On Friday, October 16, the Norris Group proudly presented its 8th annual award-winning black-tie event I Survived Real Estate. An incredible lineup of industry experts will join Bruce Norris to discuss perplexing industry trends, head-scratching legislation, and opportunities emerging for real estate professionals. Proceeds from the event benefit Make a Wish and St. Jude Children’s Research Hospital. This event could not have been possible without the generous help of the following platinum partners: HousingWire, PropertyRadar, the Apartment Owners Association, the San Diego Creative Real Estate Investors Association, San Jose Real Estate Investors Association, InvestClub for Women, MVT Productions, and White House Catering. For tickets and information, visit isurvivedrealestate.com
Over the next few weeks, the radio show will be from the I Survived Real Estate event. On this week’s radio show, Bruce continues his discussion with Eileen Reynolds, Leslie Appleton-Young, and Sean O’Toole, Doug Duncan, and David Kittle. Bruce said when he looks at charts of promises that have been made, he sees that real estate is one of those investments that has a lot of goodies. There is no other place in the world where you can make $500,000 every two years tax-free. 1031 exchange, millions of dollars of asset, never pay taxes until it becomes your estate and it turns to 0. We have all these goodies, including Prop 13, so Bruce wondered if there is an appetite to look at that box and ask if they can have any of the goodies. Bruce wondered which ones are too sacred to touch and which could go by the wayside.
Eileen Reynolds took this question and said in California the low-hanging fruit, according to employees with an endless appetite for money, is the split roll property tax. This is where you tax commercial properties at a different level than residential. They are very serious about potentially pursuing a November 2016 ballot measure that would enact a split roll, thereby bifurcating residential and commercial under Prop 13. One of the other hats she wears is she sits on the California Business Properties Association, which are commercial and industrial developers as well as real estate owners. It has been something they have feared for years, but the drums are beating louder for the people with an appetite for state money. There have been bills in the legislature that would amend the Constitution, then Prop 13 would do this. However, they cannot be successful there because in the State Legislature you need a 2/3 vote in both houses of the legislature to pass a constitutional amendment and then put it on the ballot. Instead, if it is expected they will do it at all they will do it on initiative.
Bruce asked about 1031 exchanges and if anybody was familiar with this since Bruce thought they had talked about limiting it to $1 million a year. Real estate has some goodies that could provide revenue, and some of it you could make a case of it being reasonable to have that discounted. Leslie said what is interesting about the split roll is if that really did happen it would be very beneficial to the residential market that has really been carrying the water for the commercial side forever. We do not have a split roll, and her association, CAR, has always been opposed to a split roll. What is interesting is if you look at what is happening there, the residential market would benefit. Bruce wondered how it would benefit, to which Leslie said in commercial there are a lot of transfers that happen that do not get reassessed since they are using stock.
Eileen said this has been the argument in the capital, but it has not won the day. A lot of it is a fallacy that the California Tax Payers Association have continued to propagate and it seems to be catching. In the back part of the industry she is involved with, they do not think residential will get a free ride based on commercial. At CAR they had a task force that looked into it in great detail last year and came to the conclusion they need to continue to support the current situation. Eileen said realtors always go after the MID. David Kittle speculated whether anyone in the room would be willing to give up their mortgage interest deduction for a flat tax at 24%. It is a tax code structure problem that could release all this cash back into the market. He would give it up to them. He has never qualified a borrower in all the applications he has taken to them over the years, sat down, and said to a first-time homebuyer who does not automize that their mortgage interest deductions will lower their payment a little and they can qualify for an extra $10,000. Nobody does this. The high end people don’t use it and don’t need it. The low end do not deduct for it, and it is that meat in the middle that does not make any difference. This is something that should be thrown out there if you can get a lower tax rate.
Leslie said with tax reforming it means everything is on the table, and for 4-5 years we have had a resolution going around Capitol Hill which most of the California Congressional Delegation has signed. It essentially says we support the MID and do not change it. However, in 1986 there were many deals being cut at 11:30 at night, and all of a sudden we have the $1 million cap on a residential mortgage for interest deductions. She thinks anything is possible, but she does also think there is going to be losers when you get rid of the mortgage interest deduction. How this trades off is interesting. Some of the proposals that came out during the last presidential election were not really targeted at MID, but they said they would cap all deductions at $50,000-$30,000. It would be an indirect take at this. Anything is possible, but it does not look like anything will happen until after the presidential election.
Doug said the bigger question is what your policy objectives are for housing and what are you trying to accomplish. If what you are trying to accomplish is first-time homeownership, the mortgage interest deductions are useless. The people at that income level do not itemize and therefore do not deduct it. A first-time tax credit would actually be an incentive because it comes right off the taxes you paid. It would not have the power you think it would because people at that level do not pay that much taxes. About 96% of all the taxes are paid by people at the 50 percentile and above. He thinks if they are going to attack it, the first thing that will be done is the interest deduction on home equity loans will be eliminated, which is the interest on the maximum of $100,000. This would likely be the first thing to go, then you may see an attempt to cap it at either $1 million or $1/2 million. What will happen if you eliminate it completely is because of what Dave said about it being a tool to get upper middle income households to increase leverage and buy a bigger home, people will consume less housing. Those house prices at the higher levels will fall, but prices at the low end as rise as people shift their consumption of housing down to smaller housing components. There will be a redistribution of equity wealth in the housing market.
Bruce next talked about the subject of gentrification and where it is occurring. One place for sure it is occurring is Silicon Valley. Bruce asked what it is, who is being displaced, and who is replacing them. Sean O’Toole said in Silicon Valley, which is the world’s greatest draw for tech talent and where the smartest people around the world are coming in, they are pushing the prices of those homes higher. This is displacing people who have lived there for generations and their kids cannot buy a home there. Rents are also increasing, causing people to not even be able to rent there. This is free market, not a manipulation of holding interest rates down or minimum wage. It is the market working, and this is what we all want. It is bad for some, good for others, and all of a sudden you want to come in and say it needs to be stopped. Why would you need to stop it?
Leslie said one of the issues is workforce housing. Firemen, policemen, and teachers cannot live near where they are working since it is not very efficient. You cannot have communities that accommodate diversity. If only rich white people can live there, it is probably not going to be a very robust society. For anyone who has not seen it yet, HBO has a very interesting documentary called San Francisco 2.0 that looks specifically at the IT migration into San Francisco and what it is doing. This is how it works, and you have had gentrification. She has a daughter in Brooklyn, which if you look at today and 20 years ago it is a wonderful thing. However, people are displaced and there is a lot of pain. Transitions are always tough, but she goes back to the argument that workforce housing is absolutely critical for the health of a community. If you do not have programs to help with that adjustment, you get people living and moving other places.
Right now, HUD is holding funds back to communities unless you build certain types of housing within certain types of neighborhoods. They want rental housing and lower income housing, all trying to create neighborhoods. If you don’t do that, you will not get any funding. The only way to force this is put it on the back of the new home builder. This is not a free market, this is the government taking our money and saying you cannot have it unless you do it our way.
Sean said part of the question here is if you want housing to be more affordable, then should we build more affordable housing and not put on zero energy homes? If we are going to add that $50,000 cost to every home that gets built, this is what is so crazy. These are solvable problems, and if we get these to be non-political problems then we can start with less regulation. Sean said he built a home, and he has to support a 100-year snow load and a 100-year earthquake at the same time. The cost of building that level of infrastructure is enormous compared to what has been standing for 100 years downtown. It seems so common sense that if you want to build affordable housing, we can make homes less affordable. Sean had a friend who moved from California to Washington, where it rains more. In California you have to do all these things around a window just to put it in, while up there you just nail it into the building. If it leaks, you get some caulk.
Bruce asked if there is a connection with urbanization and gentrification. Leslie and Bruce had talked about this, and jokingly said she can tell he is a gated community kind of guy. Leslie, on the other hand, likes living in a diverse environment where she can walk places and come into contact with people from all different areas she is not involved. A lot of the millennials are like this. She does not know if this will change when they have kids. She did the gated community thing for 15 years, so she has been there. She thinks there is a whole new world of people out there looking for the tradeoff between drive time and quality of life. There was a wonderful presentation at the LAEDC forecast from Price Water House Coopers who has a lot of resources around the issue of leaving your footprint in terms of resources you are consuming. One of the dates that really stuck with her was July 14. This was the date at which everything we have consumed can be replenished, and after this day we are using resources where we are in a deficit. If you are in a smaller house, such as 1,000 square feet, you are using a lot fewer resources than you are in a 4,000 square foot home. We are seeing this in the office market with these companies where everyone has a stand up desk in the middle and conference rooms around it. She thinks the whole idea of how much space you need and how much time you are actually spending outside your home is a very different aesthetic. The wonderful thing about living where we live is you can do it all, but it is happening because they are valuing their time above that kind of lifestyle. They like the energy of being in a higher density environment.
For anyone who has not trekked to downtown LA lately, it is amazing what is finally happening there. David asked if this was a free market, to which Leslie said she really does not think there are any free markets anywhere, although there have been a lot of subsidies. David said if the millennials are looking for that, the market will dictate where the builders will build. In downtown LA, what you are essentially seeing is urban reuse where they take old bank buildings and old office buildings and making them into condominiums. There are a lot of creative, wonderful things going on that do not have anything to do with government. It made sense for the developer to do that since the demand was there and you had these urban pioneers.
Doug said there is one development that gives more credibility to that than what might have back in the past. This is the development of charter schools. Part of the flight to the suburbs was to get access to good quality schools since a lot of the urban schools are not very healthy. To the extent millennials would like a closer urban setting and have access to charter schools, there has been some development here. If you match what they say is an aspiration to their actions, the majority are renting single-family homes. If you look at the American Community Survey, this is what they are actually doing. There is a statistical thing you have to be careful of when looking at any group. When you go back ten years, there were lots of predictions that the boomers like to party. When the kids moved out, they were going to sell their suburban home and get a condo downtown to party the night away.
He and his wife live in Cape Coral, Florida, which their kids call God’s waiting room. If you are going to get a reservation at a good restaurant in Cape Coral, you have to wait until about 7:30. What people saw was there were some boomers that were selling their suburban home and moving to the city. However, there are so many of them that the number out in that behavioral tail was larger than their parents’ population group. Numerically you saw it happening, but proportionally there was not a behavioral change. He thinks the same thing is going to apply to some degree with the millennials because they are a larger population group than the boomers. Some of them will do that, although we do not know for sure if it is going to be a behavioral change. However, you do need to watch this characteristic. The fact that a number of them do it is important, although it may not reflect a behavioral change.
In respect to affordability and baby boomers, one of the key distinguishing characteristics of this cycle is lack of inventory. This has to do with baby boomers who want to sell and party downtown. However, they are stuck and cannot afford to do it. Even though their home has increased in value a lot, what they want to do is even more expensive. They may be giving up a great low rate mortgage since they may be giving up a great tax base, particularly with Prop 13 in California. They have capital gains to worry about, and they may not be able to qualify for a mortgage like the one they received ten years ago. There are all kinds of reasons that have made listing inventory so sticky. People are stuck. One of the portals took a survey asking people how satisfied they were with their home. Everybody loves being a homeowner, but they want to tweak it. They would like to move, but they simply cannot afford to do it. This is a structural impediment that may be with us for quite a while.
One year Sean was in the limo talking about 3d printers, which Bruce had never even heard of prior. He was surprised to hear he was buying his ten year old son one. He went home to take a look at it, and all of a sudden he heard they were building a house with a 3d printer. Bruce wondered if there was any future in this becoming a competitor. We get these little house shows with an 80 square foot house, so the question is how long it would take a 3d printer to whip up one of these. Find out the answer next week as we continue to broadcast the event I Survived Real Estate 2015.
Find out the answer to this and more on next week’s broadcast of I Survived Real Estate 2015. The Norris Group would like to thank its gold sponsors for supporting I Survived Real Estate: Adrenaline Athletics, Coachella Valley Real Estate Investors Association, Coldwell Banker Town and Country, Elite Auctions, iMortgage, In a Day Development, Inland Valley Association of Realtors, Jennifer Buys Houses, Keller Williams Corona, Keystone CPA, Kucan and Clarke, Las Brisas Escrow, LA SouthReia, Leivas Tax Wealth Management, NationalREIA, Northern California Real Estate Investors Association, North San Diego Real Estate Investors, Pasadena FIBI, Pilot Limousine, Orange County FIBI, Real Wealth Network, Realty411 Magazine, Resonant Lens Photography, Rick and LeeAnne Rossiter, Sacramento Real Estate Club – Capital City Wealth Builders, Southern California Chapter of the Appraisal Institute, Sonoca Corporation, Spinnaker Loans, Tri-Counties Association of Realtors, uDirect IRA Services, Westin South Coast Plaza, and Wilson Investment Properties, Inc.
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