We can expect “extra innings” out of the robust real estate economy of the past several years, but all signs indicate we’re approaching the end of the cycle, according to Kenneth Rosen, faculty director of the Fisher Center for Real Estate & Urban Economics.
In his annual real estate and economic forecast last week, Rosen also pointed to red flags for California in the proposed GOP tax plan, which he calculated will take a $38 billion bite from taxpayers if the state and local income tax deduction is eliminated. That translates to a 2% to 3% reduction in the state’s economy, he said.
“One-third of people in California are going to face a tax increase that’s going to be quite substantial,” Rosen said. “There are also a number of provisions that will hurt housing, including the property tax deduction limitation and limitations on mortgage interest deductions.”
Peak moment or extra innings?
Rosen’s wide-ranging forecast, presented at the Fisher Center’s 40th Annual Real Estate & Economics Symposium on Nov. 20, was titled “Peak Moment or Extra Innings?” and covered everything from the end of artificially low interest rates to the Bitcoin bubble to an expected uptick in home ownership rates and housing starts.
“It’s important to say that unlike the late 80s or 2004 to 2007, we’re not at a point where real estate values are about to crash. They crashed then because real estate was too expensive relative to everything else—today it’s relatively fairly valued,” he said. “I think we’re going to see a correction, but my best guess is we’ve got extra innings, a couple more years.”
Rosen said that the “easy money” we’ve had for almost nine years, due to very low interest rates, has created an asset bubble that will come to an end when rates are normalized. But he believes it would take a true shock to the system—a geopolitical event such as a sharp increase in oil prices—to throw the country back into recession.
“Now is the time to harvest. You’re not going to see better pricing,” he told the audience of developers and real estate professionals at the Westin St. Francis in San Francisco.
Industrial is the new retail
In terms of real estate, returns on office, retail, and apartments—especially luxury apartments—have already cooled, while the one area that remains hot is industrial spaces. Retail REIT stock prices have fallen 20 percent in the past year, while industrial REITS are up 20 percent, he said.
“Industrial is the new retail,” Rosen said, noting that 60 percent of new warehouse construction is coming from Seattle-based Amazon. At the same time, he predicted massive retail store closures in 2018—again driven by Amazon and other e-commerce outlets.
“There’s a big restructuring happening. Cannibalization is what we call it, and the cannibal lives in Seattle,” he said.
Rosen peppered his presentation with barbs aimed at Trump administration policies, including its anti-immigration stance—which will increase construction labor shortages and hurt the rental market—and its budget plan, which will swell the deficit to $700 billion or more, he said.
“This is a widespread, full-employment economy. The last time we had a full-employment economy, we had a budget surplus, so I think this is just a mistake,” he said. “The deficit hawks seem to have disappeared.”
Tax plan hit to California
Rosen recently completed a paper on how the GOP tax cut plan will impact California, looking in detail at the effect of eliminating state and local tax deductions. Such a policy would impact 45 million Americans, disproportionately in California as well as other high-income states like Massachusetts and New York, he says.
Assuming a 35% federal tax rate, Rosen estimated that middle- and high-income Californians would owe an additional $37.9 billion in taxes. He translated that to 2% to 3% drop economic activity in the state, including thousands fewer jobs as well as reduced local sales and property tax revenue for municipal and state governments.
Even if it’s offset somewhat by lower federal tax rates, Rosen said that the plan makes California even more tax disadvantaged relative to other states. “The long-run impact of this worsening relative tax differential means that the tax motivated out-migration from California will accelerate,” he wrote.