The Wild Calculus of My 2020 Prediction.

Making market predictions is largely a fool’s errand. The information we have on hand to make decisions with is perpetually incomplete and often wrong. Even when we do have good data to go on, we are susceptible to any number of interpretation errors and confirmation biases that muck up our ability to make accurate predictions. Humans are silly and perhaps we’re just not smart enough to handle all the variables, correlations and unknown unknowns that go into an accurate market forecast. 

But what the hell man, it’s better to buckle one’s helmet and go some plays than sitting on the sidelines to let others frolic on the field of opinion making. Plus, being on the field makes the orange slices Mom brought to the game taste way better because you’ve earned them. Thanks Ma.   

So here it goes, my best arguments for both the bull and bear cases for Brooklyn real estate in 2020 are explored in detail below.

The 2020 Bull Case for Brooklyn Real Estate.

Really low interest rates.

While the low cost of money has often been referenced for what seems like a decade long bid for real estate, it makes sense to reference this as a key driver in 2020 as 30-year mortgage rates are only a few basis points above all-time lows.

To give you a frame of reference, 30-year fixed rates in December 2019 were 3.74% compared to 4.55% in December 2018. That seems like a small move but digging into the math shows the real impact on pricing.

Let’s say you buy a $1,200,000 apartment and put down $200,000 in cash to do so. On a $1,000,000 mortgage, you’d pay principal and interest of $4,625 a month in 2019 compared to $5,097 a month if you took out the same mortgage in December 2018. That’s $5,664 in annual savings for buying now over 2018 levels.

If we used some fancy math, we can calculate the net present value of those savings and see what it means for the property’s implied price. To do so, let’s assuming we hold the property for 10-years and then invest the $5,664 in an S&P 500 index fund each year with a 9% annual return. The calculation gives us $36,350 in net present value which means that apartment should now be worth $1,236,350 in the eyes of the market.

So, lower interest rates should translate to an increase in housing prices all things considered, and rates haven’t been this low in a few years which supports the bull market case for Brooklyn real estate in 2020.

Sellers are behaving more rationally.

Brooklyn homeowners have had an amazing run. Between 2011 and 2019, pricing increased 10 – 15% a year on average with some neighborhoods experiencing even more dramatic price increases. Truth be told, owners in Brooklyn developed a sizable chip on their shoulders by the time the market started to cool off. Their expectations became irrational and as more listings came to market overpriced, they languished for extended periods and often times didn’t sell at all.

Over time, housing inventory levels increased, and buyers soon felt less urgency to act given the fact that they had more to choose from in the marketplace. This lack of urgency amongst buyers compounded the growth of inventory which lead to a further softening of prices. In kind, the tone of press pieces turned negative and the feedback loop began the correction process as sellers read the paper, sobered their expectations and cut their listing prices.

One could argue that’s exactly where we are in the cycle – more sober sellers with new buyers armed with cheaper money than a year before and both of which support the bull market thesis for Brooklyn real estate in 2020.

The stock market was up 30% in 2019, so cash windfalls should be strong.

Most people are stopped from buying a home because they lack the liquidity on hand to put 20% down and still have money left over to cover the cost of living once they have closed on their home purchase. And I’m sure it comes as no surprise to you that life in NYC is about as expensive as it gets, making it even harder to sock away “extra” money each month towards your eventual down payment in Brooklyn.

That makes the cash windfall a big part of the real estate purchasing pie in NYC. Many people get money from their family to help with the down payment or perhaps they get a sizable portion of their compensation from an annual bonus. Whatever the source of the windfall, if your money was invested in or related to the equity markets last year, there’s a good chance you have a lot more of it given the run up in stocks.

Let’s say Grandma was a prolific saver back in the day. She set aside $500 a year for you during her entire 40-year career as a bookkeeper. At a quick glance, you think that’s so warmhearted of Grammy to do but $20,000 doesn’t really move the needle much for buying that new $1,500,000 condo.

Then you recall, Grandma wasn’t daft. She put that money in the market for 40 years and made 9% annual returns over four decades. That means the nest egg she created for your lazy and entitled backside is now worth $168,941. Dang man, compound interest sure is a powerful force. 

Now imagine that Grandma carried that $168,941 account into the equity markets January 1, 2019 and then sold it all on December 31, 2019 to give to you towards your down payment. You’d have a check for $219,624. That’s a real windfall! Let’s hope you were able to cut back on some brunches over the past couple of years to save the remaining $80,376 you’ll need to put 20% down.

You want to see all the math? Here’s how it lays out:

Purchase Price: $1,500,000

Money Down: $300,000 = $219,624 from Grandma and $80,376 from you

Mortgage: $1,200,000 (30-year fixed mortgage at 3.74%)

Closing costs: $54,350 (mortgage recording tax and mansion tax the stingers here)

Monthly mortgage payment: $5,602

Common charges: $1,100

Monthly taxes: $1,100

Monthly housing payment: $7,802

That means on top of Grandma’s gift, you’ll need $181,538 in cash which breaks down as:

$80,376 towards the down payment

$54,350 towards closing costs

$46,812 in the bank after closing which is 6-months of housing cost

Yes, you can absolutely find a way to buy a $1.5MM apartment with less than $401,162 in cash on hand, it just depends on your liquidity comfort level. 6-months of housing expenses on hand after closing will pad you against income disruptions. Make Grandma proud, will you please?!

In any event, people with full market exposure have 30% more money at the ready in 2020 than they did in 2019. That’s bullish for down payments and obviously supports the optimistic view of Brooklyn real estate in 2020.

The 2020 Bear Case for Brooklyn Real Estate:

 The election cycle will be likely be dramatic and certainly be contentious.

Did you get a full dose of your family member’s political opinions over the holidays? Isn’t that just a delicious treat to savor?

Well, at a minimum this holiday season will serve as conditioning for what is likely to come at you in 2020. Whatever side of the political spectrum you lean towards, we can all agree that this presidential election cycle will be highly contentious.

Brownstone Brooklyn is predominately “blue state” country. As the election ramps up this Spring, we can expect tension to mount amongst our community. Tension and uncertainty are not typically seen as demand drivers for buying a home. If the polls start to predict an increasing chance of a Trump victory, many potential buyers will spend less time on Compass.com searching for properties and more time googling “Canada citizenship process”.

Judging from the community response in 2016, a Trump reelection will put cold water on the consumer confidence of Brownstone Brooklyn buyers. Whatever the outcome, the election brings uncertainty and is therefore bearish for the 2020 Brooklyn real estate market picture.

There is a recession coming at us at some point.

If you are to take macroeconomic statistics at their word, the US economy has been performing beautifully since The Great Recession. That’s nearly a decade of GDP growth, low employment and long-legged run up in the stock markets.

But the news flow over the past year has turned negative on the economy’s prospects. Did you pay attention to all the “inverted yield curve” talk? How about the potential ripple effect of these trade wars? Even more arcane and hard to understand, did you know that the Fed pumped trillions of dollars into the system during the holidays to keep Wall Street banks out of danger?

Concerns about a recession are even harder to decipher these days as media outlets are unabashedly taking political sides. However, those who are capable of detaching from their partisan position and study the data points without bias are voicing real concerns.

For starters, household debt levels have grown for 21 consecutive quarters. If you unpack the numbers, student debt and car loans have ballooned non-housing debt levels to multiples of that seen during the credit crisis of 2008. This seems encouraging on first flush as at least we can at least say that Americans are not choking themselves out with credit card debt in this cycle. However, if unemployment rises, student debt could exacerbate the depth of our broader economic pain borrowers are forced to repay even as their incomes drop which will invariable suppress consumer spending.

Did you know that consumer spending accounts for 70% of our gross domestic product (GDP)? That’s right, our economic well-being and growth is largely driven by our collective spending habits. Do we really understand what makes us spend more freely?

Well, the cost of money is a big driver. Didn’t we just say that interest rates are at historic lows in the bull case for real estate? Yes indeed, but the problem with low rates is that they eventually go up when The Fed fears inflation and looks to reduce the amount of money in the system by increasing the bank overnight rate or the “Fed Funds” rate.

We’ve had “cheap money” for a very long time and there is good reason to believe it has inflated asset prices to unsustainable levels. That means that one could reasonably argue that stocks, bonds and real estate are all overpriced because they are being supported by this “cheap money” dynamic. 

If that hurts your head to ponder, just look up the interest rate you are earning on your savings account. Unless you spent a good amount of time searching for that rare bank that offers you 1.7% on your balance, you likely earning 0.3% a year at Chase or Citibank. Factoring in inflation at 2.0%, you are losing 1.7% a year in purchasing power by keep money in savings! The incentive to spend or invest that money is very high and certainly goes a long way to explaining why stocks seems to have an endless bid.

Markets and economies are cyclical in nature. We’ve been on a great run and it makes sense that it can’t last forever. The risk of an interest rate spike in the system is more likely than not at this point in the economic cycle and the fact that household debt has risen for 21 quarters consecutively will amply the negative effects and further drag down the economy.

While timing macroeconomic events remains elusive, the broad framework is in place to support the 2020 bear case for Brooklyn real estate. 

Local politics are creating a decisive headwind for NYC real estate.

Separate from the negative vibrations of the presidential election cycle, New York state and New York City finds itself in a state of political flux around the issue of real estate and taxes. That’s not to say the President Trump’s administration didn’t have a negative impact on local real estate, it has.

The Trump Tax Plan reduced the level of mortgage deductions from $1,000,000 to $750,000 and capped the deductions allowed from state and area local taxes at $10,000. what’s that mean for real estate prices you ask?

Well, if you owned a $2,000,000 home that you have a $1,600,000 mortgage on at 4.5% with $45,000 a year in property taxes, your taxes went up about $12,325 a year. If you plan on owning the home for 10-years, that’s a net present value loss of $94,832 on your home valuation. That means your house would sell for $1,905,168 all things considered. That’s a 4-5% decrease in home prices that I imagine the marketplace has pricing in over the last 18 months.

If you’d like to play around with our Trump Tax plan model and input your own data, follow this link to download the Excel file.

On the local level, New York raised all of its real estate tax transaction costs in 2019. That means your closing costs went up when buying or selling property. For buyers, the mansion tax went from 1% over a $1,000,000 to a progressive tax that tops out at 3.5% for luxury properties. Sellers will face higher transfer taxes which similarly became progressively staged as well.

Things got more intense in 2019 vis-à-vis The Housing Stability and Tenant Protection Act of 2019. Widely touted as a great win for tenants, this new piece of legislation is being viewed by the investor/landlord community as an “unconstitutional taking” of private assets without fair compensation. Landlords are crying foul as their capacity to earn a fair return on their investment is now largely voided in the public interest of creating more affordable housing.

As a result, commercial real estate transactions are significantly down since the law was passed, some say as much as 85%. This means there is a large decline in transfer taxes flowing to the state which puts pressure on the budget and motivates politicians to make up the revenue shortfall from some other part of the tax base. More on that shortly.

The immediate effect is the cash outflow from investors of NYC apartment buildings and commercial properties. Not only from the standpoint of new purchases but also capital improvements. You can expect to see less spent of apartment building maintenance and upgrades implying that housing quality will trend downward. Buildings may fall into disrepair in great numbers which would lead to increased apartment vacancy and downward asset pricing. 

The feeling of dread amongst landlords and investors is set to hit a fever pitch with the “Good Cause Eviction” Bill on the State Senate floor in 2020. While marketed by legislators as an additional protection for tenants against unfair evictions, the bill contains language that places governmental control over free-market apartments and sets the rate of rent price increases at 1.5% above an inflation index.

While you may say that sounds fair, the real issue is that the bill puts the power to set rent pricing into the government’s control. Does that affect the garden rental you have in your 2-family brownstone? Yes, all apartment rental price increases will be under government control and subject to revision as that legislative body sees fit in the future. It's hard to argue that is a boon to property values.

Remember those politicians on the hunt for lost transfer taxes? They have their sights set on increasing property tax assessments in “gentrified neighborhoods". For decades in NYC, a debate has raged around how to best apply state defined standards regarding tax assessments to our city-centric markets. Clarity on the subject matter is hard to find here while conflict is everywhere.

Where increasing transaction costs like the mansion tax is one-time kind of tax-slap in the face, changing the way property tax assessments work so that property taxes go up in Brownstone Brooklyn will have a perpetual negative effect on pricing.

That’s a lot of local politics to factor into the analysis but they certainly summate to a meaningful headwind for Brooklyn real estate prices in 2020 in the bear market case.

Conclusion:

 I’m neither smart nor dumb enough to make a firm call on the direction of the market. There are just too many variables in play and not enough clarity in the data to make a prediction with real conviction. In reading through both arguments as presented, there are reasonable cases to be made on both sides. To put it all in a one question - does cheap money and stronger down payments beat out election nerves and local politics in 2020? Time will tell.

When making a decision to buy or sell a home, the direction of the market should be something you set to the side and largely ignore. Would you really not take that job in California because the housing market in NYC remains soft and you want to sell your place at top dollar? Are you sure you want to wait until the market bottom ticks before making an offer on an apartment? Those who attempt to time the market lose more than they win, particularly in real estate.

Solidify your reasons to buy or sell, pick the right strategy and team then execute the plan. That approach beats the market’s results all the time.

Here’s to a year of great adventures and renew enthusiasm.

All the best,

Evan