I recently took advantage of the mobility that working from home offers to take a short trip with my son to Washington D.C. I made a local journey there after work to visit family as well as the former home of my grandparents located just outside Washington in Takoma Park Maryland. I had fond memories of the home they lived in. It was perched on a corner lot on a hill. Ivy covered 2/3 of the hill leading up to the home from the road and a gently curved set of concrete steps led up to the door on the hill top. The garage was actually dug out of the hill and located adjacent to the basement. in the back yard, there was a small concrete patio when you immediately stepped out which then rose up to 3 terraced garden plots which followed up the hill upwards behind the house. Meeting with my aunt, who had long ago moved on to a single family home in a wealthier neighborhood, she told me the story of the home which was interesting but quite telling of the unaffordability of the current housing market in many large cities.
She explained that the home was purchased in 1942 and my grandparents had what they considered at the time to be a large mortgage of $7,000. This was the same year that the home is listed as built on Trulia so they likely bought it as part of a new development. At the time, Takoma Park was located around a stop of the B&O Railroad and it was being built up as a commuter suburb for those working in Washington D.C. My grandparents stayed in this home for 50 years until my grandmother decided to move on to a retirement community further out near Aspen Hill Maryland in 1992. At the time my aunt recalls she thought she got a great deal on the house, selling it for around $220,000. I deduced that the original purchase price with a conventional 30 year fixed mortgage was around $8,750, which equates to a 6.6% increase in value annually over a period of 50 years, which was indeed a good investment. To compare, the annualized return of the S&P 500 over this period was around 12.67%. They seemed to have been fortunate to invest and own a home during this time. The home price growth has slowed in the past 30 years or so to around 3% annually. Still, a look at Trulia showed that the home’s estimated value is now around $550,000, a sum which my aunt found baffling considering that the neighborhood is not considered a great one nowadays.
That the neighborhood is not considered “great” may be due to the large housing blocks that were constructed in the city which came to house a number of poorer immigrants in the 70’s and 80’s. The city at the time was considered quite liberal, having welcomed El Salvadoran and Guatemalan refugees as well as decreasing itself a “nuclear free” zone at the time, earning it the nickname “The People’s Republic of Takoma Park”. This didn’t surprise me as it was consistent with the activism my grandparents were involved in during the civil rights era.
I was curious on affordability though. My grandparents were notorious for always claiming they never had money and they were meticulous savers as well as avid investors. Given they were living off of one income most of the time and that my grandfather was a government employee, would they have been able to afford the same lifestyle they had then today? To find the answer, I referred to a handy historical inflation calculator that can be found here. I found that the price of the home they bought at $8,750 in 2020 dollars was equivalent to almost $140,000 today. This would imply a down payment of $28,000 and a mortgage of $112,000 which would equate to monthly mortgage payments of about $481 at today’s rates. Of course rates were not at 0% in 1942 but the mortgage rates actually may have been somewhat close to today’s rates. If we add 2% to the 10 year treasury rate at the time (mortgage rates tend to move with a spread to the 10 year treasury rate) rates would be around 4.5% then. This would push the monthly mortgage cost up to $567, still a very reasonable rate for a home, especially for today.
To put this in contrast, a buyer today of the same home would have to put $110,000 down, carry a mortgage of $440,000 which would require monthly payments of approximately $1,880. This is a monthly payment more than 3 times as expensive for a house that is almost 4 times as expensive as what my grandparents originally paid. Add to that the taxes and insurance and a family buying this home today could easily find themselves paying $2,300 a month for this 1500 square foot home. A worker would have to make around $80,000 to $90,000 to afford such a place and that is assuming 1/3 of income for housing. In reality paying 1/3 of your gross income for housing make other expenses difficult. It means potentially paying 40% to 50% of your take home pay to a mortgage, essentially one paycheck a month just goes to paying your home.
Uneven Costs
This is common in many of the most expensive cities in the US. The Washington D.C. metro area is somewhat middle of the road when it comes to housing costs but relative costs over time are not as often examined. The fact of the matter is many of our parents and grandparents had much more affordable housing options in large cities compared to today and this has important impacts for savers and inequality.
The first question it begs is how much higher can this go? Prices at this point are really being driven by rates which are at an all time low for mortgages and have been outpacing wages for some time. It shuts out many first time home buyers or burdens them with expensive mortgages that could easily run into trouble with an unexpected job loss.
The second larger question is, with remote work a real option now, will families continue to pay these prices? As I have pointed out in previous posts, there is a widening gap in terms of affordability within the country, even in so called perceived “nice places”. It’s one reason hedge fund billionaire Bill Ackman is betting on younger people moving towards Warner and cheaper climates, think Texas and Nevada. He is doing this through Howard Hughes Corp. a Houston based property developer that focuses on multi family construction in warmer climates. These include Nevada, Texas, Maryland and Hawaii. Although Maryland and Hawaii are not exactly low tax states, all of those states bar Hawaii are relatively cheap compared to the NYC and Bay Area stratospheric prices. You can see this further detailed below in the “home price p/e” or put another way, the median home price as a multiple of the median income for a statistical metro area.
Ackman’s Pershing Square Capital Management now has a 25% stake in the company and Ackman is calling this a “generational bet” which I tend to agree with.
In fact this trend has already played out over the last 40 years which is the reason behind the price disparity between regions. High tax, highly controlled markets such as New York, Boston and the Bay Area have seen prices grow as much as 5-6% annually over a period of decades. This has made their housing markets increasingly unaffordable. The winners in these markets were the people that got in or already were in on owning. Many of them were able to easily make a fortune just by having a home. Residents in places like Detroit, Cleveland and Chicago were not as likely, home values in these locations barely or didn’t keep up with inflation at all. The secular decline in rates since the 1980’s has simply magnified this difference but I’m in the camp of many who, although we love the culture in some of these cities, is considering another location, especially if work is done more remotely now.
The Little Guy Can Also Benefit
It’s not just hedge fund managers that can take advantages of the trends. Buying a home in an expensive area, renting it out and the. Renting our buying in cheaper area is like a natural hedge. You get the price upside of the more expensive are while experiencing the low costs of the cheaper area. If this is too Capital intensive for you, you can simply buy a residential REIT with a presence in the expensive areas. Examples of this include Essex Property Trust (ESS) which focuses on California and Washington or AvalonBay Communities (AVB) which focuses on the Northeast as well as California. These REITs will likely see the upside in both the rents they take in as well as the refinancing they can perform at lower rates to distribute back to shareholders. Again the key for someone looking to take advantage of the trend would be to pay to live in the cheaper place while owning in the more expensive place so would require at least moving somewhere cheaper, if not to another state.
These are multi decade trends that will take years to play out but the moves have already started. Tech companies have been in many of these cheaper locales such as Austin for years. Rather than complaining about the rich get richer, any of us can actively take a role in benefitting from these multi year trends just as my grandparents did (although they may not have seen the trend and just gotten lucky). The little guy doesn’t need to just buy GameStop shares to outmaneuver the system, it can be as someone as just picking where you live and investing smartly over the long term.
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