The Cul-De-Sac Reaches Out From The Past
Anytime you’re on a trip with friends, someone will always whip out the Zillow app and announce “hey look what you can get for $X here!” as you all think about that fat NYC or CA state tax your paying to live in a place that makes you feel like you are the villain. Places where the cover charge for a 2nd bathroom cost $1mm (clarification: half-bath). Alas you x out the Zillow app with a resignation that whispers “in my next life”.
Well, it’s starting to look like that next life might not require incarnation.
Twitter announced all employees can work from home forever. Many desk workers are finding out they can WFH. Elon Musk and Joe Rogan are the latest Californians contemplating moves to Texas. I saw that 400k people left NYC during Covid to hunker down elsewhere. The prospect of geo-arbitrage has many excited. Bigger house, more acres, lower costs, and less traffic while maintaining a big city salary. It’s the life I envision Chicago people have but without bone-chilling winds for most of the year.
An assortment of real estate riffs as they relate to geo-arbitrage:
On the high price-tag of real estate
• Is the price expensive or “high”?
CA has a high cost of living. However, I’d push back a bit on the idea of housing being expensive versus just high. Expensive implies an expected return is very poor going forward. People like to point to near-zero cap rates to claim CA homes are overpriced. That might be true but it’s hardly obvious. Real estate is priced according to supply which is pathologically constrained in SF and LA and demand which is dictated by job prospects. Low cap rates imply price appreciation not stupidity. Higher cash-flowing properties have lower or zero expectations of appreciating because of the supply/demand outlooks. This is basic finance. You are free to have an outlook on the supply/demand factors but zoomed out expensive is expensive for a reason and cheap is cheap for a reason. Markets are smart.
• Minimum Ticket Size Frustration
Real estate prices that are high are mostly annoying because they force you to put a lot of eggs in one basket. This can be true even if the prices are high but cheap (a house on Carbon Beach for $3mm is cheap even if the price is “high”). If you are worth $1.5mm and own a house worth $1mm it’s hard to diversify. Your home is 2/3 of your assets. Many homeowners are even more concentrated than that. The high price might not be a problem from an affordability point of view but it’s a problem from a risk or portfolio point of view. So when you live in a high cost of living area, the minimum acceptable house forces you to concentrate wealth more than you’d like to.
Here’s another way to look at it. Imagine if the lowest-priced stock in the world was $50,000 a share and there’s no way to buy fractional shares. We don’t need to make a statement about whether the stock is cheap or expensive (that depends on its earnings and how many shares outstanding there are) to be frustrated that the price is high even if it’s not “expensive”. We would just be frustrated that creating a diversified portfolio would be difficult if the minimum purchase prices were so high.
It’s important to differentiate “high” from “expensive”. I’d find Bay Area prices frustratingly high even if I was bullish.
• Location, location, location
When I lived back East I remember a trader friend commenting on how NJ suburb pricing was efficiently sorted according to commute times to NYC. I grew up in NJ, this sounds right. My family settled purposefully where the Academy bus line ran. People like to gawk at what $500k can buy you in the middle of nowhere as if to say “look what you can buy if you didn’t care where you lived”. As if the “where” wasn’t THE ENTIRE BASIS OF HOW REAL ESTATE IS PRICED! It’s all about location. Not the price of wood.
• Property Taxes
Here’s another difference in CA real estate. It’s a call on inflation because Prop 13 limits how quickly your property taxes can increase. Consider a state with high property taxes like NJ that get re-assessed as your property value increases. An apples-to-apples comparison would require amortizing the higher property tax value into a mortgage. So a $1,000,000 NJ house with a 2% property tax is equivalent to about a $1,220,000 CA house (An extra 10k per year in taxes corresponds to about a $220,000 mortgage). But as a CA property appreciated the tax rate falls as a proportion of the property. (The homeowner’s gain comes at the expense of everyone else but that’s another conversation).
The great-schools premium
I live in Lafayette, CA which is similar to neighboring Walnut Creek. But Lafayette homes command maybe a $250k premium because the schools are rated 10. When you sell your home you get the premium back in the sale price. So you can think of the cost as the additional interest costs on the $250k, as opposed to the full cost of $250k. So about $11k per year at current mortgage rates. The more kids you have the more value you get from the premium. Pretty obvious.
Beware, if the schools get worse the premium can erode by the time you sell.
How to spot a contractor shortage
If there is a large spread between newly finished homes and older homes of similar size, location and acreage you are looking at a market with a contractor shortage. That market is daring you to buy a fixer. It could also be a market like SF with a draconian permit process. Same thing. Go ahead and try to fix up a place. If you are especially handy and connected these make for good markets to be a flipper.
Migration patterns and doom loops
While I don’t have a high conviction view on CA real estate I can envision a nightmare scenario. Businesses leaving the state followed by well-paid employees. A shrinking tax base is asked to pay for the state’s bloat, leading to more fed up residents leaving, and so on. Doom loop. Imagine CA with even higher income taxes or perhaps less services like police and fire (services that CA desperately needs even more of as things stand today). In such a downward spiral can you imagine state exit taxes? The US has one if you try to renounce your citizenship. Desperate times will call for desperate measures.
For all the Medium posts by techies thrilled to be leaving for Austin or Seattle, CA still sees a net inflow of people. But this will be an important flow to keep an eye on. Will the remote work momentum free people from the Bay or will the outperformance of tech during covid indicate even more magnetism to Silicon Valley?
For more on CA real estate and economics, I encourage you to check Byrne Hobart’s amazing post, Peak California (Link)