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Jim Scott

A Time for Caution

Seven years have passed since The Great Recession ended. Home prices have steadily increased and are now slightly higher than they were when the housing market crashed in 2008. Unfortunately, there could be problems in the housing market next year. First, Washington has concocted a regressive tax plan that if enacted, will be toxic for states with expensive housing and above average state and local taxes. Additionally, the Federal Reserve Board will continue to ratchet up interest rates. Last, the ugly brew of housing shortages and income inequality probably will shrink the pool of financially-able first-time buyers. This could lead to lower demand for starter residential properties which could eventually impact prices of higher-priced homes. Will a combination of punishing tax increases, rising income inequality, growth restrictions, and changes in interest rates, push the San DIego home market into a recession?

There is still no final consensus on the details of the proposed overhaul of the Federal tax code. The Republicans seem committed to passing any kind of tax reform this year regardless of potential consequences; it is a political imperative for them to do so. The House and Senate versions do agree on one key point; the new laws will shift more of the nation’s tax burden to wealthier states. California’s coastal belt is where housing costs, state income taxes, and property taxes take an inordinate share of a typical homeowner’s income.

It is not hard to connect the dots. Many households survive economically because of existing tax preferences---the ability to deduct state and local taxes and mortgage expense. Real income growth, adjusted for inflation, for the lower 80% of wage earners has been stagnant since the Reagan administration. Wage inequality and the dearth of personal savings for many Americans is troubling in that an additional and unexpected tax burden, now being debated in Washington, could easily lead to an increase in foreclosures.  

It is possible some homeowners and buyers will have a lower net Federal tax bill in 2018, partially offsetting the deleterious effects of the new tax bill. This, in combination with San Diego’s inadequate housing supply, could mitigate downward pressure on home prices. In theory the low supply of houses for sale should support the current price structure but without adequate community income (or purchasing power), constrained supply does not necessarily translate into stable prices. What could easily occur is fewer resales and price stagnation. Perhaps some real estate agents should start looking for another career.

Also, home loans will get more expensive next year. The Federal Reserve Board has a new Chair who is widely expected to continue the policies of Janet Yellen. Quantitative Easing is now running in reverse, increasing the price of borrowing long-term money. The subset of the population who are trying to make the leap to homeownership will shrink, exacerbated by income inequality and daunting prospective house payments. Real estate affordability will more problematic (another way of defining effective demand) and this can lead to local political, social, and economic problems.


I know it is usually never wise to bet against San Diego real estate, at least in the long run. Local real estate recessions, however, pop up everything now and then. I have seen four of them and if there is any commonality, each successive downturn has been worse than the one preceding. Even though there were always signs of trouble lying around for all to see, price bubbles can obscure clear vision. This time around I do not think anything will pop dramatically in residential real estate. My concern is the fundamental fact that many, if not most, home-owning households in San Diego will have fewer after tax dollars to spend in 2018, possibly triggering a local economic recession and real estate price stagnation.

It is possible trickle-down economics, the philosophical justification for reducing the taxes of corporations and wealthy people, might work. San Diegans might get to enjoy tremendous bounties because our economic betters rushed out and invested their tax cuts in growth producing enterprises. I surely hope that is the case, but the hard lessons of history tell us otherwise. For example, today there is no shortage of cash to invest in new enterprises and the price of money is incredibly low. American businesses are relentlessly opportunistic; if there is an opportunity to make money, the capital will always show up. Cutting the corporate tax rate will not change the economic landscape, this country is awash with cash chasing too few investment opportunities.  

Since the 1950’s families in San Diego have learned to live with the Sunshine Tax. The new bill working its way through Congress will add the Blue State Tax. This new Federal revenue source could easily tip California into a housing recession, or in the best of circumstances, residential price stagnation.

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