patrick.net

SFwoman,
The one thing that always strikes me as being really off is the lack of children in the BA. What I mean by this is that while these days there seems to be a verifiable sea of newborns, it seems that there are no children between the ages of 5-15 or so.Either that or the prevelance of older, 45-50-something parents with young children. I think most younger people that have kids these days simply pack up and leave.As a parent, haven't you noticed this as well?I gauge this as a way of telling how many middle income families are actually still here. I'll retract my statement about a majority of white populace, but while I agree with the Brazil model, as has been mentioned a number of times by me and others here, I think that the model could very well be heavy on the upper class side, and very low on the middle class side, with an almost equal lower income class, and a massive sea of young, transient, unsettled single professionals. This transient population could potentially be a bad thing for business that relies on long-established experience.

FAB,

The 500K exemption and recent run up has caused lots of people to think of their primary residences as investments, rather than a conservative savings account + durable good. Thus, lots of people are buying the biggest house possible and buying/selling as often as possible, to cash in on their "investment". So during the upswing of the bubble, it causes more speculative buying and higher bid prices.

I definitely agree with you about the impact of the 500K exemption on the way down. This will dramatically reduce the cost of selling for long time owners, something that a future buyer should keep in mind and take advantage of.

Astrid,
Yup. It still strikes me as very strange the number of people I've met who readily ackowledge that they're planning on selling, buying something else as soon as they can. Most recently, A client remodled their kitchen. They spent over 50k on it, and subsequently had just bought the place less than a year ago. Selling it was already an option for them. Why remodel a kitchen when you aren't there to enjoy it?

astrid,

I couldn't think of any "schmizing" that ryhmes with downsizing. On that I agree, would you prefer the 20% a year appreciation on our 500K "investment" or would you prefer the 20% appreciation on our 1 mil. "investment home?" Let's see?

There is so much evidence (anecdotal and otherwise) in nearly every facet of American life today. Frankly, I didn't really anticipate there would be much to "debate" here at all. I thought we would be treating it more like an "intervention" where the "problem/abuse" has already been identified and we are now plotting a path to recovery! Folks, it's a problem. Let's fix it.

DinOR Says:

> I mean, how could there possibly be a more direct
> and clear connection between the cap gains exemption
> and the housing bubble?

I have not met (or heard of) a single person who is buying a house in the Bay Area just so they can sit on it for two years and cash out under the 1997 cap gains law change (where will they live after they put the $250K or $500K in the bank)?

> Now that you and Zephyr have somehow put the burden of
> proof back into my court I’ll simply ask you:
> If cap gains (STCG or LTCG) were due on every transaction
> on every penny above your cost basis would everybody be
> so eager to sell, move and “lock in their gains”?

Let’s not forget that before 1997 very few people paid cap gains on home sales. How many American’s move to a smaller home before they are 55 (most of the people I know in their 50 have High School age kids)? I know a lot of realtors and in the last few years under the new laws “MORE” people are actually paying cap gains on home sales than they did prior to 1997 (it is still very few people)…

> If the ever abundant “serial refinancer” were told that every
> dime he/she took out in the form of a HELOC was going to
> be added to their AGI would they be chomping at the bit?

Where did this come from? Equity loan proceeds have never been added to AGI. Let’s stick to why a change in the tax laws that does not change things for most people has caused the bubble…

> You guys can pooh pooh it all you like but if it’s it really a
> “non-factor” either of you mind if we change it back?
> I mean, since it doesn’t really matter anyway?

I wouldn’t care if the law was changed back and I don’t think many other people who bought bubble homes would care if we go back to the old laws. The young couples I know that are buying $1mm TIC flats in the Marina and Cow Hollow are not planning to cash in any time soon, but plan to sell at a profit and roll all the equity in to a single family home (usually outside the city if their kids will not be the third generation to go to Town/Cathedral or Burke/Convent)…

astrid Says:

> FAB, The 500K exemption and recent run up has caused
> lots of people to think of their primary residences as
> investments, rather than a conservative savings account
> + durable good.

People thought of their homes as “investments” long before 1997…

> Thus, lots of people are buying the biggest house possible
> and buying/selling as often as possible, to cash in on their
> “investment”.

Do you really know anyone that is doing this?

Let’s say I bought a condo in the Marina for $500K with my wife (if I was married) in 1997 and we sold for $1mm in 2002 and put the $500K profit in the bank what are the odds I could talk my wife in to moving to the Sunset (since we couldn’t afford another condo in the Marina without the $500K) and buying another condo so we could wait for it to double in value like the last one.

My main points on this “change in the cap gains laws did not cause the bubble” debate is that:

1. Prior to 1997 almost no one paid capital gains on a home sale or pulls out any cash.
2. After 1997 almost no one pays capital gains on a home sale or pulls out any cash.

P.S. Post 1997, just like Pre 1997 anyone could refinance and pull out equity tax free…

Asrtid, Dinor, FAB & Zephyr:

Astrid said:

So during the upswing of the bubble, it causes more speculative buying and higher bid prices. I ... agree about ... the impact of the 500K exemption on the way down. This will dramatically reduce the cost of selling for long time owners, something that a future buyer should keep in mind and take advantage of.

This makes sense too, which argues for a harder landing. Wasn't Zephyr's original point that IRC121 creates no fundamental support for a higher plateau. He didn't say that the 2yr exclusion is irrelevant to the direction and velocity of prices. In this view the exclusion makes the roller coaster ride steeper both up and back down.

But, at near the bottom, or near a false bottom, some speculators will come back for tax free money again. It's an extraordinary lure -- an attractive nuisance if you will, for the unsophisticated "investor" who either has cash or can borrow the loose money spread around by "loan originators" who don't actually lend the money.

FAB

Do you believe that the 2yr exclusion has not aggravated flipper-mania?

FAB,

"People thought of their homes as “investments” long before 1997…"

However, not nearly as many as now and back then, only for the very long haul via paying down the mortgage. Most of my parents' friends bought only as big of a home as they needed, and a few lived in apartments even though they could afford homes. In fact, when my parents were planning to sell their home, they were only expecting a 20-30% increase in value (they got 125% increase), even with the awareness of prices going up all over D.C.

"> Thus, lots of people are buying the biggest house possible
> and buying/selling as often as possible, to cash in on their
> “investment”.

Do you really know anyone that is doing this?"

Yes! I know quite a few of people in their 20s and early 30s who bought prematurely (buying with boyfriend/girlfriend, buying with downpayment from parents, taking ARMs, paying more than 1/3 of their gross salary for the houses). These people are not traditional house buyers, they are also buying more house than they can comfortably buy. And almost every one of them expect to sell the house in 2 to 5 years, when their life situation changes, for a substantial profit after basis and transaction costs. This thinking is also creeping into my parents' generation. Most of their friends still think houses can only go up and feel they need to lock into a house immediately

It is precisely the high end that's most affected by the 500K/2 yr exemption. Most shitboxes do not go up by 500K in 2 years, the higher end stuff can --- even when experiencing smaller percentage increases. The tax exemption on the 500K is free money, and it makes sense to lock in that tax savings and reset the clock, which will cause market volatility. So even if you continue to buy and sell the same property, you get to lock in appreciation tax free all along the way. (I know this calculation gets tricky in CA with prop 13)

Furthermore, in your house selling and repurchase scenario, perhaps you can persuade your wife to sell the house and then dump it onto two 500K properties. Then get tax free appreciation on the primary residence and LTCG taxed appreciation on the vacation property.

"My main points on this “change in the cap gains laws did not cause the bubble” debate is that:

1. Prior to 1997 almost no one paid capital gains on a home sale or pulls out any cash.
2. After 1997 almost no one pays capital gains on a home sale or pulls out any cash.

P.S. Post 1997, just like Pre 1997 anyone could refinance and pull out equity tax free… "

Excellent points. I primarily see greater volatility (people seeking to lock-in the tax exemption) and more entrants who seek this tax benefit earlier than prior to 1997. More people are also selling their much appreciated primary residences to finance the purchase of 2 or more houses, to maximize the potential appreciation.

Unlike Zephyr, I still think that a permanent 500K primary residence exemption will raise prices, though I'm clueless as to how much. It operates just like any other subsidy to distort the market and shift long time prices upwards.

However, other restrictions can bottleneck the market to prevent the buy side (for example, via strict lending that forces everyone to buy less house than they'd want otherwise), which may result in greater supply on the supply side, as FAB mentioned.

Wow, some great posts this AM on the "capital gains contributed to the bubble" debate. I think both sides have some good points. On Zephyr & FAB's side, I can see their point about tax-free money from SELLING, not necessarily REINVESTING not being able to support higher prices (long-term) and even providing an incentive for some to sell early.

However.... and this is the big "but", eliminating the "once-in-a-lifetime/over-55" restrictions has enormously increased the incentive to CHURN and SPECULATE in residential real estate to an extent that would have been unthinkable for average people before the law was passed.

Lets' not forget an important sea change (dare I say "paradigm shift") in Joe McHomedebtor's psychology prior to 1997 vs. now, as DinOR, astrid & Garth have pointed out:

Pre-1997: housing = mainly a place to live and sort of long-term "forced savings/retirement account".

Today: housing = the new NASDAQ, Vegas & Amway all rolled into one. A rapidly (perpetually) appreciating and frequently traded volatile commodity to be flipped, traded, leveraged and borrowed against as often as possible, with no nasty tax consequences.

I think herein lies the heart of our differing opinions. I see the new laws incentivizing volatility and helping to turn housing into a new vehicle for reckless speculation.

SFwoman,
I'm not going to rationalize whether having kids at an older age is a good idea or not. My grandfather had my mother and her sister at the age of 45, and this was back in 1950, in the rural south where at the time, people were expected to get married right after high school, if they even went, and therafter have large numbers of kids. He lived until he was 98, thus saw both his children grow up and lead sucessful lives. But the reasons for him doing so were never tied to finances.
I can't put my finger on it, but it disturbs me to see people around here in their 40's, 50's having kids. It makes the kids appear more like luxury items that are their "reward" for having run the rat race, saved up enough so they can "afford" to have children. It's weird to me because in my neighborhood, just like what I imagine what it is like in your neighborhood, if people have children at all and live their permenently, then they tend to be pretty well off and older. I have no problem with older people having kids. It is a personal choice. I can even say that I too fit under the category of "saving up" for the day that I might have children. Having them now would be financial disaster, at least in my mind. I'm not really all that wild about having kids now anyhow, so that too is a good reason I feel the way I do.
At the end of the day, I can think back to what it was like when my parents were raising me, and we didn't have much money. Did we turn out ok? sure, and they are actually doing pretty well. My dad told me something a long time ago that " you never have enough money to have kids,so just get used to the idea. Otherwise, you'll never have them." There is some truth to that statement. My gut feeling is that if I ever really want to have children, I'll not even give a 2nd thought to leaving the state immediatly. Money will never be a deciding factor into whether or not I could or would have kids. There's no right or wrong answer here. It's just the way I feel, so if others feel diffrently, then that's ok too.

HARM,

I agree and I think that unlike Nasdaq and Vegas, the average flipper person is not afraid of real estate. Real estate is a little bit like the weather, a constant subject of idle chatter. IMHO most folks think they understand the real estate market.

I agree with flippers percieving RE as a safe bet because since the start if the modern economy, RE has always been touted as the "safe" investment. How could you go wrong? now... when people start investing in housing like stocks, and NOT houses, that's why we have a forum like Patrick.net, to question the end result of a trading tactic never before seen nationwide.

WW2,

My wife are in our forties and have a four year old. He's the light of our lives. Trust me it's not a hobby.

The reason we both waited is we met late in life and neither of us ever found anyone we trusted to have a child with.

I do agree that having kids isn't about money. I once got offended here when someone implied that poor folks shouldn't have children. If you are a decent, loving, caring person and want to pass that on to your child, then you're probably qualified to be a parent even if you're poor.

Garth,

I don't think poor people shouldn't have kids, but it does feel increasingly like the middle class can't have kids. It's just so scary now, since you need to save for their education, have consistent health insurance, a reliable social network to care for them, live in a decent school district, and not move much. Such a tall order in the days of globalization...

It makes me rather nostalgic for the 50s.

The poor seems to have an easier time, since they're less demanding. I don't think most of them do a good job, but since they can live without all those middle class pretensions, it's at least possible.

O.T., but you gotta admire this classic "head-and-shoulders" for TOL:

http://tinyurl.com/cyhbl

DinOR,

I'll have to come in on the side of FAB and Zephyr on the tax variable. I will make this reasoning:

Tax rates, deductions and credits in their application to individuals (the mechanics are different for businesses) have a very significant impact on consumption versus savings/investment decisions.

However, since home ownership is a savings decision for individuals, the net effect of a tax deduction generally results merely in a shifting of savings/investment decisions.

The tax argument is more tortured because what you are essentially arguing is that increased tax deductions have rebalanced savings/investment allocation into higher priced housing assets, which itself has spawned derivative dissavings (HELOC behavior). There's some macroeconomic logic to this reasoning, but it doesn't hold up in a micro economic analysis. It's possible that the missing "external" variable here is liquidity versus inflation in the broader economy, and that the individual micro economic actors aren't changing specific demand behaviors in aggregate merely due to tax deductions.

Keep in mind that saying tax deductions don't affect micro economic behavior doesn't mean that specific individuals don't change their behaviors. We all probably know of people who do or don't buy/sell directly because of tax implications.

HOWEVER, the question is does it all even out. With this type of tax application it most probably does, in a micro economic context. Again, the cost is probably in terms of inflation, which is not at all micro economic, but purely macro.

One more note on the impact of the 2yr exclusion:

We left out the idea that the roller coaster shoots up so fast it actually leaves the rails and catches air. The capital gains exclusion won't help the flipper who has to sell at a loss or can't find a seller at all. That's when the roller coaster crashes. That's what I call an impact.

Garth,
Hopefully I didn't step on any toes. Again- Most members in my family had kids late, and things turned out just fine. My only problem is the money thing. I have met a number of folks who had kids right when they thought they were well off enough, which is silly. Astrid, I agree that they middle class are getting F*cked every which way. The education aspect is in itself severe. I was in college just a short 8 years ago. I went to what I thought was an expensive art school that cost 11k a year. I paid with a mutual fund that had been started when I was born. My brother who just now completed his bachelor's at the Univ of TN paid more than that, and that's for a state school. The tuition at the college I went to now costs around 15k more per year. Who in the hell can afford that on a middle class income is a mystery to me. My brother is next starting his masters, then Doctorate. Even if he stays at UT, he will be paying for it for years. I feel bad about this because when I lived there, tuition was only around 5-6k a year, so just like my situation with housing, he is suffering from inflation of a diffrent kind in education- a problem that I didn't have.

Lill,
you've outlined one burning question I've wondered about parents with young kids, which is if they want their kids to stay in the state, what plans are they making for them? I think your plan sounds really great as far as planning for your son. I guess I would possibly do the same thing.
I just can't help it that I see the irony sometimes, like my neighbors that kept a " say no to proposition a- keep California uncrowded!" sign in their yard for over a year and yet have a 15 year old kid who someday will have to find a way to buy something thanks to people like their parents who've paved the way to make things difficult for the future generations.
Good lucj in whatever decision you make. We might pass each other in our moving trucks someday.

We left out the idea that the roller coaster shoots up so fast it actually leaves the rails and catches air. The capital gains exclusion won’t help the flipper who has to sell at a loss or can’t find a seller at all. That’s when the roller coaster crashes. That’s what I call an impact.

One of the guys over at Ben's blog had the *perfect* visual metaphor for this: Wile E. Coyote, while blindly pursuing the Road Runner (RE profits), runs right off the cliff without even realizing it. He hangs in mid-air for a moment, just as he finally realizes where he is. That's when he plunges head-first to his doom.

WW2,

No offense taken. I really agree with you (or at least your Pop) that having kids isn't about dollars. I do hear you and Astrid both it's daunting for the middle class. I stopped by CSUMB student bookstore last week for the macro text that Randy recommended. Ninety (yes, $90) for a used off-brand text. I'm stunned.

Action in the markets shouldn't surprise anyone who's not wrapped in this or that theory of doom.

- US core inflation rate up for 2nd month

- Concern over Bernanke's inflation credibility

- EU inflation rises also; EU ECB will perhaps be forced to .50 rate increase

- Currency instability

The predictable short-term results:

- Sell off in equities in US, Europe and Asia

- Challenges to central banker's credibility noted by rising Treasury yields.

- Commodity sell off (yes, even gold)

- USD rise relative to most other currencies, due to unwinding of risky carry trades in emerging markets

- Overall flight to quality and away from volatility, meaning USD denominated assets and debt.

That's exactly what's happening now. It's probably pretty short-term and just a shock while things re-balance.

This is also the "beware investing in gold" lesson. Gold doesn't inversely track USD inflation so cleanly. That's because lots of investors use gold as a hedge, and once the hedge scenario is played out, they re-balance away from gold.

WWII,

I agree, college education is something that really screws it up for the responsible middle class family. I was lucky to go to college when my father just started working and just bought a home. So they basically only paid 1/3 of my 30K/yr tuition. Meanwhile, my friends with parents who started working 20 years earlier were paying for the whole thing. With my friends whose parents made 20K or so, they were basically only worried about the federal loans. Thus, it actually makes little sense to save for your kids, since the amount you save (esp. in home equity) will be wiped out by educational expenses...basically, my father at 55 is on the same economic step as people who started working and saving 20 years ahead of him, which is a truly bizarre result -- albeit one that benefits my family.

SP, astrid,

I would go so far as to say that exploitation of the tax code has become such a common practice many homeowners these days simply take it for granted. It's the "new" path to wealth. I appreciate and respect FAB and Zephyr's considerable experience and expertise but saying you can't think of one person that's mentioned it as a "strategy" is kind of thin. I've managed a lot money for a lot of people over the years and my experience is that people would rather admit to being sexually inadequate before they admitted (they really could use the money). In the end, the proof is in the pudding and you won't have to look too hard to find it. Over half of the mortgages in this country are UNDER 2 years old! Tenure in a home has plummeted and sale prices have well....... pretty much flirted with 500K increases. Would you like that up front when you buy the home?

But, seriously folks.

Can we all agree that the 250K/500K will be less relevant in the immediate future since Patrickans generally agree, skyrocketing prices are done? No gain = no exclusion. The only immediate impact would be some stickiness on the way down.

LiLLL,

"Unless you are the Partridge Family or the Jackson 5… :)"

LOL! Have you heard the rumors that Michael Jackson is close to bankruptcy?

To sort of contradict myself from a historical standpoint, my grandfather was amoungst 10 other kids in his family. He and the other 9 were had primarily FOR financial reasons- to be extra hands on the farm, except in his case he went away to college instead, thus limiting his free labor. Maybe people aught to have 10 kids once more for the same reason, except that kids today would help YOU out with taking care of you once you're too old. In fact, it's strange that in many countries, this is still the case. An old-fashioned retirement plan.Not so here anymore, that's for sure.

Apart from winning the lottery (whether literally or through stock options or inheritance or the like), I see the majority of my peers hitting their 30s in the bay area still trying to carve out a niche for themselves. Kids are not even on the table. When I cruise amongst the hoi polloi on weekends, most of those that I see with strollers look more like grandparents. Personally, it's such a rat race here (and really has been for decades) that I'm happy to pay a cheap monthly rent ad infinitum rather than ostensibly living to pay a mortgage. I've already seen up close and personal what happens when people live beyond their means, and the endgame is not pretty; and unfortunately when kids are added to that equation, it makes it spectacularly worse (for the kids).

(First post after two years of voyeurism; as Peter Sellers said: "I like to watch.")

WWII,

That's never going to happen again. Indeed, kids were once a safeguard against old age, but that's really not the case any longer. The chance of coming in with a net profit on kids is just about zero.

This is extremely obvious in Shanghai, my hometown. While my grandparents' generation receive a lot of help from their kids for support, my parents' generation is actually paying out substantial amounts just to support their kids. Most of their children can't even dream about having their own flat without majority support from parents.

chuckleby,

LOL! Welcome to the world of posting and stage II addiction :)

Garth,

No argument here! Where the problem comes in is that if we don't get it fixed when prices "auger in" (and they will) we start the whole process all over again! I AM NOT PRO TAXES! I am "anti-bubble". Really...... truly, I don't need or want any more. Will the re-implementation (prior to 1997) fix the entire problem? Well no. We know that much. But it's a step in the right direction. If bullish, ahem, excuse me "non-bearish" investors insist that CGE is a non-issue they certainly won't have any objections when we repeal it. Guys, this is just a distraction technique. Bulls don't want to give up an inch, mort. int. ded., cheap/free money, opening the MLS, everyone qualifies, CGE and on and on.........

$500k cap gains exemption-

I think this influences people's behavior, too. Here's how.

I'm a late 40's/early 50's Boomer with a 2000 sq foot stucco tract home in Orange County which is now "worth" 900k. I've saved virtually nothing for retirement, I spend every cent I make. I become aware of the huge gains in RE and decide to get in on the action.

I was around during the last r/e bubble and know the market is going to tank eventually. I'm not THAT stupid. The only questions are when it will go down, and by how much.

I learn of the $500 cap gains exemption from my mortgage broker/neighbor/Money magazine/brother the CPA. $500k is just about the balance I should have, but don't, in my 401(k).

I start flipping houses. I watch the market like a hawk and intend to unload them once the music stops. Will I be successful? Who knows. Will the dramtic initial short term gains cause me to lose perspective and become overly optomistic? Perhaps. But one thing is for sure -- I DO INTEND TO SELL. I am not in this to build a real estate empire of tract homes, I am in this for money to spend. In fact, I am ALREADY SPENDING IT right now, thanks to the miracle of home equity loans.

Anyway, this is how I beleive the $500k cap gains exemption influences the market. Obviously not every homebuyer engages in specualtion like this. But there are a lot of them, and they help set the comps for everyone else.

And when the comps go up, younger people who want to buy houses to live in start buying them sooner/taking on too much risk and debt, etc., just as Astrid noted. Young people are interested in building up their net worth too. Even if you don't intend to spend that $500k immediatley, it sure feels great to have it, and there is always the possiblity that you might spend it in the future if you lose your job or something. Even the ability of extracting $500k is seen as a cushion of wealth by many; that equity is money in the bank as far as they are concerned.

astrid, grazie mille!

the level of discourse here is pretty stellar. Personal anecdotes and angst are about all I can reasonably contribute. Still, I loves me my daily fix of patrick.net.

I wrote that:

> I have not met (or heard of) a single
> person who is buying a house in the Bay Area just so they
> can sit on it for two years and cash out under the 1997 cap
> gains law change

Then SP Says:

> I know three of them. All of them factored the
> 500K exclusion into their plan.
> Every one of them then plowed the gains back
> as down-payments and bought houses that were
> about _double_ the size and price of the houses
> they had just sold.

These people did not “cash out” and their situation is no different than it would have been under the old system that allowed the deferral if cap gains on the purchase of a new home pre 1997.

Does anyone on the BLOG know someone that bought a nice home in a nice area for $500K in 1997 then sold for $1mm who is now living in a $500K pile of crap Bay Area home in a bad area waiting to take another $500K tax free?

FAB,

There is one difference btwn people then and people now, the basis has altered. I think the people here have argued that people who have the opportunity to exercise the 500K exemption have gone in the other direction, towards multiple investments properties or bigger investment properties. While on the surface, it appears the same as pre BushCo behavior, those behavior in fact have different motivations.

SP,
I agree to an extent, but me and my wife grew up in traditional areas where family members tend to stick together. Our living so far away out here has caused some problems, which is yet another reason we're probably moving- that and the impractical economics that exsist here as we speak. Diffrent families have diffrent ways of interacting with each other, so this single aspect will diffre from family to family.

Joe Schmoe Says:

> $500k cap gains exemption-
> I think this influences people’s behavior, too.
> Here’s how.
> I’m a late 40’s/early 50’s Boomer with a 2000 sq
> foot stucco tract home in Orange County which is
> now “worth” 900k.

It sounds like you have owned the home for a while and didn’t “buy” it due to the change in the tax laws…

> I learn of the $500 cap gains exemption from my
> mortgage broker/neighbor/Money magazine/
> brother the CPA. $500k is just about the balance
> I should have, but don’t, in my 401(k).
> I start flipping houses. I watch the market like a hawk
> and intend to unload them once the music stops.

1. You should have a lot more than $500K if you are pushing 50.
2. The $500 cap gains deduction only applies to your personal home not the investment homes you plan to flip.

The big question is if home prices continue to drop in OC will you actually sell your home and take the $500K tax free and practice your Spanish so you can rent a little apartment in Santa Ana or Costa Mesa?

For people that can move out of state I think the tax law change will increase the number of “sales” on the way down, but I still don’t see many people who “bought” with the idea of watching prices increase so they could cash out and buy something much much smaller and try to do it again…