“Prediction is very difficult, especially if it’s about the future.” – Niels Bohr, Nobel laureate in physics
While prognosticating always has risks, doing so now feels particularly perilous in light of the recent presidential election result. Media pundits mostly got it wrong, and the few that hedged their bets were branded as outliers. However, real estate and elections have one thing in common: people want to know the results beforehand. Given this, I will cautiously wade in with my 2017 forecast for the Silicon Valley real estate market. Here are my six specific predictions:
1. CAPITAL GAINS RATES WILL LIKELY DECLINE
Republican presidencies have generally been associated with lower taxes, and this trend is likely to continue with the Trump administration. If Mr. Trump honors his 2016 campaign promises, then his administration will lower both short-term and long-term capital gains rates. Currently, short-term capital gains, which apply when one buys a home and holds it for less than a year, are taxed at ordinary income tax rates. Trump’s proposed plan lowers the top income tax bracket from 39.6 percent to 33 percent.
While Mr. Trump didn’t campaign for a change in the long-term capital gains tax rate (which is at the 20 percent level), most pundits predict that the 3.8 percent capital gains surcharge to fund the Affordable Care Act will be eliminated if the Affordable Care Act is repealed or scaled back significantly. The net effect will be a lowering of long-term capital gains tax rates by that percentage.
While extrapolation isn’t particularly useful where Mr. Trump is concerned, some are already anticipating that the Trump presidency will only last one four-year term. Rather than dwell on future uncertainties, investors and homeowners with significant capital gains will be incentivized to sell as soon as this drop in rates occurs, for fear of rates bouncing back after 2020.
2. INVENTORY SHOULD INCREASE SLIGHTLY
In past editions of this newsletter, I have discussed the strong correlation between an increase in capital gains tax rate and the reduction in the number of local homes coming to market. You may recall that the Internal Revenue Code provides that homeowners who have lived in their home for at least two of the past five years can sell their residence and pocket up to $250,000 in individual capital gains (or $500,000 in joint capital gains if married) without paying capital gains. However, many long-term residents in prime locations have seen appreciation well beyond these levels, and are electing to hold their homes as part of their estate plans for future generations.
Consequently, it makes sense that the cities that have experienced the most appreciation are the ones that have seen the greatest decrease in inventory. For example, the annual number of single-family homes sold in Palo Alto declined from 474 homes in 2012 to 326 homes in 2015 (per the MLS). This was a drop of over 32 percent. More than one-half of this drop occurred between 2012 and 2013, when capital gains tax rates went up on both the federal and state levels. Expect increased inventory in 2017, partially caused by the lower capital gains rates.
3. INTEREST RATES WILL CONTINUE TO RISE.
After being spoiled with historically low interest rates for a decade, the party is finally coming to a close. While many have focused on how much the Federal Reserve is raising the prime rate, the real attention should be on 10-year Treasury bonds. Yields on Treasury securities provide the best proxy for mortgage rates as increases in that rate translate into increased interest rates. The 10-year Treasury bond has risen from 1.83 percent on November 7th (before the election) to over 2.5 percent at the time of this writing. This increase is based upon market anticipation that Trump will lower taxes, spend more on infrastructure, and generally create a more inflationary environment. Many economists are now predicting that the 30-year fixed mortgage rate, which dropped as low as 3.25 percent after Brexit and is now around 4 percent, will rise to the 4.5 percent to 5 percent range by late 2017. In the short-term, rising mortgage rates should spur the housing market as savvy buyers rush to buy before rates rise higher. However, in the long-term, rising interest rates will dampen demand for entry-level housing as affordability drops significantly for these buyers.
4. TOWNHOMES AND CONDOS WILL CONTINUE TO OUTPACE SINGLE-FAMILY HOMES IN APPRECIATION.
Historically, single-family homes have appreciated at a more rapid rate than townhomes and condos. Yet in 2016, townhomes and condos in San Mateo and Santa Clara Counties went up in value more than single-family homes. The strong appeal of Silicon Valley condos is that they are relatively affordable and often near downtown shops and restaurants. Young tech workers enjoy the turn-key aspect of condo ownership with no yard maintenance requirements, and downsizing baby boomers increasingly desire this “lock-and-leave” approach to living as they travel the world.
Indeed, the logic of this buying pattern is reinforced by the rising interest rates described above. Nineteen percent of the residents in Santa Clara County have the ability to purchase a median-priced home in 2016. That number will drop significantly as interest rates climb, and the only viable alternatives will be either longer commutes or more affordable condominiums and townhouses.
5. THE MARKET WILL NOT BE AS FRENZIED NEXT YEAR.
While buyers are still out there, the days of exuberance have ended and we are now in a more balanced market. By the end of 2016, buyers were more cautious, and this trend will continue into 2017. This “cooling down” can be empirically illustrated in two ways:
- The total number of listings in Santa Clara County selling for more than their original list price declined from 73 percent in 2015 to 67 percent in 2016.
- The sales price/list price ratio for single-family homes in both Santa Clara and San Mateo Counties dropped from 105 percent and 108 percent in 2015 to 103 percent and 105 percent in 2016, respectively (per MLS statistics).
While occasional miracles happen, such as one of our sellers recently getting more than $1.25 million above list price on a home listed below $3 million, generally the market has moderated and sellers should adjust their expectations accordingly.
6. MORE SALES IN THE UPPER END WILL OCCUR.
As you would anticipate with all of the economic and political uncertainty around the world, many affluent buyers continue looking for a safe asset class in which to invest. The DeLeon Platinum brand saw an increase in sales at or over $5 million from just 10 in 2015 to 26 sales in 2016 (per BrokerMetrics), allowing DeLeon Realty to be the top selling office in Santa Clara County, and one of the top in San Mateo County, for luxury home sales (per BrokerMetrics)—with this increase projected to continue in 2017. With both an appreciating dollar and strong long-term prospects for Silicon Valley, I project that there will be renewed strength in purchasing homes over $5 million.
While there is some uncertainty heading into 2017, DeLeon Realty does project appreciation between four and seven percent for the cities that we serve in Silicon Valley. While this is below the double-digit price growth that we experienced between 2010 and 2015, our local housing market will continue to be a stable and strong investment.