The reason that real estate prices in San Francisco respond so vigorously to relatively minor changes in demand is because the supply is so inelastic. I realize full well that so far, I have just restated the definition of supply elasticity, but bear with me.
Some people would say that real estate in a geographically contained space like San Francisco is inherently in inelastic supply. And those people would be wrong. The binding constraint on San Francisco real estate is regulation. There are plenty of areas of San Francisco that are relatively low-density, but it is ridiculously hard to develop or redevelop anything.
You may counter that here and there you see enormous over-the-top development and re-development projects going on. But that is precisely the problem.
Try to buy up four adjacent townhouses in the Sunset and convert them to a ten unit apartment building. I would argue that is precisely the kind of human-scale gradual redevelopment that can be done without disturbing the social structure of neighborhoods and other such intangibles that development opponents complain about.
You will soon find there is no way. The only way to do any sort of development in San Francisco is to amass such enormous resources that you can lobby your way into a mega-project.
These really big mega-projects then proceed to antagonize the electorate, stir up anti-development sentiment, and cause people to vote for even more restrictive land use regulations next time around.
And that makes it harder for anyone to do the sort of gradual, organically driven, small-scale density-increasing redevelopment of lower-density residential and industrial areas that San Francisco could easily absorb and that existing residents wouldn't generally be all that upset by.
As a consequence, supply is very inelastic. When new units become available, it's often in big chunks (see e.g. the big luxury apartment projects around AT&T park), but the total volume of development is nothing like what it could be.
The problem is by no means unique to San Francisco, but I do have the impression that San Francisco suffers from this problem worse than other cities in the area.
And don't get me started about rent control.
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