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Although I have not posted in a few weeks in order to finalize studying for the final level of the CFA (it didn’t go well, oh well), the world did not slow down. Exxon Mobil lost a proxy fight to put 2 new “green” directors on its board, AT&T cut its large dividend after divesting itself of its disastrous acquisition of Time Warner and crypto entered the third bear market in 4 years as billions were wiped off of its market cap in its plunge.

Yet it’s housing that continues to capture the attention of many and what I would like to discuss in this post. Whether you rent or own, it’s the one asset class we all pretty much have to deal with. Much of the last few weeks wasn’t just spent on studying for me but also on shopping for a new investment property with a few other investors. Doing this in Texas while renovating my rental home in California and traveling back and forth to New York gave me a good perspective on how wide and broad the housing rally is.

The West

Already outrageous markets are becoming even more so. Bay Area homes are selling for $500k above asking price. I know this for a fact as my uncle’s home was recently sold for $2.1 million after being listed for $1.5 million. Outside of the Bay Area, even homes in Sacramento were going for $75k to $95k above ask. Personally, I decided not to partake in any sale due to the location of my particular property where a $4 billion casino is being constructed a few miles away. Add to that the general exodus from the Bay Area due to price increases, and I think there is a strong case for continued migration and growth in the periphery of the most expensive cities which will continue to boost home prices there.

When I asked my realtor in Sacramento who were the buyers placing bids at $95k above asking price he told me it is primarily Bay Area professionals who realize they can get much more house for their money in Sacramento. Being within a 2 hour drive of downtown San Francisco means that they can spend the majority of their time in a larger home for cheaper and commute into the office sporadically when needed.

This logic tracks to Southern California as well with Riverside County seeing some of the largest percentage gains in home prices along with Sacramento county in the state of California. There aren’t too many couples that can afford a mortgage of $9k in the Bay Area so I would wager that much of the money pushing valuations up so high there is being fueled by intergenerational transfers from parents and even grandparents helping their adult children to buy homes, or even selling their appreciated homes to move into another one.

The South

The story was different in Texas. Prices in the San Antonio area remain reasonable with a media price of $257k but have experienced a rise of 13.7% compared to last year as of April 2021. That is in contrast to the median price of $758,990 in California as of March 2021 and $530,000 in the Sacramento region.

Yet the story of who the buyers were reflected the other side of the coin of the housing boom in the Northeast and West. Our realtor there relayed to me that most of the buyers, especially the cash buyers, were either millennial buyers that received help from their parents or they were buyers in their 50’s who had just cashed in on the rising home prices in California and the Northeast and were relocating to Texas to get the same sized home for a third of the price.

For the moment, Texas has builder friendly policies and the land to build. But I can already see the seeds of the same issues that saw California home prices increase from their reasonable levels in the 1970’s when many started moving to California en masse.

San Antonio, along with 4 other cities in Texas make up half of the top ten growing metro areas in terms of shear numbers since 2010. This represents a general demographic shift to the South and West that the country has been seeing for the past 50 years. Yet with these new people come new problems. With new homes being built come new needs for water sources, sewage systems, roads and administration. As cities with large footprints start to see their more crowded areas become more expensive and roads become congested, calls for kore public transportation will likely then follow.

Add to that the fact that many of the new residents are accustomed to the services and social policies afforded to them from high tax states and we may well start to see these states shift from a light tax light regulation political leaning to being more friendly to infrastructure and higher taxes. Only time will tell how this plays out. Although the latter is debatable as to whether it will benefit the residents there, the outcome may well be an increase in home prices over the long run which states like California experienced in the last 30 years.

The Source of the Boom

In previous posts, I have discussed how in the short term, low interest rates were driving the jump in prices. Mortgage rates continue to be extremely low by historical standards at around 3.5%, even if they have seen a jump from where they were earlier in the year when they fell below 3% for many borrowers.

I have also extensively discussed the construction of new housing and the policies which create a disincentive to invest in many large cities like New York. Policies like rent control may benefit a few renters but come at the expense of young and future renters, who confront a lack of supply and housing that has had little investment due to prices being capped. The result is high prices for poor quality housing, exactly what has been happening in NYC for decades.

Yet there are longer term trends at play that are separate from city and state level policies and surprisingly they show that home prices overall haven’t budged that much on a national level in the past 40 years, it’s our tastes that changed.

If we just look at the median home price which currently sits at around $391k in the US, this has risen substantially, even in inflation adjusted terms, since 1971.

Looking at in in inflation adjusted terms, houses seem to be about 55% more expensive than those purchased by millennial parents but there are some factors here that aren’t often discussed that are very relevant.

The first is that the price appreciation has been a regional phenomenon. The Northeast and California have seen the bulk of the appreciation. The South is priced about the same and the Midwest is even cheaper.

Yet all of this hides the fact that the average home has increased in size by a huge amount. The median new home in 2018 was 781 square feet larger than the median new home in 1978. That’s a difference of 47%. It’s not that we can’t afford homes, is that new homes are getting much more larger and hence more unaffordable.

The figure which breaks this down to be comparable to the past is the inflation adjusted price per square foot, which shows that the price of homes actually hasn’t changed that much.

In 2017 dollars, the median price per square foot of a home was only $3, or 4% more than the cost in 1979. Add to that only 8% of home had 3 or more bathrooms and only 63% had air conditioning whereas now 40% have 3 or more bathrooms and 94% have air conditioning and it’s easy to see that other features of homes have changed to become more expensive as well.

Conclusion

Combine these factors with the remote work boom and you can see why demographics are shifting to the South and Mountain West as opposed to coastal California and the Northeast. Whether the housing prices in these areas remains affordable over the long term with these shifts remains to be seen but my investors and I have now hedged our bets in Texas at least.

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