By Michael Repka, Esq.
By virtually any measure, 2018 has been a turbulent year for Silicon Valley real estate despite the general local economy doing very well. Overall, businesses have been thriving but there have been some hiccups along the way.
In the spring, a variety of local tech companies found themselves answering questions about data usage and online influence, especially in light of the 2016 presidential election.
Stories such as the activities of Cambridge Analytica remain front page stories, err, make that, trending topics for weeks, and ultimately brought about a level of congressional scrutiny generally unexperienced by local tech companies.
On April 10, 2018, the CEO of Facebook, Mark Zuckerberg, testified before Congress for the first time. While he was generally praised for his candor and demeanor, many began to speculate as to whether tech companies would see increasing governmental regulations and oversight. Some news outlets even started positing the idea of breaking up some of the area’s largest companies.
Despite these bumps in the road, many of the local tech companies continued to generate strong profits and significantly expand their operations.
2018 Tax Changes
On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act, which represented the most significant overhaul to the U.S. tax system since 1986. This tax legislation included very significant tax cuts for corporations and a general lowering of tax rates for individuals.
However, the devil is in the details. Overall, the tax legislation will end up negatively impacting affluent people in California particularly hard, especially if they are not already paying the alternative minimum tax.
Reduction in the Deductibility of State Income Taxes
California has the highest state tax in the United States, with a maximum tax rate of 13.3%, which was enacted as part of Proposition 30.
Historically, state taxes were deductible when an individual filed a federal return. Therefore, the effective state tax rate was approximately 8% (net of the federal benefit) for someone in the highest tax bracket. However, now these affluent individuals will be paying at the marginal rate of 13.3% with no corresponding federal tax benefit.
As a result of these changes, we have seen a material increase in people contacting DeLeon Realty about selling homes, especially in the $5 million to $15 million range. Many of these potential sellers are considering moving outside of the state of California in light of these changes. Some are nearing retirement age and would be closer to kids and grandkids, while others plan to continue to work, but from an office in a low or no-tax state, such as Nevada.
To illustrate how seriously local residents are taking these text changes, one only needs to look at the attendance at my January tax seminar. Typically my tax seminars attract around 100 to 120 homeowners looking to understand and minimize their state and federal real estate-related tax. This level of attendance is not bad for a local real estate seminar, but certainly nothing earth shattering. However, when we presented the same topic in January, we had over 850 people sign up and attend—we had to split the session into two sessions and rent out a theater. Needless to say, this dramatic increase in attendance illustrates the serious level of concern amongst local residents.
Another factor that seems to be lessening demand is the significant increase in interest rates over the past year.
Buyers have seen interest rates climb materially in the past 12 months. For example, the 7-year Adjustable Rate Mortgage (“ARM”) rate has gone from 3.25% in November of last year to 4.25% in November of this year.
While we have not seen a dramatic impact on the demand of higher-priced homes as a result of the rate increase, we have noted a drop-off of buyers stretching to purchase entry-level homes.
Net Effect Market Changes
Although I have gone on more listing appointments for homes in the $5 million to $15 million range, a number of these sellers are still contemplating their future plans. I do expect to see an increase in the inventory for these higher-priced homes over the next two to three years, but there has not been a high level of panic or overreaction thus far.
Homes Priced Above $5 Million
Overall, we have seen a slowing of demand for homes priced above $5 million. Our study of the period between September 1, 2017 and November 30, 2017 and the same period in 2018 reflects an increase in the average days on market from 45 days to 59 days. We have also seen the number of expired, canceled, or withdrawn listings increase from 39 properties in 2017 to 47 properties in 2018. Fortunately, this slowing of demand has only resulted in the marginal decrease in the average price per square foot from $1,639 to $1,610.
Homes Priced Under $5 Million
We have seen a significant decline in the number of homes sold for less than $5 million. In the period from September 1, 2017 until November 30, 2017 as compared to the same period in 2018, we saw a drop in sales from Sunnyvale to Atherton of over 20%. Additionally, the number of active listings has skyrocketed from 172 to 325. Days on market has also jumped from 23 to 29 days. The great news is, however, prices have remained remarkably resilient, with an average price per square foot increasing from $1,164 to $1,230.
Cost of Construction
With the fires in Santa Rosa last year, and the devastating Camp Fire near Chico this year, builders are seeing very material increases to the cost of skilled labor and construction materials. As a result, we estimate that construction costs are up approximately 25-30%.
There is still a significant shortage in the supply of housing within Silicon Valley. However, with the increase in inventory of homes available for sale and the increased cost of ownership, both in terms of higher interest rates and less favorable tax treatment, we do expect to see a more balanced housing market, with a slight shift towards a buyer’s market, over the next 24 to 36 months.
There are still buyers that are interested in purchasing properties, but they will be more particular and have higher expectations.
Despite the significant reduction in the number of homes sold in our primary market from Sunnyvale to Atherton, we have just completed our best year ever. We are finding that, in a slowing market, sellers realize the importance of having a higher level of service, enhanced legal protection, and very strong marketing.
With this slowing market, sellers should also be more demanding of the services they receive from listing agents. Once again, it’s supply and demand. If fewer homes sell in the coming years, listing agents should be willing to step up their game with more marketing and enhanced services.