In the years leading up to the housing bubble of 2007, it seemed like everyone was getting a piece of the American Dream of homeownership (or maybe even second homeownership). McMansions filled America’s suburbs, real estate values were skyrocketing and luxury homeownership was becoming an expected norm, particularly among the upper middle class.
But when the bubble burst and housing prices tanked, luxury residential real estate took a hard hit. In the wake of the Great Recession, residences listed at $750k or higher were sitting on the market for months… if not years.
A decade out from the worst recession in three generations, how is luxury residential real estate faring? Was the recent market slowdown just a temporary blip on the radar and will the sector continue to draw the aspirational interest of buyers as it did in the early to mid-2000s?
Lawrence Yun, chief economist with the National Association of Realtors, said luxury real estate, by its very nature, is “a slower moving market.” Even though housing on the low end of the market is moving very fast right now in most places, things remain slower in luxury housing.
But Yun doesn’t consider that cause for concern given that luxury real estate only appeals to about 10% of the market. And it’s always the last segment to recover after an economic slowdown. In fact, he points to not insubstantial growth in luxury home sales.
REASON FOR CONFIDENCE— OR NOT
“We’ve seen much improvement year-over-year in the number of home sales at $750,000 and over,” he said. “The data shows a 15 to 20% increase in sales compared to the same time a year ago.”
Jonathan J. Miller, CRE, CRP, president and CEO of Miller Samuel Inc. in New York, also acknowledged that housing is typically softer at the top, but said the luxury market saw a tremendous boom in both luxury construction and sales between 2011 and 2014 because foreign investors were seeing the U.S. as a safe market for investment after the Recession. The market has softened a bit since then, occupying what Miller calls “the hangover phase.”
Miller has been writing market studies for the last 20 years for Douglas Elliman that have frequently been used by the Federal Reserve, Federal Housing Administration and other agencies. His real estate appraisal and consulting firm serves New York, Los Angeles and Miami.
Meanwhile, sales price increases on lower-end homes have moved up only slightly. That being said, lower- to mid-priced homes are also selling quickly in many metro areas, with an average of one month to 45 days until going under contract.
Yun said the average supply for luxury residential real estate right now is about nine months. A year ago it was 12 months. “Things are not flying off the shelf in luxury real estate,” he remarked, “but it’s improving.”
Yun said a major reason for the growing confidence in luxury home purchasing is the strong stock market. “That makes people in the top 10% much more financially comfortable,” he pointed out. “They may be buying first and second homes or even diversifying their investments by buying real estate.”
Luxury buyers largely disappeared with the onset of the Recession, but now the economy has seen almost seven consecutive years of expansion, including new job creation. Meanwhile, income growth has largely been among those making higher salaries and, in some cases, benefiting from stock options.
However, the luxury market recorded slower growth in 2016. According to Knight Frank’s Prime International Residential Index (PIRI), luxury home values in 100 key markets worldwide rose 1.4% in 2016 compared to 1.8% in 2015. The index also reveals an ever-widening gap between the top and bottom of the luxury residential real estate market — a vast 49 percentage points.
China and Canada lead the pack with Shanghai showing the largest luxury market growth — more than 27% year-over-year. Compare that to the PIRI’s highest ranking U.S. city, Los Angeles, which grew by 5.3%.
WHERE IT'S HOT… AND WHERE IT'S NOT
Yun points to the San Francisco Bay Area as one of the country’s strongest housing markets and credits much of the growth in sales prices and short housing supply to workers with technology industry stocks.
Boston is another region with strong job growth and luxury homes sales as is, surprisingly, Dallas. “Dallas’ housing economy used to be exposed to oil prices,” Yun explained. “Oil prices are low now, but the city has other industries that are growing. It’s all tied to the strength of the job market.” Dallas is no longer just about oil. The North Texas city has seen substantial growth in information technology, telecommunications, logistics and the relocation of company headquarters to the area.
Denver and Seattle are also hot markets, according to Yun. The average home price in Denver increased by over 10% in the course of the last 12 months, driven in part by Millennials relocating to the city to take advantage of new jobs in information technology and renewable energy. In the case of Seattle, the city has benefited from its status as home base to tech giants like Amazon and Microsoft as well as Starbucks.
Yun also attributes a lot of growth in the West Coast luxury market to foreign buyers, particularly the Chinese, who have invested heavily not just in San Francisco and Seattle but also Los Angeles and Portland. “They have become the dominant foreign buyers,” Yun explained. “Their GDP is rising much faster compared to that of other countries, plus the Pacific region has cultural ties to our West Coast.”
Another reason for increased Chinese interest in the U.S. luxury market is the recent institution of a 15% foreign property buyer tax in Vancouver, British Columbia, Canada. The tax has curbed Chinese real estate investment in this multicultural seaport city and coaxed many into the American market.
Miller said it’s hard to say just how much of an impact Chinese buyers are having on the luxury market. “There’s very little capture of country of origin associated with real estate purchase,” he noted. But he also pointed out that NAR surveys of foreign buyers tend to correlate with tourism numbers in the U.S. with Chinese typically being the major foreign investors in American real estate.
Over the course of the last three decades, foreign buyers have typically made up about 15% of luxury home sales in New York City, specifically Manhattan, according to Miller. However, in the current real estate cycle, he said foreigners now make up about 30 to 35% of luxury real estate buyers in the city.
Nevertheless, the New York City metro area market is not as hot as it was a few years ago. While Miller said the luxury market in Brooklyn is strong, that’s not the case in Manhattan. “It’s about where the regional economy is faring well,” he explained. “California’s economy is booming, and while New York also continues to have a strong economy, there’s still too much product in a narrow niche.”
The area’s luxury housing market has generally been fueled to a large degree by large bonuses given to executives and employees working in financials. But Yun posits that increased scrutiny of big Wall Street players has reduced the prevalence of big bonuses and, indirectly, made the city’s luxury real estate market soft. That softness has spilled over into bedroom communities in Connecticut as well.
Miller said one way to assess the health of a market is to look at the listing discount — that’s the percent difference between the home’s list price at the time of contract and the actual contract price. “In weaker luxury markets, like New York and Miami, you’re seeing that discount widen,” he explained. “The sellers are traveling further to meet the buyer; they’re not meeting in the middle.”
However, Miller acknowledges the overall health of a market has more to do with volume of sales than prices. “When you have a slowdown in activity, that means buyers and sellers are too far apart on price,” he said. What’s gradually disappearing from the market are “aspirationally” priced listings. Developers are starting to see that buyers are looking for real value. “That’s healing,” Miller noted. “Then you have transactions.”
Russia’s recession has also impacted the New York City luxury market. Whereas Russian oligarchs were once investing heavily in U.S. real estate in New York as well as Miami, they’ve stopped buying.
Sagging Latin American economies have also hurt Miami’s luxury market, which was formerly powered to a large degree by investors and immigrants from Mexico as well as Central and South America.
Miller noted that when a housing market slows, developers and real estate agents have a tendency to try to drive sales with creative marketing attempts: offering to pay transfer taxes or a year’s worth of homeowners’ association dues, for example. The reason for that is an effort to protect the asking price of a home. “They want the closing to show that list price to avoid cannibalizing the remaining sales in their project,” he explained. But these tactics rarely work. “The buyer doesn’t want a free Ferrari,” he chuckled. “He just wants a price cut on a home.”
Real estate industry professionals shouldn’t assume “the buyer has disappeared” when sales slow down. “The buyer is there. He or she is just going to pay his or her sales price,” Miller noted. “When you adjust the price to the current market value, properties sell.”
“I think it’s more about timing,” said Miller. “Some markets are just farther along the cycle than others.” Miller said that three years ago, he would have said Miami was outperforming LA in luxury home sales, but “now Miami has more supply at the high end,” he noted. “We’re seeing activity, but it’s still softer than the balance of the market. In LA, [the luxury market] is just getting going.”
LA’s luxury market has also shifted inventory during the last decade. Today it’s all about new condo towers, whereas the luxury residential market in the City of Angels used to be dominated by high-end, single-family homes.
Stephen Kotler, president, Douglas Elliman’s western region, said the surge of interest in mixed-use condos in LA reflects the same shift in values and lifestyle of other metro areas in recent years. Millennials want to live in the city and be within walking distance of work and entertainment, while empty nesters are shedding the maintenance headaches of large estates.
While Kotler said the market in and around LA hit a slowdown during the third and fourth quarter of 2016, sales volume is up 25% year-over-year.
He said the market currently has a 6.7-month supply. That’s up 19% from last year. And while movement in overpriced properties has slowed, Kotler attributes that to unrealistic expectations on the part of sellers. “The responsibility of brokers is to help sellers understand where the market is now,” he said. “Things are selling if priced correctly.”
According to Kotler, 15 to 20% of luxury buyers in LA are foreigners, primarily Asians and Britons. “The pricing here in LA and Beverly Hills compared to a place like New York City makes for an attractive purchase,” he explained. The top of the market in Southern California is $3,000 per square foot for a condo; in New York, it’s over $10,000.
Foreigners are also attracted to the lifestyle and climate of LA, and most, says Kotler, are buying second homes in which they plan to reside a portion of the year.
Kotler said he recently saw a property in Malibu go to an Asian buyer for $60 million, and the buyer intends on being the end user of the property.
Miller noted that there is also a glut on luxury new construction in many metro areas, especially New York. “The pipeline is still full,” he said, pointing out that financing of new development projects didn’t slow down until a year ago. “You still have another year of product that will continue to hit many of these markets,” he added. “In the interim, developers are trying to modify product while it’s in the pipeline to reflect a lower price point in luxury real estate.”
That’s because there has been an overabundance of properties in New York in the $10 million+ range. “How many buyers are there for that?” Miller asked. Developers and sellers are seeing the light, however. More and more luxury properties in New York are listing in the $1 to $3 million range.
LUXURY WILL LIVE ON
Those who said post-Recession the luxury market was dead due to shifting values, lifestyles and expectations about the benefits of homeownership were wrong. “It’s just an ebb and flow,” Miller explained. “Record low interest rates as a general concept inflate asset prices.”
Meanwhile there is an overall shortage in low to mid-priced homes. “The homeowner who is house-rich but credit-poor doesn’t qualify for a trade-up home,” Miller said, and that impacts the luxury market, too. “Credit conditions for mortgages at the high end of the market have not eased,” he added. “Lenders are still grappling with the legacy of bad lending decisions in the last cycle.”
He acknowledges there has been too much emphasis on luxury housing for too long, which means the market is correcting right now. He expects the high-end market to remain soft in most places for some time to come due to oversupply on the high end and under-supply on the low end.
Yun doesn’t fully agree, however, and believes the luxury market nationwide is on the upswing and will continue to grow unless there is a sudden stock market correction or an international trade war that curbs investment by foreign buyers, who tend to concentrate their money in high-end properties.
“The luxury market is always going to be somewhat unique because it only caters to certain individuals,” said Yun. “But we are off the lows from the financial Recession. Home price growth has been much stronger on the lower end and saw faster recovery. Now we are seeing the upper end market beginning to move,” Yun added. “There is more pent-up growth potential on the upper end these days.”