What's happening n the Santa Clara Valley, fruitbasket of the world? They paved paradise, and put up a parking lot.
April 9, 2004
View from Silicon Valley- Real Estate: When will this come to an end?
(c) copyright 2004, View from Silicon Valley. All rights reserved.
You will not be surprised to learn Santa Clara County, the heart of Silicon Valley, has seen declining employment for the last three-plus years:
2003 2002 2001 2000 1999 1998 1997
Avg Employment 821K 863K 952K 981K 936K 928K 909K
Pending the local numbers for March, the trend continues in 2004 with an average of 815K.
When will this come to an end?
The last time there were 815K or fewer jobs in Santa Clara County was 1994. The lowest figure since 1990 was 792K in 1992 and again in 1993(##).
As shown in an earlier missive, employed Californians' average 2003 wage also declined despite paying below-average health insurance rates.(*)
Maybe I just don't get this new math, but it seems to me there used to be some relationship between jobs, wages and real estate price trends. Did I miss a memo?
Using the latest BLS and local statistics, nationwide vs. California vs. Silicon Valley numbers are as follows(#):
Median Ration to Avg Ratio to Wage/Home
Home$ National Wage National Ratio
Nationwide $171.6K 1.00 $35,734 1.00 0.208
California $406.2K% 2.37 $39,640 1.11 0.101
Silicon Valley $509.3K$ 2.97 $50,485 1.41 0.090
% through January, 2004
$ through February, 2004
While 2003 employment and net wages declined, the median Silicon Valley home price increased another 7 -10%. In the more expensive areas, presumably less dependent on wages, the increase was reported at over 26%! (@)
When will this come to an end?
Higher home prices in the face of declining employment and wages are explained away as reasonable since interest rates are at 40- or 50-year lows. On top of this, stock prices, and therefore tech company employee option gains, are up strongly. There are several problems with this
rationale:
1) It used to be Silicon Valley could be counted on to lead any recovery. Thanks to off-shoring, Silicon Valley is instead still leading the decline. (Or leading a surge in India and China.) Local companies are increasingly admitting their intentions to add workers only in lower-cost places than Silicon Valley.
Sun Microsystems finally began to bite the bullet and announced 3,300 layoffs last week. (About half the headcount reduction needed.) If Sun is paying attention, a significant percentage of these figure to be Silicon Valley residents.
1A) To repeat, those who still have jobs are experiencing declining wages.
2) Employee stock options are under pressure. Under proposed rules changes, even our poster child for cavalier management, Sun Micro, would, "have no choice but to share fewer options with rank-and-file workers."
For now, home prices continue to rise as "free money" comes in from stock gains and buyers trade over-priced stock for an over-priced house. This is what passes for diversification in Silicon Valley.
3) Interest rates are held low "patiently" but they do not figure to fall much further. As of late last week, Mr. Market began casting his votes for higher rates forthwith.
Yet Silicon Valley home sales are up in both price and volume.
When will this come to an end?
I find it illuminating to look at the buyers who are plunging in under these market conditions.
The realtors' propaganda has lately shifted. One of the methods to keep people buying lately is to compare owning to renting. If the costs are comparable, "everyone" wants to own. After all, rent is "lost" money.
A few steps are omitted from this dogma:
1) The interest portion of a mortgage payment is indeed deductible but the homeowner still has to cough up the cash every month. You pay 100% of the cash and get 37% or less back at tax time. The other 63% is still spent money. (28% Federal, 9% California)
2) Even a mediocre income or capital gains year can put you in the AMT. You lose the deduction on not only of your property taxes but also your state income taxes. At California's high tax rates, the AMT can really byte. (Can you tell I just finished my taxes?)
3) Everyone is taught 10% down buys you ten times that amount in a house. Lately, I've seem a lot of solicitation pointing out how a 10% home price gain doubles your "investment." Nobody talks about the flip
side: a 10% decline loses 100% of your money.
Taking this last point a step further, how does the risk of losing your 10% down payment compare to renting?
One way to calculate it arises from a recent Economist article(**), stating there will be decline of, "at least 20 per cent in many economies over the next four years" from when interest rates reverse. While this may be a reasonable assumption, it overlooks the initial frenzy which will take place when rates start to rise. "Buy now, before it's too late," seems likely to give the market another, possibly final, spike up.
Even so, this gives us a basis to run some numbers:
20% of $400K is $80K, which is a $1,667 per month loss for 48 months.
20% of $500K (or 25% of $400k) is $100K = $2,083/month.
20% of $1.2M is $240K which is $5,000/month for 48 months.
The message? At Silicon Valley's "low end" of $400K to $500K house prices, many people are already paying this much in rent. Rent is lost money. If you can put together $40K or $50K, you can own a house. Think of it as paying two years of rent up front in a lump sum.
If $50K is all your money in the world, this can be a reasonable decision. In this week's paper you could still buy with a "no cost, no points" 4.00% Jumbo five-year ARM.
A $500K mortgage at 4% costs $1,667/interest + ~$540principal =$2,206/month. Real estate tax at 1% is $417/month. The monthly nut is $2,623/month.
Mortgage interest and taxes are deductible, so the after-tax is only $1,852!
Even with an extra couple-$100 per month to carry the second mortgage needed to dodge PMI payments or supplement the down payment, this is cheaper than renting!
For the extra-aggressive, you can go interest-only, increasing the interest rate slightly but further reducing they total payment. And the extra interest is still deductible!
But what if the market crashes? If you live two years in the house, you've "saved" the lost 10% down payment by not paying rent. You walk away empty-handed but "even." Sounds like a low-risk decision.
You say you don't have $50K? No problem! Zero-down programs make buying a NO-risk decision. With zero equity invested, who cares? It's still cheaper than renting!
As long as you can make the payment, you're better off holding on and hoping the market comes back. If you can't make the payments, you only lose what you put down. And it will take months to get evicted...
Perversely, this all changes if the down payment does not represent all your money in the world.
Obviously, you can lose the $120K down you put on that $1.2M fixer-upper in Palo Alto. If prices drop more than 10%, you can lose more than you put in.
Bottom line, low- and mid-range buyers can "afford" to buy & be "wrong." Increasingly, they are sucking it up and buying.
Given this wide range of circumstances in which it makes sense for low-equity homeowner to hang on, low-/mid-range home prices figure to be "sticky" on the way down. A spike in foreclosures in this price range might be one sign of a change in trend.
At the other end of the market, before homes in the $1M+ range drop, look for sales volume to drop off. As prices start to edge lower, sellers will pull their homes off the market rather than accept sub-peak prices. A drop in high end sales volume could be the indicator for trouble ahead.
When will this come to an end? When it is finished...
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