Forget the costly coasts because housing wealth is about to shift inland
Coastal housing markets face headwinds while inland markets benefit from Trump’s economic policies.
Coastal housing markets had a great run over the last 40 years. Land use restrictions created a shortage, falling mortgage rates inflated prices, wage growth created demand, and trade and tax policies favored upward distribution of income and wealth. The combination of all these factors caused residential real estate values to appreciate much more quickly on America’s coasts than it did in the heartland.
This may be about to change.
Land Use Regulatory Relief
Donald Trump stated during the campaign that he wanted to roll back land use regulations that restricted growth. I doubt he progresses much on this front, but he could initiate lawsuits that could negate some local restrictions on development. If he were to succeed on this front, the influx of new home supply would negate the primary mechanism that inflates house prices in Coastal California.
Since Trump’s election mortgage interest rates skyrocketed. Higher mortgage rates will disproportionately hit areas like Coastal California where house prices quickly inflated to the limit of available financing.
From Freddie Mac’s weekly survey: The 30-year fixed rate continues to rise, landing at 4.13 percent, up 5 basis points from a week ago to the highest rate in over two years. The 15-year fixed moved to 3.36 percent, also a two-year high and up 2 basis pointsfrom last week. …
Assuming a borrower gets the average 30-year conforming fixed rate on the conforming $424,100 loan, last year’s rate of 3.95 percent and payment of $2,013 was $44 less than this week’s payment of $2,057.
Most people accepted that we reached a permanently low floor in mortgage interest rates. As recently as late July, it looked like mortgage interest rates may hit a new record low. All that changed starting the day after Trump’s election.
Mortgage interest rates strongly impact homeownership costs, so increasing mortgage rates harm the housing market by pricing out marginal borrowers. Fewer home sales or lower prices sure to follow higher mortgage interest rates.
Since most people in Coastal California borrow the max when buying a house, then if mortgage rates rise to 5.5%, they won’t be able to borrow near as much money. Assuming prices remain constant, many simply won’t be able to afford to buy a home. This effect will be more strongly felt in Coastal California than in flyover country.
If mortgage interest rates rise to 5.5%, future buyers won’t be able to finance such large loans; therefore, they won’t be able to buy out today’s buyers allowing them to make a move-up purchase, or if they do execute a sale, it will be at a lower price, and the owner will obtain less equity (or none at all). Without the additional equity from a future sale, the people who own today won’t be able to leverage into a move-up home tomorrow at higher interest rates. The market freezes up.
Therefore, if rising mortgage rates result in smaller loan balances, then either sales volumes will go down, or house prices will go down, or perhaps some combination of both. This isn’t speculation; it’s basic math.
Wage Growth, Trade and Tax policy
The other factors that strongly contributed to Coastal California’s rapid home price appreciation are wage growth and trade and tax policy. These factors are interrelated.
Ross Perot quixotically ran for president in 1992 and 1996 as a protectionist. He’s famous for describing the North American Free Trade Agreement as the cause of “the giant sucking sound” of jobs leaving the US for Mexico.
It turns out that Ross Perot was right.
Bill Clinton facilitated the hollowing out of our industrial base, and when his wife ran for President against Donald Trump, the election was decided in America’s rustbelt, the region most impacted by the loss of manufacturing jobs.
Published: 05 December 2016
… the intention and the outcome of trade policy has been to redistribute income upward.
The point of making it as easy as possible to move a factory to Mexico, and then import the output back to the United States, is to get access to low cost labor. The predicted and actual effect of this policy is to reduce the number of jobs available to manufacturing workers in the United States. This puts downward pressure on their wages, as fans of Econ 101 everywhere know. And, since manufacturing is a traditional source of high-wage employment for workers without college degrees, the loss of manufacturing jobs to Mexico and other developing countries puts downward pressure on the wages of non-college educated workers more generally.
This is why the rustbelt gave the presidency to Donald Trump.
For some reason, the NYT and other news outlets never point out that the “free traders” seem to have no problem with protectionist measures that benefit highly-educated professionals. For example, foreign doctors are prohibited from practicing medicine in the United States unless they complete a U.S. residency program. As a result, our doctors are paid twice as much as doctors in other wealthy countries (more than $250,000 a year on average, net of malpractice insurance and other expenses). This costs the country almost $100 billion a year in higher health care costs (@ $700 per family, per year).
We prohibit dentists from practicing in the United States unless they graduate from a U.S. dental school. (Since 2011, graduates of Canadian schools are also allowed to practice here.) These and other protectionist measures inflate the pay of highly educated professionals at great cost to the economy. However, these protectionist barriers never seem to be on the agenda of free traders. …
This phenomenon explains much of the wage growth in Coastal California. With our strict environmental regulations, many manufacturers left the state. With our high house prices, many less-educated workers left the state too. All we’re left with are the highly educated professionals who benefit from policies that distribute income upward.
It is also important to note that stronger and longer patent and copyright and related protections have been a central part of recent trade deals. These protections are protectionism, the opposite of free trade. They are enormously costly and redistribute income upward. In the case of prescription drugs alone, patent and related protections raise the amount we pay for drugs by around $350 billion annually (@ $2,500 per family, per year) compared with the free market price. Patent monopolies do support research, but there are other more efficient mechanisms for financing research. …
Anyhow, it is touching to see that elite types are discovering that much of the country is unhappy with policies that were designed to redistribute from them to elite-types. The question we all must ask is, “are our elites learning?”
No. Right now, they are praying Donald Trump is one of them rather than a champion of the common man.
I recently reported that Trump’s tax plan will shift housing demand from move-ups to entry-level. In that post I outlined how raising the standard deduction to $30,000 from $12,600 will make Coastal real estate less attractive because buyers won’t gain a large tax deduction.
An increase in the personal exemption is a major tax cut for low-income and middle-income Americans because it reduces their taxable incomes by $18,400 per year. Increased disposable income will increase demand for low-end housing. So while the increased personal exemption may reduce demand in high-cost neighborhoods, this may be offset by increased demand in low-cost neighborhoods.
In other words, raising the standard deduction will shift demand away from Coastal California toward inland markets, including flyover country.
Reversing the trends of the last 40 years
Land use restrictions created a housing shortage, falling mortgage rates inflated house prices, wage growth created housing demand, and trade and tax policies favored upward distribution of income and wealth. All those trends could reverse under a Trump administration, and in doing so, Coastal California real estate may not do as well as inland areas. This time, the giant sucking sound may be real estate wealth leaving Coastal California for flyover country.