Monday, August 10, 2009

Trophy Houses

In the midst of this current economic resurgence since last March, where it is hard to discern any economic growth driving it but it keeps progressing and beating expectations, I’d like to comment on a clear pattern seen in the real estate market since declines began in 2006 (or 2007 in San Francisco). It is this: low-end properties are correcting toward fundamentals faster than the higher-end ones, with middle-range properties somewhere in between.

To me the explanation is straightforward: there is greater economic capacitance at the wealthier end of the spectrum, so more ability there to sustain a drain of wealth while waiting for a turnaround. (Those getting the bailouts enjoy a whole lot of economic capacitance.) Low economic capacitance has a snowball effect: inability to keep up with underwater mortgages leads to that many more properties on the market, which leads to further erosion of prices, which means more underwater mortgages and more homeowners with a motive to walk away, and less ability to buy in worsening economic times.

However, if low-end properties become a decent investment once you factor in the rent-to-mortgage ratio, whereas higher tier properties demand mortgages well in excess of rents, then the low-end market will draw interest from middle-range buyers, exerting a downward pressure on that market, which will eventually work its way to the top.

So goes economic theory. In actuality, upper-end properties in areas of high demand are declining in price very slowly, at best. I’m thinking of San Francisco. Which begs the question—might there be areas immune to economic factors, “trophy” properties in other words, which will maintain a strong market so long as there is an upper 5% of the population that controls 80% of the wealth, or so?

Now I’m all for redistribution of wealth, so long as it is voluntary, and trophy purchases of any kind—cars, boats, houses—have exactly that effect: a drain on wealth from those who have it. By “trophy” I mean a purchase which commands prices above and beyond fundamental value because of general desirability and status benefit which comes of it. So, is this trophy market sustainable? Could somebody get an upper tier house in San Francisco with the anticipation that wealth would at least be preserved and capital gains could even improve on the investment?

I suppose the only answer is: “time will tell.” It depends on how deep the pockets of the wealthy run. But one does not become rich or stay rich by losing money. In anything but a climate of compelling capitals gains, trophy properties are costly.

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