As we look to the past year and forward to the new year, we have created some notes that we feel give a sense of where we might go.  Last year was full of challenges, some of which are unresolved.  The one that remains and which will have the most impact is the COVID-19 Pandemic.  But, there are others.  We welcome you to read the notes and to comment.  We love hearing from you.

Again, have a bright and prosperous New Year - Greg Hood

2020 - A Year In Reflection

January February 2020 - Inventory down

The National Association of Realtors (NAR) reported that the active listing count for Sunnyvale-Santa Clara-San Jose was down -36.6% YoY and the median days on market was 22 days.  For San Francisco-Oakland-Hayward, inventory was down -22.3% and the median days on market was 18.  Of the top 50 US metropolitan areas, the Bay area had the fewest median days on market and held the 1st and 3rd spots the most expensive residential real estate for this group of 50.  Los Angeles was number 2.

• COVID 19 - SARS-Type Pandemic Begins

As of this writing, there have been more than 410,000 deaths related to COVID-19 and the number is accelerating, with expected fatalities to eclipse 500,000 by the end of February this year.  Back on 1/21/2021, Dr. Anthony Fauci shared, we should return to ‘normalcy’ by the end of this year, but reaching ‘herd immunity’ is wholly dependent on 75-80% of Americans being vaccinated by the end of Q2.

• Presidential Election

The elections are over..  While of national interest, they had little direct impact on real estate. 

• Affordable Housing

In the Bay Area, affordable housing remains a major concern.  This said, rents in many parts of the Bay Area have dropped somewhere between 15%-30%.  The US Census ‘Supplemental Poverty Measure’ (SPM) sets the Bay Area’s minimum annual household income at $40,000 without extreme hardship.  Tipping Point Community, a non-profit, in conjunction with U.C. Berkeley, estimates $75,000 is a more realistic amount.[1]  Based on information from HUD, 30% of Bay Area households fall under the $75,000 threshold.  With the median income for a Bay Area family of four at $128,100 [2] and average Bay Area home prices around $1,100,000, renting remains the only realistic option for most households.  A 30-year mortgage at 2.69% is $4,456/month before taxes and insurance, whereas most rents are somewhere between $2,800 and $3,800.

[1] "A Study on Poverty in the Bay Area " - https://tippingpoint.org https://bit.ly/3qQzj1I

[2} "2020 Maximum Income By Household Size" - https://sfmohcd.org https://bit.ly/3a2qLho

• Corporate Relocations

HP Enterprise, Tesla, Oracle, Palantir, and others continue to move out of the Bay Area.  This is directly related to remote work as well as workers looking for more ‘bang for their buck, and fewer taxes elsewhere.   Nationally, corporate relocations are 38% of all moves and slightly behind 44% for personal moves.[3]  Leaving the Bay Area, many tech employees have hit the road looking for greener pastures.  While some have settled elsewhere, there are as many who are camping the world, but whom we expect to see returning.

And, as a recent New York Times article states, “The biggest tech companies aren’t going anywhere, and tech stocks are still soaring. Apple’s flying-saucer-shaped campus is not going to zoom away. Google is still absorbing ever more office space in San Jose and San Francisco.“[4]

The allure of San Francisco and its surroundings remain, even as apartment values slump. Single-family home prices proved to be resilient in 2020.  Average home values in San Mateo County increased by 9.7%.  Santa Clara County, which is arguably much more diverse, saw home values increase by 4.3%.

This suggests the drain from corporate relocations, while newsworthy, have not had a substantive, negative impact on home prices.  Instead, the brunt of the slowdown caused by COVID 19 has impacted apartment rentals occupied by tech employees.

[3] "Moving Industry Statistics" - https://www.movebudda.com - https://bit.ly/3iKu9RO

[4] “They Can't Leave the Bay Area Fast Enough" - https://www.nytimes.com/.- https://nyti.ms/3a27HzL

• Remote Work & Learning

The new mantra at many tech companies from Facebook to Twitter is, “Work from home forever.”  Stanford researcher, Nicholas Bloom, in a study with Trip.com has found productivity for employees who worked from home 4 days a week increased by 13% while enjoying benefits of fewer distractions, more time with family and friends, and a reduction in commutes.[5]  The average Bay Area commute accounts for 64 minutes a day.[6]  This has pushed the need for an extra room, most often a bedroom, or home office, and the shift from apartments to single-family homes.

[5] "The Remote Work Experiment that Upped Productivity 13%" - BBC World News - https://bbc.in/3oalLMv

[6] Metropolitan Transportation Commission, Etc. - Vitalsigns - https://bit.ly/3675amB

• Entertainment/Work at Home

Another major change last year was the explosion of home-delivery platforms and home entertainment.  While service industries suffered greatly, other areas blossomed.  Of course, Amazon, Grubhub, Doordash, and many others have benefited greatly.  Other notables were Zoom and Netflix.  The result is home computing, video conferencing, food storage and entertainment will take center stage as we look at housing in the future.  How homes work as a whole will increase in importance as buyer priorities shift towards at-home activities ranging from school work to Saturday night at the movies. For new and renovated homes IoT integration will be paramount.

Looking forward with the increased demand for internet services, we would not be surprised to see some type of disclosure on the quality of service included in future disclosure packages.  Certainly, a good question for anyone working remotely.

• Tight Credit

The Housing Finance Policy Center's latest credit availability index (HCAI) shows that mortgage credit availability was just under 5.0 percent in the third quarter of 2020 (Q3 2020), down from 5.1 percent in Q2 2020.  This is the lowest it has been since the index’s introduction, indicating a further tightening of credit.

• Income Changes

Overall Bay Area households are earning $89,000/year and for many, wages have stagnated. While this is the nation’s second-highest median income, it is far from what is needed to purchase a home.  2019 statistics suggested entry-level buyers need to have an income of $178,400 to purchase an average home in the Bay Area.[7]

[7] "You Need To Earn..., "- ABC7, San Francisco - https://abc7ne.ws/2Y6N0wS

• Rent Declines

Again, rents across the Bay Area have been in steep decline through December 2020.  NAR reported nationally that four of the areas hardest hit have been around the Bay.  San Francisco has been the worst hit with median rent at $2,086/month, a decline of -33.8%.  Other cities included Santa Clara, Alameda, and San Mateo.

It is important to note real estate is a lagging indicator, and will not show the full impact of the past year for some time.

2021 - Looking Forward

• COVID 19 Vaccine Release (California) 

The roll-out is in 4 effective phases although stated as 3 phases by the state government.  Dates are not ‘set in stone.’  From the guidelines, it is not clear if college students will ever get the vaccine. Most out of house workers could come under Phase 1B Tier 2, but this is not clear. Proof of employment could be a challenge for some people who don’t fit neatly into the guidelines.  And, of course, the path to herd immunity is wholly dependent on how successfully the roll-out is conducted.  Other factors towards a successful roll-out include the refusal of front-line and health workers to accept vaccination, setting a very dangerous precedent, and how quickly new variant production can be ramped up.

• Biden/ Harris Presidency 

Beginning with a tumultuous start, only time will tell what will happen here.  While many predict swift change, it’s useful to remember the Republicans held both Houses at the start of Donald Trump’s Presidency.  That said, we believe the greatest challenges will be answering COVID–19, stabilizing a battered economy, addressing massive unemployment, a divided electorate, as well as matters of national security, immigration, and legislative moves to address climate change.

• Stock Market Surge 

For many, the stock market remains the best place to invest if seeking high growth.  

“But, the stock market, a forward-looking animal, seems to have priced in a stronger economy and the arrest of the coronavirus pandemic. That raises the risk that any disappointment in the recovery will rattle investors, especially with the S&P 500 about 60% above its March 2020 lows.”[8]  Last week’s GameStop (GME) trading only illustrates how volatile markets have become. 

[8] ."..2021 Could Be Bumpier Than You Think" - Investors Daily - https://bit.ly/39YoG64

• Low-Interest Rates 

The Treasury is committed to keeping rates as low as possible but expected additional stimulus will push interest rates higher.  NAR expects mortgage rates to average 3.1 percent in 2021, up from 3.0 percent in 2020 — the Mortgage Bankers Association pegs its 2021 rate estimate at an average of 3.3 percent.  This will slow some buyers, but minimally.  This will add about $380/month to a $1,000,000 30 year fixed rate mortgage at a current interest rate of 2.65%. While this may give some buyers pause, it will not stop them.

As of this writing, the 10-year Treasury minus the 3-month note is in positive territory suggesting an improving long-term outlook.  We believe this is attributable to the quick release of a COVID–19 vaccine.  But, as noted earlier, investors are fickle and easily disappointed in the face of uncertainty.  If the vaccine roll-out is slow or new variants take hold,  this metric could swing negatively.[9]

[9] US Treasury - Saint Louis -  https://fred.stlouisfed,org - https://bit.ly/3a7h7tV 

• Declining Job Growth and Birth Rates

Brookings Institute is expecting that there will be between 300,000 and 500,000 fewer births this year.  This expectation is extrapolated from both the 1918 Spanish Flu Influenza epidemic and the Great Recession of 2007 and is partially due to reduced incomes.  Nationally, this represents a decline of nearly 10% from 2019.  This will reduce demand in most areas.[10]

And, Indeed’s Hiring Lab suggests the following on jobs:

“As of November 8, 2020, job posts are down in San Jose by about 30.9% year-over-year. Compare that to February, when posts were down by 0.1%. San Jose is seeing 7.1% unemployment, more than triple what it was a year ago at 2.3%.  And, San Francisco is even worse off in terms of job postings, which are down 31.7% from last year, compared to .5% in February. The city experienced an 8.6% unemployment rate in September. The year prior, that rate was only 2.3%. Total employment is off by about 300,000 jobs or an unemployment rate of about 7.3% from the pre-pandemic high.”[11]

The San Jose Business Journal suggests the following:

•  Most labor market measures are more than halfway back to pre-pandemic levels.

•  Much of America still faces a long road back despite the strong rebound.

• The coronavirus recession was different from other downturns, with service jobs suffering most and much of the job loss temporary.

• Next year’s labor market depends on the path of the virus, politics and policy in the new administration, and the extent to which pandemic-era behaviors like remote work become permanent.[12]

[10] "The coming COVIC baby bust..." - Brookings Institute - https://brook.gs/3oh6eKR  

[11] "2020 US Labor Market Review and 2021 Outlook: Better Than Feared, but Plenty of Damage Remains" - Indeed Hiringlab - https://bit.ly/3iHsKeW

[12] "The overall jobs outlook..."  - San Jose Business Journal - https://bit.ly/3pjL804

• New Economic Paradigm - virtually unchanged GDP - Increased debt

Goldman Sachs increased their GDP forecast from 6.4% to 6.6% in response to the new Biden stimulus bill.

While debt in the short-term will not impact real estate, the long-term outlook is unknown.  Janet Yellen as the incoming Treasury Secretary is facing an unprecedented $21.7 billion in debt. This number now exceeds GDP and is expected to grow.  How this relates to GDP is unknown and creates uncertainty even though “Economists who adhere to modern monetary theory (MMT) argue that sovereign nations capable of printing their own money cannot ever go bankrupt, because they can simply produce more fiat currency to service debts.”[13]  No matter what you believe, this is unchartered territory and may trigger a further shift from the US Dollar to other trade currencies, making it harder to sell debt.

[13] Debt to GDP Ratio Definition - Investopedia - https://bit.ly/39eiLL0      

• Tight Lending Continues 

Housing Affordability Index (HAI) indicates as of November 2020 that a household with a median income had 1.67 times the income to qualify for a median cost home nationally. Nationally we expect housing sales to be strong, suggesting a continued sellers’ market. Consumers are looking for places to put their money and homes continue to be their favorite spot.  

The Bay Area, which is always unique, continues to have strong demand even though the HAI for Q3 2020 was 26.  San Mateo County had an HAI of 19, which means San Mateo households on average only had 19% of the income required to qualify for a home locally.  In spite of this, demand has remained strong and is expected to continue.[14]

Housing Credit Availability Index (HCAI) - Indicates the willingness of lenders/banks to lend based on current risk assumptions.  The Housing Finance Policy Center's latest credit availability index shows that mortgage credit availability was just under 5.0 percent in the third quarter of 2020 (Q3 2020), down from 5.1 percent in Q2 2020 and the lowest it has been since the introduction of the index. So, even with rates rising slightly, expect money to be tight for the foreseeable future.[15] 

Consumer Financial Protection Board (CFPB) Qualified Mortgage (QM), a result of Dodd-Frank in 2010, was extended this last year.  These rules limit borrowers’ debt-to-income ratio (DTI) to 43%.  Lenders would like the flexibility to reduce this number but with the new administration, changes may not come.  If changed this could ease lending standards.[16] 

[14] Housing Affordability Index (Fixed) - US Treasury, Saint Louis - https://bit.ly/2YhKuny  

[15] "Housing Credit Availability Index" - Urban Institute - https://urbn.is/3sRhkd9

[16] Consumer Finance Monitor" - Ballard Spahr, LLP - https://bit.ly/3qKEznf

• Real Estate Tax Changes

Possible elimination of 1031 real estate exchanges, a swap of one investment property for another that allows capital gains taxes to be deferred.

1031 Features that may go away with new tax rules: 

• A 1031 exchange is a swap of properties that are held for business or investment purposes.

• The properties being exchanged must be considered like-kind in the eyes of the IRS for capital gains taxes to be deferred.

• If used correctly, there is no limit on how many times or how frequently you can do 1031 exchanges.

• The rules can apply to a former primary residence under very specific conditions.

Long term capital gains tax rate may increase from 20% to 39.6% for adjusted gross incomes greater than $1,000,000.  This means that a windfall from the sale of a property could be subject to an additional 19.6% tax over the current capital gains tax.  Many Bay Area properties would be subject to this tax increase.

• Federal Estate Tax Changes

Estate taxes may see a 5% for inheritance over $11.58 million to 45% from 40%.  Simultaneously, it has been proposed that the asset value subject to estate taxes be reduced from $11.58 million to $3.5 million.

• Proposition 19 Changes

“Proposition 19 is a constitutional amendment that limits people who inherit family properties from keeping the low property tax base unless they use the home as their primary residence, but it also allows homeowners who are over 55 years of age, disabled, or victims of a wildfire or natural disaster to transfer the assessed value of their primary home to a newly purchased or newly constructed replacement primary residence up to three times.  It is not clear to us how this will work with federal tax rules.”[17] 

The step-up-basis on the value of a property to the current market value on the inherited property may be eliminated.  This cuts two ways.  First, if the property is passed from one family member to another, the tax basis will jump to the current market value.  This represents a huge property tax increase for property held for any length of time.  But, if the property is sold close to the time of the benefactors' death, then the capital gains tax could be minimal.

[17] ""About Proposition 19 (2020)" San Francisco Tax Assessor - https://bit.ly/399Qbug

Speak with an accountant or tax advisor for further information on how to best structure property ownership and resulting taxes.             

Further Reading

https://www.forbes.com/sites/forbesrealestatecouncil/2021/01/13/eight-ways-the-biden-tax-plan-could-affect-your-real-estate-business/?sh=6137c896334c

https://www.cre.org/external-affairs/2020-21-top-ten-issues-affecting-real-estate/

https://www.mercurynews.com/2020/12/18/coronavirus-economy-bay-area-california-job-growth-sputters-tech/

https://www.thebalance.com/world-currency- consumer finance monitor

https://fortune.com/2019/08/14/mortgage-lending-rule-change/

https://sfmohcd.org/sites/default/files/Documents/MOH/Asset%20Management/2020%20AMI-IncomeLimits-HMFA_05-01-20.pdf

Bright Homes Real Estate does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. We strongly recommend you consult your own tax, legal, and accounting advisors before engaging in any transaction based upon this information.