It’s intriguing to see that real estate prices in the toniest West Coast markets have been sloppy for a while, and experts anticipate this trend will continue. The reason for using the word “intriguing” is that I know some owners of prime San Francisco property who were hoping that prices for homes like theirs would double based on the tsunami of unicorn IPOs slotted for this year, and newly minted millionaires looking to park their money in suitable digs.
Now admittedly, in the cases where the IPO has fallen below its initial offering price (we’re looking at you, Uber, along with Lyft and Pinterest), others like Beyond Meat and Crowdstrike traded up nicely. Remember that only a portion of a company’s shares are sold in an IPO; insiders cashing out fully is very bad form, as well as bearish-looking, so even employees who got in early and got a nice chuck of change in the IPO might be a wee bit chastened by the aftermarket wobbles. Even so, most of the remaining 2019 IPOs are on track, save for AirBnB due to mounting legal challenges not making for the best investor story.
Yet despite all this new liquidity flowing largely into West Coast hands, the Wall Street Journal reports that on what looks to be a broad basis, urban West Coast real estate is languishing. If this were one city, you could attribute it to local factors, like a spike in residential construction. But that doesn’t seem to be a significant factor. From the Journal:
U.S. home sales slumped in June as home prices for major West Coast cities declined for the first time since 2012, ending the spring selling season with a thud.
Real-estate agents said lower asking prices could eventually attract more buyers, but home values in the Bay Area, Los Angeles and Seattle have roughly doubled over the past seven years. That means prices may have to retreat further before buyers do more than look, economists said.
“Prices have dropped in Silicon Valley and sellers just aren’t used to the concept that [prices] can go down,” said Ken DeLeon, founder of DeLeon Realty in Palo Alto, Calif. “There’s just this malaise buyers had of, ‘I feel like it’s gonna drop further.’”….
The median price of a home fell in San Jose, Seattle and Los Angeles in June, compared with a year earlier, according to real-estate brokerage Redfin. For San Jose, that was the seventh month of annual price declines. The slowdown in the West Coast marketsnow spans all price points, including starter homes, which had been the tightest segment of the market. In San Jose, inventory for homes in the bottom-third price tier nearly doubled in June compared with a year earlier, while prices dropped 3.8%, according to Redfin.
What is striking about this shift is the breadth of the change: it’s hitting so many West Coast cities, and across so many types of homes. The article attributes the price reversal to two factors: that prices have outstripped incomes of even high-end professionals, and the Trump tax reforms have limited the deductibility of property taxes and mortgage interest in high-price, high tax states like California. But if tax changes were the main driver, you’d expect the dampening to be most pronounced in the biggest-ticket properties.
One Journal reader volunteered that first time buyers were knowingly speculating on price appreciation and planning to make relatively quick flips. If this practice is as widespread as he intimates, one wonders how many will be caught out:
Many people (and I’m talking families with modest means, both working parents needing 1000-1500+ sq ft in Santa Clara) is to often start with an interest only loan (e.g. 7/1 ARM) and then try to flip the home in 3-5 years after a 20-30% run up in prices.
Take the gains and use that as a down payment on a more modest home with a traditional mortgage.
The first step in this often rewards those who pick up a larger home than they normally could afford in order to maximize the gain (via leverage).
In the San Jose Metropolitan area, we’re looking at sq ft prices of $500-$800 for homes built decades ago.
Admittedly, in light of the boom in the biggest cities, the slackening this year is just a blip. But when real estate professionals, who are constitutionally optimistic, say that things are likely to get worse before they get better, they are probably right since that view is so out of character.
How does the sharp decline in Chinese investment in the US play into this picture? On the one hand, “Chinese nationals” accounted for only 3% of US housing buys in 2018. But wealthier foreign buyers often use corporations to mask their ownership, so this figure understates the magnitude of Chinese purchases. And Chinese investors like California.
Last week, CNBC reported Foreign purchases of American homes plunge 36% as Chinese buyers flee the market:
The dollar volume of homes purchased by foreign buyers from April 2018 through March 2019 dropped 36% from the previous year, according to the National Association of Realtors. The decline was due to a drop in the number and average price of purchases. Foreigners bought 183,100 properties with a total value of about $77.9 billion, down from 266,800 valued at $121 billion in the previous period.
Notice also that foreign buyers on average pay more than locals, suggesting a combination of typically preferring higher-end properties and overpaying1:
Another data point suggesting that the West Coast well-off may be feeling nervous or even pinched comes in another Journal story, this one on Tesla. Its high-end, as in highest-status cars, aren’t selling well any more:
Sales of Tesla Inc.’s high-end Model S sedan have taken a big hit in the company’s most important U.S. market, California, as the electric auto maker is leaning more heavily on selling the lower-priced Model 3 compact car, new data show.
Falling sales of the Model S—and its sister sport-utility vehicle Model X—threaten Tesla’s growth goals and profit ambitions as it must rely more on its cheaper Model 3 to make up the difference.
Registrations of new Model S sedans in the second quarter plummeted 54% to 1,205 in California, according to the Dominion Cross-Sell report, which compiles data from state motor-vehicle records. The Golden State is a strong indicator of demand as Tesla’s largest U.S. market, representing 40% of Model S registrations in the country last year, according to auto-sales tracker Edmunds.com Inc.
The new data from research firm Dominion Enterprises indicates the stylish sedan that arguably changed car buyers’ view of electric cars is losing its luster.
So is the West Coast starting to lose its mojo? Are these wobbles an an early warning that the economy is getting soft? Or is this a sign that air is coming out of the Silicon Valley bubble, and that touches enough people on the Pacific coast to have a bigger impact than you’d expect? Tech titans are finally being depicted as 21st century robber barons. They aren’t used to having their status as Masters of the Universe questioned, let alone having their economic interests targeted.
For instance, the lead story today in all the business press is that the Department of Justice is launching an investigation into whether “online platforms” were hurting competition. It’s easy to depict this as a gambit for the US to get in front of the European Commission’s competition ministry, which is threatening to become more stringent. Recall also that France is threatening to impose a transactions tax that would hit 24 large tech players, many of them American. From the Financial Times:
The US Department of Justice announced a broad antitrust investigation into the leading online platforms, raising the stakes in Washington’s scrutiny of Big Tech’s power over growing parts of the economy.
The agency said it would look into how the platforms had achieved their market power, and whether they were “engaging in practices that have reduced competition, stifled innovation or otherwise harmed consumers”….
The DoJ move comes after the outgoing European Commission signalled it was also looking to become more aggressive in checking the market power of the largest online platform companies. A report issued in April recommended lowering the bar for companies deemed “dominant players”, subjecting them to stricter antitrust rules.
Donald Trump has been critical of the EU’s scrutiny of American tech groups, suggesting it should be US rather than European authorities investigating wrongdoing by the technology sector.
It’s obvious the DoJ intent is to blunt whatever the Europeans might do. But it’s hard to see how that can work. The EU can set the rules for its own market, which is so large that it will impose costs on tech giants, both via reducing their revenues and/or profits, and by requiring them to do business differently. That imposes costs via having to make changes to their systems and procedures and forces them to incur ongoing costs via having more balkanized operations.
Mr. Market took note, with Facebook and Amazon shares falling more than a percent in after-hours trading, while Google recovered from a similar drop. The pink paper described how there have been jurisdictional issues regarding which agency, the Federal Trade Commission or the DoJ, should be taking the lead not just with respect to the general question of anti-trust but also with respect to particular companies.
It’s admittedly a long time before anything happens legally but the presumption of tech virtue is over, and that’s a step in the right direction.
1 Having worked with foreign investors, this is way more common than you’d think. It’s easy for a broker to take a buyer who doesn’t know the city or market to a few wildly overpriced properties, then show them ones only somewhat overpriced to give them the false impression that the latter are a good deal.