Altos Research Real Estate Insights

Here's a quick snapshot of inventory in zip code 94022, Los Altos. Looks like we've turned the corner for winter and we won't see a lot of availability until February. The low inventory keeps us in a Seller's market for now.

There's little question that interest rates will continue to climb into the next year.
What's less clear, however, is what that means for the housing market and the market's impact on the overall economy. Most headlines seem to be looking for doom.

Bear Stearns chief economist David Malpass takes the most sanguine view of the situation that I've seen. Malpass' position essentially is that the American consumer is well positioned to benefit from interest rate hikes. Thus housing markets will cool in places (the monthly payments get more expensive, so demand will fall) but overall we aren't looking at a crash (because a strong economy and well-positioned American consumer imply people won't be panicking).

Time deposits and savings accounts alone total a staggering $4.3
trillion, versus slow-growing credit-card debt of $800 billion. True,
the U.S. is the world's biggest debtor, but it is building assets
faster than debt. Even if household assets took a hard fall, the
remaining net worth would still dwarf other countries'. On a per capita
basis, counting mortgages but not houses, net financial assets total
$89,800 in the U.S. versus $76,900 in No. 2 saver, Japan.

Savings will pay more interest, some of which will be eaten up servicing revolving debt, but it's a net positive to the consumer's wallet. Over 80% of mortgages are fixed rate, so here the rising rates have no direct impact.

So this week's news give the bubblistas more fodder. But does it play all the way through to a pop? Don't count us out yet.

A lot of coverage today about the Existing Home Sales report from the NAR.

Total existing-home sales—including single-family, townhomes,
condominiums, and co-ops – were at a seasonally adjusted annual rate of
7.09 million units in October, down 2.7 percent from September’s pace
of 7.29 million. Sales were 3.7 percent above the 6.84 million-unit
level in October 2004.


Total housing inventory levels rose 3.5 percent at the end of October
to 2.87 million existing homes available for sale, which represents a
4.9-month supply at the current sales pace.



“The rise in inventory means that buyers will have a wider choice
available to them, and the significant price appreciation over October
last year shows that demand is still there, as markets continues to
balance themselves,” says NAR President Thomas M. Stevens

In the Bay Area, we see the cooling manifesting itself in homes taking longer to sell rather than massive inventory build up.

A lot of folks are talking about higher inventory levels lately (including Paul Kedrosky's BubbleWire). I always make a point to look at relative demand levels whenever we cite inventory. That is, looking at "supply" alone is only (at best) half of the equation. So here's supply (inventory) and demand (homes sold) for Santa Clara County during 2005.

Here's a look at prices in Palo Alto this week. (note these are all single family homes listed for sales).

Here's a fun spreadsheet. Got $10mil? There are currently 12 homes in your
price range in Atherton. Note that you save a pile of money if you're
willing to buy a place built in the 60's:

The home mortgage deduction is so ingrained into the economic fiber of the country, that the potential consequences of altering this are ginormous. The risk to overall economy, if this were to be even slightly mishandled, would be devastating. As is, the impact would be very significant, given Real Estate's contribution to the economy.

One suggestion, which hadn't occurred to me, is that the elimination hits Blue States the hardest and therefore Democratic donors. Coincidence? Evil plot by the neocons?

...the changes recommended by a commission appointed by the President will have much greater negative effects on taxpayers in Democratic regions. Its as if the tax changes are a form of economic gerrymandering whose impact will be to significantly reduce the net take-home pay of (surprise!) Democratic donors.

...the so-called Blue states are high level of Government services, higher income, higher state and local taxes.
Property values are significantly higher. The mortgage deduction in these regions is worth quite alot more than it might be in the lower tax/lower property value Red states.

Likely though, it's all a moot point.

The entire issue may be moot -- at least for now -- given the present political situation. Perhaps if President Bush were at full political strength, if he wasn't dealing with numerous crisis and scandals and staff indictments and the fading support for the war in Iraq, while still smarting from the rejection of social security reform, and if his own polling numbers were not at an all time low in popularity -- if all that were not weighing against him, the chance of eliminating or greatly modifying the home mortgage deduction might be 15-25%. Given his current predicament*, my expectations are that eliminating this extremely popular -- even beloved -- deduction are all but impossible.

There's a lot of talk lately about the slowdown in the housing market. Bubblistas are pointing to latest news as evidence that we've popped. However, it could be that we're experiencing smart corrections. Housing starts are down, therefore we'll be less likely to get an oversupply when demand drops. Here's a roundup:

Calculated Risk comments here.

Besides, permits and housing starts are historically lagging indicators for a
housing slowdown. In addition to rising inventories, I believe the more timely
indicators are falling mortgage applications and declining sales.

Brad Setser points to a housing slowdown as one of the factors that will cool the US economy as a whole in 2006 (but may have a positive impact on the current account deficit).

An increase in the fiscal deficit will tend to increase
the current account deficit (the gap between savings and investment)
barring offsetting changes in private saving and
investment. Such offsetting changes are certainly possible:
leading indicators for the housing market seem to suggest that the pace
of increase in housing prices will slow, and, who knows, housing prices
might even fall in some places. That, in turn, could well lead to
higher personal savings and less consumption, through channels that are
by now well known.

Mark Thoma adds thoughts here.

It almost seems like the expectation of a housing slowdown is turning into a
self-fulfilling prophecy. But fundamentals such as the slow increase in mortgage
interest rates in recent weeks are also at play.

Mark Thoma highlights an article by Hal Varian in the Times on the recent tax reform proposal:

Varian's basic thesis is that the mortgage interest tax break causes "distortions" in the markets

...many economists would argue ... [i]t would make a lot of sense to eliminate the housing mortgage deduction entirely. ...[H]ousing is highly subsidized in this country and we would probably be better off if the tax treatment of housing were brought more into line with that of other assets.

I find it fascinating how the debate in this country has been turned on it's head. The tax deduction isn't the distorter, it's the tax itself. An individual is compelled to structure his income and investments around the things that are taxed.

In order to support his thesis, Varian piles on the "evidence"

How is housing subsidized? ... First, there is the mortgage interest deduction. Second, the deduction for property taxes. Third, the capital gains exclusion... Fourth, the deduction for points on mortgage loans. Fifth, the deduction ... on home equity loans. And there are many more tax breaks, among them home office deductions.

No question that the mortgage deduction is a biggie. But c'mon Hal, Home Equity Loans are mortgages by another name. And if points weren't deductible then those fees would just be rolled into the loan itself.

Capital gains exemptions don't necessarily impact the price, they impact the liquidity of the market. Can you imagine what would happen if every time you moved you had to sign away your gains? You'd never sell. (If you need an illustration of the impact of this, just look at what happens to apartment supply and demand in a rent-control city.)

The home office deduction isn't a subsidy of home ownership, it is a subsidy of business (particularly small business). You get taxed on those deductions later, from the homeowner perspective.

So that's one thing. But Varian continues...

I've had a few people ask about the Peninsula lately so I thought I'd try to construct a story around what we see there. I'm going to use Redwood City as a proxy because it has a nice distribution across the price ranges (with representation in all but the higest-end homes). First, the basics: Redwood City is acting in a very familiar pattern.

The town has as much inventory as we've seen all year. Our Market Action Index shows that demand remains robust, although cooling for the last 6 months. Because demand remains strong, prices in general remain solid. Again, like the rest of the Bay Area, prices spiked last year into early this year, but have generally plateaued for the last 6 months. There aren't double-digit price increases nor major price pluges in progress except...

The Wall Street Journal has a front page article today on the weakening market. Subscription is required, but here's the gist:

Rising mortgage rates, higher energy costs, widespread
talk about the risk of a "bubble" in housing and a surge in the number
of homes on the market are among the factors behind the apparent
slowdown. They have combined to make home shoppers more cautious,
economists and real-estate brokers say. Buyers are taking their time to
look for bargains, while many sellers have put unrealistically high
price tags on their homes. That leads to a standoff, causing the number
of sales to drop -- a classic ending to a period of unusually rapid
house-price increases.

In a survey conducted last week, real-estate
consulting firm Real Trends found that the number of home-purchase
contracts signed last month dropped 8% from a year earlier at 48 of the
nation's large real-estate brokerage firms. Those brokers responded to
an email poll sent to 80 brokerage firms.

So bubble-talk may be our savior from a bubble-burst. A pleasant little contrarian irony.

In the next few posts, we'll continue our theme for pointing out where the weakening market observation is accurate and where it misses the mark (because in some local markets, things are as strong as ever) and why.

The WSJ publishes a weekly home price index where it measures the price of homes in zip codes with comparable median incomes. This week, it's the Starter Home Index (subscription required), for zips with median income of $40k. Some samples:

“There
is no evidence here of prices topping out,” said OFHEO Chief
Economist Patrick Lawler. “On the contrary, house price inflation
continues to accelerate, as some areas that have experienced
relatively slow appreciation are picking up steam.”

What the quote should have read is, “As
of July, there was no evidence of prices topping out. What's going on
right now, however, we have no idea.”

Turns out that, in Silicon Valley at least, there
was indeed evidence of prices topping out. By September 1, we saw prices plateau across the region. Here are the samples.

Toll Brothers cut its estimates for new homes to be built next year.

The company cut the amount of homes it expects to deliver in 2006 to
between 9,500 and 10,200, from previous guidance of between 10,200 and
10,600 homes, due to fewer selling communities and because some it
brought forward some deliveries to 2005.

The company blamed it's slowdown on, of all things, the hurricanes.

"We attribute this change to the significant decline in consumer
confidence in the last two months that was precipitated by the
hurricanes and their aftermath, and to record gas prices," Toll said.

Hey guys, what about rising interest rates, home prices as record levels, and multi-year-highs on new home inventory? Could that have anything to do with how many you'll build next year?

The company has projects in San Jose, Sunnyvale, Alameda and Contra Costa Counties as well as the Sacramento and Southern Cal areas.