds in recent months. Los Gatos firm Netflix, one of the earlier winners of the pandemic, has seen its stock slide around 70% this year and laid off another 300 employees last month.

Tech giants such as Facebook parent Meta and Salesforce, San Francisco’s largest private employer, said they are still hiring but doing so more selectively.

The huge balance sheets and continued growth of the biggest names in tech will be a bulwark against a severe downturn, Egan said.

“There are more layoffs in tech now, and the ratio of job listings to hires is trending downward. But for the industry as a whole, there are still more job postings than hires, which is a positive sign,” Egan said. “I don’t think this is dot-com crash 2.0,” or a sequel to the 2001 recession.

A recession is generally defined as at least two consecutive quarters of shrinking gross domestic product output and rising unemployment.

The Commerce Department said GDP shrank 1.6% in the first quarter because of lower consumer spending of 1.8% and a record trade deficit. The agency’s second-quarter GDP estimate will be reported in late July.

Scott Anderson, chief economist of Bank of the West, wrote in a research note in late June that the country is “still a ways away” from the economic contraction that marks a recession, citing low weekly initial jobless claims that are around 45% below the levels seen last summer. National new home sales also rebounded in May, a surprise for economists.

Anderson forecasts US GDP growth of 1.8% in the second quarter, which he expects to slow to around 1% in the second half of the year, because of slowing consumer spending and flat investment growth.

“I can envision many things that could put the US in recession by next year, including further aggressive interest rate hikes from the Fed, another extensive equity and bond market selloff from current levels, a sharper than expected drop in US home prices, and a business investment retrenchment as corporate profits struggled under rising input costs and softening demand,” Anderson wrote.

A storefront remains vacant on Kearny Street in San Francisco’s Financial District. Experts suggest rising federal interest rates could hurt the city if a recession hits.

Jessica Christian/The Chronicle

Although the Bay Area real estate market is showing signs of cooling as mortgage rates rise, experts say the situation isn’t comparable to the apocalyptic housing crash of 2008. But buying a home is getting more challenging.

Patrick Carlisle, Bay Area chief market analyst for real estate brokerage Compass, said rising interest rates, a plunging stock market and the surprise of tech layoffs are all dampening the housing market. Consumer sentiment has also hit a record low in June amid soaring inflation. Compass itself laid off 10% last month, or 450 employees, citing “slowing economic growth.”

“All of it adds together to create a psychology of caution, and fear of what may be coming, which, naturally, is covered by the media, which reinforces that fearful or pessimistic psychology,” Carlisle said. “And besides the very real economic changes impacting people’s ability to buy, psychology is always an enormous factor in real estate and financial markets. Optimism and confidence fuel markets, pessimism and fear throw cold water on markets.”

But decades of underbuilding homes in the Bay Area and a bleak prospect for new residential supply, particularly in San Francisco, means that the local housing market is not inflated and not at risk of a bubble, Egan said.

And unlike the pandemic crisis of 2020, the housing crash of 2008 and the dot-com burst of 2001, Egan said he believes the potential recession of 2022 will be triggered by federal monetary policy with a goal of taming inflation. If inflation falls faster than expected, that could mean a smaller interest rate increase and less of an impact on tech and the local economy, he said.

“The Fed deliberately cooling something off is not popping a bubble,” Egan said. “It’s turning down the heat.”

Roland Li is a San Francisco Chronicle staff writer. Email: roland.li@sfchronicle.com Twitter: @rolandlisf