Wharton’s Benjamin Keys and USC’s Richard Green discuss what home buyers can expect in this year’s challenging real estate market.
It’s spring time in the U.S., and that means people should see more and more ‘For Sale’ signs up in their neighborhoods. But this time around, the housing market faces several dampeners, according to experts.
For one, the Tax Cuts and Jobs Act passed in December reduces the incentive to own a home by capping deductions for state and local property taxes and mortgage interest payments. Second, mortgage interest rates are higher than they were last year, although they are still low by historical standards. Additionally, the outlook for new home construction is facing drags from stiff permitting fees, and rising costs of construction labor and materials. However, the impact of those would vary across housing markets as other local factors come into play, such as zoning restrictions and permitting processes.
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Outside of the tax act changes, the dominant factor is that housing finance costs are higher now than they were a year ago. “We’ve seen interest rates rise quite a bit, and that’s going to lead to higher costs for borrowing going forward,” said Wharton real estate professor Benjamin Keys, who is also a faculty fellow at the National Bureau of Economic Research. However, aspiring homeowners should treat their purchase “as a consumption good, and not an investment good,” said Richard Green, professor at the University of Southern California, who is also director and chair of the university’s Lusk Center for Real Estate. His advice to them: “Buy it. Enjoy it. Afford it.”
Keys and Green shared their insights into the changing housing market on the [email protected] show on SiriusXM channel 111. (Listen to the full podcast using the player at the top of this page.)
Following are highlights from their discussion:
Impact of Tax Changes
According to Keys, “three big changes” will affect home buyers and homeowners. One is the $10,000 cap on deductions for state and local income and property taxes. That change would have a bigger impact in states with higher income taxes and localities with higher property taxes. “That’s really going to change the benefits of homeownership,” he said. “A lot of homeowners have viewed those property tax [deductions] as though they’re getting a discount.”
The increase in the standard deduction for married couples to $24,000 would lead fewer people to itemize their deductions for mortgage interest, and state and local property taxes. “You can get that type of benefit regardless of whether you own or you rent, and so that shifts the needle a bit over towards the renting side,” said Keys.
Keys, however, noted that those impacts on housing demand would be more pronounced in expensive and higher-tax markets. Green, too, said that the impact of the tax act is “context dependent,” and that while some markets like Texas may not see a big impact, California could see “a material impact.”
The housing market in California is also particularly sensitive to the health of its technology companies since its economy has a high reliance on the tech sector, Green said. For example, he noted that “selloffs in tech stocks could have a pretty pronounced impact on the housing market” in the Bay Area.
Constraints on New Home Building
According to Green, “We still don’t have remotely enough houses in this country, and [that] should be an opportunity for builders to build.” However, he said builders face several obstacles. One is “more and more fees” related to building new homes from local administrations. Secondly, tighter bank regulation has made it more difficult to obtain construction loans, which he noted are deemed more risky than others. Keys added that construction costs are higher than in earlier times. In some markets, the anti-immigration push has made it harder to hire construction workers and has consequently lifted labor costs, while the talk of tariff wars with China have made steel, lumber and other materials costlier, he said.
“We’ve seen interest rates rise quite a bit and that’s going to lead to higher costs for borrowing going forward.” –Benjamin Keys
At the same time, Keys described the tax code and interest rates as short-term factors. He sensed longer-term trends where “demographic and economic forces are pushing people towards toward cities.” On the one hand, baby boomers are looking to downsize from their larger homes; and on the other hand, millennials want to stay in cities, he noted. “So the need for the sprawling subdivision type of development may be less there. That said, long term, there’s still potential across a range of geographies where we’re going to need some additional building to relieve some of these cost pressures.”
Afford It, Think Longer term, and Like the Place
For those who break through all those barriers and want to buy a new home, Green and Keys offered some advice, given the current environment. “The most important thing is that [buyers] don’t extend themselves too much when they buy the house, and that they are planning on staying in the house for a while, because buying and selling houses by itself is expensive and it takes a while to amortize those costs,” Green said. “So I would say to anybody about buying a house: If you’re not planning to live there for at least five years, then you’re better off renting.” It is also important for home buyers to ensure that they truly like the property, he added.
Keys agreed. “The experience of the last 10 years shows that people who may have moved into a house expecting to climb the property ladder quickly found that that wasn’t so easy to do,” he said. “And people who were underwater on their mortgage found it difficult to move out of their house. So, think about a house not as a short-term option where you’re going to move from one house to the next to the next, but as Richard was saying, take the longer view and think about dealing with all of those costs that come with buying and selling, spreading those out over a longer period of time, and looking for a space that you can be happy in.”
“I would say to anybody about buying a house: If you’re not planning to live there for at least five years, then you’re better off renting.” –Richard Green
Waiting on Millennials
According to the U.S. Census Bureau, homeownership rose to 63.9% in the third quarter of 2017, the highest rate in three years. But that’s still not close to levels seen in the last 20 years. Millennials are partly responsible for the uptick; they have begun to wade into the market as the economy has improved. Still, there’s significant room for growth in millennial home buying. “One thing about millennials is they’re just not getting married,” said Green. He added that the trend is particularly true of millennials who don’t have a college degree (two-thirds of millennials have not obtained a four-year degree). “The leading predictor of whether people become homeowners is whether they get married or not,” Green continued. “I’m waiting to see if we’ll finally see a big uptick in marriage among millennials as they get further into their 30s. We’re certainly not seeing it yet, and if we’re seeing depressed marriage for years to come, then that’s going to depress homeownership for years to come.”
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