It’s different this time…

[PerryChase]

ybc, yes you can adjust your property tax down in case of depreciation. That’s proposition 8 — temporary reduction of assessed value for property tax purposes.

However, when prices go up again, your house will automatically revert back to the original basis + 2% annual compound. Therefore, for property taxes purposes, it’s always better to buy low and hold-on forever. When you retire (after 55, I think), you can transfer the original basis to another house of equal or lesser value.

Here’s more on Prop 13. I benefit but I still think it’s unfair.
http://patrick.net/prop13/unfair.html

[VCJIM]

Perry, what part do you think is unfair? The reversion back when prices go up again?

[ybc]

I think that once interest on other consumer debt (student loan, or even some other loans) was also tax deductible, but were taken away (don’t remember when). So relatively speaking, mortgage debt became more attractive to other consumer debt. Also, the capital gain tax was introduced in 1995 or 1996, I believe. Before that, you have to “roll” your gain into another house. So again, relatitively speaking, the added flexibility makes a house more attractive as …. an investment. So over the years, house became an asset class of its own as far as tax is concerned.

As far as prop 13 is concerned, the result is cumulative. That is, if you bought a house 10 years ago and had a very low tax base, you’ll want to keep it, or to give it to your children. So that might have reduced housing turnover in CA and pushed up the marginal costs for new buyers.

Note that I’m not arguing for a “permanent” high price point because of all these. In fact, I think that these favorable factors couraged more speculative buys in California, therefore making the size of the bubble bigger. How it’ll deflate depends on interest rate, credit availability and employment….

[ybc]

PerryChase, thanks for answering my question on prop 13. Yes, I think that prop 13 is a bad policy, too. (And I don’t benefit from it). The shortcoming of the policy is that overtime, it really creates different “carrying costs” for homes based on when you entered the market. It’s kind of like rent control. While it reduces costs for earlier residents, it makes the marginal cost of late entry much higher.

[VCJIM]

Wow, I think prop 13 is a godsend. I don’t know if it’s national news but Idaho is having a huge problem with property taxes. In Northern Idaho (where I have family), they went up 60% this year, resulting in massive protests. Northern Idaho has very little middle class, it is largely rich people from out of state, and locals that do not earn a lot of money. So the locals are being priced out of their homes. With something like Prop 13 in place, this is prevented.

Here’s one quick article I found, I will look for others with more data:

http://www.mtexpress.com/index2.php?issue_date=07-26-2006&ID=2005111538

[ybc]

The problem with prop 13 is the it discourages mobility (over a very long time). So suppose that 50% of the people bought houses 10 years ago. Suppose 20% of them have some desire to go somewhere else or take the profit, but would rather not “lose” their property tax base. So this 20% of housing stock will stay somewhat permanently within the family, hence increases the price volatility for the rest of the market, mostly upward volatility. I believe that I saw families with savvy parents who’ve bought several houses early, and it seems that the whole family (adult kids) now live on rent income due to later inflation. This is NOT a productive way of life.

I agree that the scenario in Idaho is not desirable either. A better solution could be a hybrid — prop 13 like protection only for primary homes; not for rental and 2nd/vacation homes. A “cap” that’s inflation indexed rather than an arbitrary 2%.

Again, a policy like Prop 13’s impact is only felt decades later…If you think that overal inflation is always positive and likely higher than 2%, then a home, relatively speaking, is always a fairly good bet in California in a normal environment (and I don’t consider today as normal)..

[VCJIM]

ybc, I see what you’re saying. You’re right about prop 13 discouraging mobility, I seriously thought about property tax implications when I sold my house. It is also one of many reasons I am renting and waiting for prices to fall. I’d much rather have a higher mortgage interest rate, with a lower sales price and lower property tax base.

As far as your solution, I like it! I think they are considering something like that in Idaho, because so many of the expensive homes are second / vacation, and they have had a lot of speculative buying from newly rich Californians. Limiting property tax increases on primary residence only seems very workable, even with the likely fraud that would result.

[ybc]

Another un-intended consequences of prop 13 is that existing homeowners do not feel the pain of high house prices. So you see homeowners are all very protective of house prices — they don’t care about affordability at all. There is a very strong “not in my backyard” mentality. In fact, the higher the price, the merrier. So what should be a community problem (i.e. high housing prices) became a minority problem (i.e. for the unlucky late comers).

So I probably will be for using a 5 year average property value as a tax base (maybe subject to an initial price adjusted by inflation cap) to make it easier for curent homeowners, but not making them forever delinked with high housing price except at the time of profit taking — not that I’ll be a policy maker anytime soon, and not that prop 13 will be changed anytime soon.

Sorry for the many posts on prop 13. Obviously I feel strongly about it. I don’t like a policy that seems to serve a good purpose at the time but creates distortions years later. So I’ll make it my last. You’re welcome to disagree.

[bmarum]

Interesting points regarding rents Daniel. I know this probably isn’t exactly what you’re talking about, but one of the UCLA Anderson forecast guys, Leamer, analyzed the relationship between rent and median home prices in SD from 1988 to 2000. From the articles I’ve read, it looks like he compared the median value of a home with the annual rent for a two bedroom unit over the course of these twelve years. San Diego’s average P/E during that time was 22.8, i.e. the median house was on average 22.8 times the annual rent of a two bedroom unit. I have no idea what the data before 1988 looks like, or whether Leamer analyzed that.

Using Leamer’s data, and the most recent rental rate reported by the Union Tribune for a two bedroom unit, would give us a median home price of $394,531 ($1442*12*22.8). Certainly a good bit below the current median priced home, but not half of the current median. It is my understanding that in the short term the purchase market and the rental market move in opposite directions but that over the long term they move together. That is, that when the purchase market softens or drops, the rental market improves and vice versa, but that over the long term rents and prices both increase. Do I have that right? If so, it seems to me that as housing prices decline, rents will likely increase, which means we’ll get back to the trend line but some of the movement may come from rental increases and not all of it (althoug quite likely the vast majority of it) will come from price drops.

http://moneycentral.msn.com/content/Banking/Homebuyingguide/P37631.asp

http://www.signonsandiego.com/news/business/20060719-9999-1b19rent.html

[smfj]

JES, you are correct in my opinion – examaning behavioral elements, such as herd mentality, of market movement is critical. (I do think that a certain amount of this is shown in historical price movement because I mostly subscribe to the efficient market theory, but that’s another topic).

I’d argue that speculation is nothing new. An excerpt from “The Next Little Dollar” by Mike Davis, the first section from the book Under the Perfect Sun: The San
Diego Tourists Never See (interesting read):

“Although there were no industries and few farms to support the increase, San Diego (population 2,637 in 1880) had swelled to more than 40,000 residents by the winter of 1887. The city’s boom economy seemingly consisted of speculators selling land to other speculators . Four hundred realtors were busy subdividing enough lots for the
population of one million that some zealots were predicting for San Diego by 1900… Like the cloud city of Laputa in Gulliver’s Travels, San Diego defied the laws of economic gravity… Then, in 1888, the boom abruptly collapsed, and San Diego’s inflated land values came crashing back to earth… (As one ruined speculator supposedly told a local paper: “I had a million dollars wiped out in the crash, and
what’s worse, $500 of it was in cash.”)”

[Bugs]

If we’re looking at asset bubbles there are lots of examples of reversion to the mean and not one example of the new paradigm. With that kind of track record I believe the burden of proof is on the bull side of this argument, not the bear side. The bears have something to point to as a demonstration of how it can work and how it has happened in the past; the bulls don’t.

Just looking at the reversal of the markets over the last 12 months, I’d say the uber-bulls are running on empty right about now. Their primary argument before was “It won’t happen this time because it hasn’t happened this time”, a rather circular argument in that it could only be true until it wasn’t.

[bubba99]

I tried posting this elsewhere but I think I failed. It speaks to why this time is different

Of course it is a bubble!

During the discussion of bubble or no bubble, people tend to cite history and argue that we have seen housing correction in the past and never has there been anything like the crash currently forecasted for California housing. But this crash is not the product of nature, but the product of 9/11

Remember back in late 2000 and early 2001, how the dot com bubble had burst and the stock market began a significant slide. It was not coming back, and then 9/11 struck and the market began to crash. The only thing the United States could do to counter the looming financial disaster was to inject liquidity into the market place. I don’t think the Federal Reserve intended the real estate market to move so quickly, but it was a conscious decision to combat a financial panic after 9/11. Why else would an economy based on growing under employment create a trillion dollars in new wealth?

Like all attempts to control the economy by the fed, this one had un- intended consequences. Housing almost doubling in value was un-intended, but OK as long as it did not get too far out of control. The early increases in housing values must have been read as a positive result by the fed. It allowed people to borrow against their houses and raised consumer sales across the board. As it developed in late 2002 and through 2003, the federal reserve must have been delighted that they were able to stave off the financial disaster from 9/11 and create trillions of dollars in real estate value all at the same time. The stock markets were not only stabilized, but growing with gusto. People speculated with two and three houses, serially refinanced their own home and took full advantage of the liquidity injected by the artificially low interest rates.

But housing grew into the proverbial 200-pound guerilla. Housing had superheated, and interest rates were almost as low as they could go. Lenders had fully embraced the easy money and created financial instrument meant for investors that were being used by mom and pop to buy more house than they could afford. Housing had almost doubled in value by the end of 2005, most of the new debt was “special instruments” – arms, interest only, negative amortization and even more exotic loans. It was time to rein in the monster. Predictably, the fed thought they could fix it by simply un-raising interest rates, and that is where the pop is going to come from. The wide spread between short term and long term interest rates is narrowing.

Unlike when they lowered rates, there is now a lot of special financing out in the market place, and it will begin to have un- intended consequences in a few months. Rates will continue to rise, they must to continue to sell US debt to foreign investors. The dollar has been falling against all major currencies, and “they” will not continue to lose money on US government debt. This will start a rapid move out of real estate. The creative financing will accelerate the move out of real estate, and the bubble pops. This is already too long, or I would continue on why the bubble bursting in real estate is not going to cause a financial crash.

[Daniel]

bmarum,

I have long recommended people read the following financial report on the US housing bubble:

http://neweconomist.blogs.com/new_economist/files/HSBC_frothfindingmission.pdf

In my opinion, it is the best paper out there, bar none. Imagine Rich’s bubble primer, but 110 pages long. Full of graphs, charts, and models. It is very good. There is a lot about rents in there.

And regarding the rental market, I totally agree. It tends to diverge in the short term from the housing market, as demand shifts from one to another, but the two track each other extremely well over the long term.

[PerryChase]

I second the notion that RE depreciation is no longer debatable. We just need to sit back and see how far down it’ll go.

vcjim, on Prop 13, what I find unfair, is that if your parents bought a house in La Jolla for $100k, and now it’s worth $2 Million, you now own the house but you pay less in property tax than somone who just bought a condo in Escondido. That’s just a very regressive tax structure.

[bob007]

when prop 13 is repealed look for California real estate market to take a hit.

it will happen when central valley/inland empire voters outnumber the coastal voters. it will happen in 15-20 years.

[Author]

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