Wolf Richter wolfstreet.com, www.amazon.com/author/wolfrichter
Here’s how it works. Meanwhile, the media is busy publishing real-estate industry hype.
This is a shorter, less angry version of my podcast last Sunday (as many have found out, I’m freer when I talk than when I write).
It’s now a standard theme in San Francisco and Silicon Valley conversations, and it’s everywhere in the media: The wave of mega IPOs – including Lyft’s IPO last month and the forthcoming IPOs of Uber, AirBnb, Palantir, etc. – will cause the Bay Area to drown in millionaires that are all going to move out of their rinky-dink apartments and buy homes and cause the housing market that has been sinking since spring last year to make a violent U-turn and inflate a whole lot more. The entire real-estate industry is salivating and pushing this theme. But wait…
First, there’s history. The last two mega waves of IPOs were followed by, well, not further home price increases but housing busts.
The IPO boom in 1999 and early 2000 led to the same kinds of speculations that these newly minted millionaires in Silicon Valley and San Francisco would push up home prices. But then came the bust, and these startups cratered and people lost their jobs and couldn’t afford to live in the Bay Area without a job, and they packed up and left. Some dumped their homes. Others defaulted on the mortgage and walked away because they could: California is one of only 12 “non-recourse” states. Housing units began to empty out. Home prices, instead of being further inflated by this mega-wave of IPOs, fell.
Similar hype about IPO moola further inflating an already inflated housing market, with the entire real estate industry salivating, occurred in 2006. In 2007, the local housing market started to crash.
And there are reasons for this – as counter-intuitive as this may seem to folks who have never been through these boom-and-bust cycles.
Much of this hype is based on the assumption that these IPOs will suddenly generate billions of dollars of real wealth out of the hypothetical and unreal wealth of non-publicly traded shares, convertible notes, or stock options.
But that’s not how it works. This hypothetical money is not hypothetical. It’s real, it has been real for years, and it has grown over the years – in Uber’s case, in 10 years from a few million dollars to tens of billions of dollars. The equity of these companies has been worth many billions of dollars for years. People and entities that own this equity have gotten immensely wealthy by owning it.
The IPO, which is in essence a round of funding, might inflate the equity value a little further from the last round of funding and shift ownership a little. That’s about all it does.
If Uber’s IPO values the company at $90+ billion, as is being rumored, it doesn’t suddenly create $90 billion. At the last round of funding, Uber was already valued at $76 billion. And that has been real wealth – not hypothetical wealth. Here’s why:
One, during fund raising rounds, employees can often sell their shares or convertible notes to new investors. For example, in January 2018, a consortium led by Softbank bought $9.3 billion of Uber shares both from existing shareholders and from Uber itself. In this deal, former Uber CEO and co-founder Travis Kalanick reportedly sold $1.4 billion of his shares to Softbank. Other Uber employees sold too.
Two, some of these startup companies have programs in place where they buy back shares from employees to allow them to cash out some of their wealth.
Three, in tech centers such as San Francisco and Silicon Valley, some banks have departments dedicated to converting pre-IPO equity into cash by lending money to those people, with the equity being used as collateral.
Four, many employees have been able to sell their shares in the secondary market that exists for the shares of startup companies.
All these methods allow employees to cash out some of their wealth. And they went ahead and used this moola to buy expensive homes years ago.
This money has been circulating in San Francisco and Silicon Valley for years and was a big driver of the blistering housing bubble that peaked last year!
Are Uber billionaires somehow not billionaires just because the IPO hasn’t taken place yet? Nope. They have been billionaires for years. And their multi-millionaire underlings have been multi-millionaires for years as well. And they have already bought expensive homes based on their wealth.
But wait… that’s not all.
The biggest winners in an IPO are the institutional investors, such as venture capital funds; or for late-stage investments, private equity funds, pension funds, even mutual funds. Their money comes from around the globe. When they sell their Uber shares to the public during and after the IPO, they will make huge gains. But this is not San Francisco money. This is global money, and it goes back where it came from.
It took Uber 10 years to become what it is today. During this time, its “value” as determined by investors has skyrocketed. Uber employees that have worked there for years, and that are multi-millionaires based on their stock compensation plans, have been multi-millionaires for years. And they generally don’t live in some dumpy apartment with three other roommates. They cashed out some of their wealth years ago and bought a nice place years ago.
This home-buying by wealthy startup employees has been in part responsible for the surge in home prices in San Francisco. They’re not going to do this in the future. They already did. And that’s one of the reasons home prices are already so high.
But even if they’re suddenly buying an even more expensive home, they’d have to sell the home they’re in now. They’re not creating new demand. First-time buyers or new arrivals create new demand. But people selling their home and buying another home don’t create new demand. They’re just churning the market.
Certainly, there are some recently hired employees whose shares or convertible notes are going to be worth $100,000 or $300,000 dollars, assuming that the post IPO-shares don’t crash. And some of them – after the lockup period expires and they can sell the shares – can use this money for a down-payment on a ludicrously overpriced home.
They’ll buy a median apartment that may run them over a million bucks. And they’ll make huge monthly mortgage payments, and they pay home-owner association fees, and they pay property taxes on that inflated home price. And they have a good chance of losing money on their home because this is precisely how it happened after the last two big IPO waves.
Both those times – in 1999/2000 and 2006/2007 – institutional investors cashed out, and the global money went to global investors, not to San Francisco. And founders and early employees had gotten rich years before the IPO and had bought homes before the IPO, which contributed to the inflation in the housing market long before the IPO wave. When the startup boom crashed, as it always does, home prices sank with it.
What these mega-IPO waves tell us is this: It’s the peak of the cycle, or past the peak of the cycle. It’s when global money – VCs, PE funds, and other institutional investors – are trying to cash out by selling their shares at hugely hyped-up valuations to the public.
Uber’s 330-page IPO filing disclosed all kinds of goodies, including huge losses from operations, big tax benefits, large gains from the sale of some operations, stagnating rideshare revenues, growing revenues from Uber Eats, and an enormous list of bone-chilling “Risk Factors.” Read… Uber Discloses 3-Yr $10-Billion Loss from Operations, Stalling Rideshare Revenue & 50 Pages of “Risk Factors” that Are Not for the Squeamish