Tenderloin Heights
by Jim Forbes
As most of you know, the upcoming presidential election is being touted as one of the most important in our lifetime.
Well, in many ways it may be, but what will the results mean to residential rental property owners, especially in San Francisco and the wider Bay Area? Will the policies of one candidate be significantly better than those of the other? Although no one knows for sure, there are several areas that can and most likely will be impacted by our next president. Here are a few of those areas.
Inflation
One reason many people invest in real estate is to
have an inflation hedge. Generally speaking, when
the cost of living goes up, so does the value of
real estate, in large part because rents rise. Inflation
has been minuscule for nearly 18 years because of
the effects of supply-side economics, first brought
to us by the Reagan Administration.
With supply-side economics, greater assistance (or more accurately, less resistance) is given primarily to the rich (the “suppliers”) with the expectation that they will invest their extra funds, creating jobs and other economics benefits. This is called the “trickle down” theory. Supply-side economics does not allocate significant financial resources to consumers, government (except for defense) or other demand-side forces, and as a result, inflation is held at bay. This is often referred to as “starving the beast.”
Free trade is another restraint on inflation. While running the risk of draining the nation of valuable capital by importing substantially more than we export ($600 billion in the last year), we have effectively reduced the price of most goods and many services. This has kept consumer prices low and, along with increased immigration of low-cost workers, has put tremendous downward pressure on American labor rates.
If President George W. Bush is reelected, this multipronged attack on inflation will no doubt continue: Tax breaks directed mostly at the richest Americans and corporations will continue; less will be given to the consumer; and importation of foreign goods from the lowest bidder will continue unabated. Short of a convergence of significant increases in the price of oil (say to $80 or $100 per barrel and $3 per gallon for gas) and runaway government spending (a possibility—see below), inflation should stay relatively low if Bush is reelected.
Rents
However, so will rents. With the exception of luxury
apartments, the customer for residential landlords
is the middle class on down (in crude terms, the “beast”).
As I have said, the supply-side economic model does little for the beast,
and as a result, wages only go up when economic times
are very good and the excess cash from the rich “trickles
down.” In the Bay Area, where home
prices have reached unparalleled levels; excess cash has trickled down
from homeowners who are spending millions remodeling.
These dollars are being earned by contractors and
home improvement stores and are a major engine of
growth for the region.
Economic recovery is dependent on that trickle continuing. But with nearly all other well-paying working-class jobs gone, the renter class is poorer than ever. Without well-paying jobs, or any job for some people, the cash to pay more rent is just not there. As a result, rents will continue to stay flat in the Bay Area under Bush.
If John Kerry is elected, I doubt that his presidency will change the supply-side formulas significantly. Kerry has argued for restoring both the top-end and capital gains tax rates back to those under President Clinton and diverting this money to the middle class for health care, but it is unlikely that this adjustment will produce a major difference. After all, inflation under Clinton decreased steadily, even as economic activity increased.
Kerry has also argued for more resources to improve the income levels of the working class. If successful, this could push inflation up a bit, but I doubt that it will come anywhere near the runaway figures of the early eighties. I would be more inclined to guess that the little inflation this would create would be good thing, keeping us away from the greater fear of deflation.
Where inflation could arise is from the rapid growth in the size of government. Under George W. Bush, spending by the federal government has increased by a half trillion dollars per year, the largest amount ever and has accounted for four out of every ten workers hired since Bush became president. If the private economy gets some real legs, this competing demand for labor could collide and start to drive up prices. As we know, once government grows, it is very hard to shrink.
Kerry seems to be more of fiscal hawk than Bush. Nearly all his votes in the Senate, including many that involved weapon systems (a present source of political heat), were votes to restrain government spending. Chances are he will slow the growth of spending much as Clinton did, which is an odd turnaround in the political parties, but one that will also curb inflation. Of course, he will come into office much like Clinton did, faced with record deficits and a huge bureaucracy.
Interest Rates
Another benefit to the supply-side economic plan is
it keeps interest rates down. First, high interest
rates are not needed to cool down inflation, and
second, large amounts of cash are available to be
loaned. With demand for money outpacing the supply,
the cost of money is very cheap and will stay cheap
so long as a supply-side economic approach is maintained,
and inflation stays low.
For residential landlords, low interest rates are very advantageous, as we have seen over the last few years. Of course, it is better to have already owned, because skyrocketing low interest rates prices have made it very expensive to get into the market. And, besides, for properties owned without debt, the effect is not realized until a property is sold.
Low interest rates have also made home ownership much more achievable for Americans. Indeed, home ownership in this country is at an all-time high, reaching nearly 70 percent of all households. But the effect of this has been a softening of demand for rental units. As a result, rents, as we have seen for nearly five years now, have stayed flat. If interest rates stay low and construction of new housing continues, the competition for tenants will continue.
Low interest rates, however have possibly allowed an elephant to enter the room, albeit still unnoticed. This is because it has permitted the federal government (and states like our own) to borrow money very cheaply. During the first three and half years of George W. Bush’s presidency, the feds have added $1.7 trillion to the national debt, nearly as much as Clinton did in eight years. But the cost of this debt has been vastly reduced, possibly artificially. As a result, this elephant could turn mean. If interest rates go up even one point, the added interest cost could create a snowball effect where servicing the $7.4 trillion national debt, along with the $22 trillion owed by others, could crowd out other needs for capital, causing nothing less than the worst recession we have had since the last Republican president took liberty with the federal deficit—Ronald Reagan.
Conclusion
If President Bush is reelected, I see downward
pressure on rents (which in San Francisco and surrounding
areas probably means the status quo) with an attempt
to keep interest rates low and inflation low. The risks
are that the burgeoning growth in government and higher
demands for capital to service the debt will cause
interest rates to rise and the economy to slow down.
For high-income property owners, I see lower income
taxes; and for those who want to sell, a capital gains
rate at a very attractive 15 percent.
If John Kerry is elected president I see a greater chance of rising rents as workers have more money, and a greater chance of interest rates climbing as the economy starts to percolate from down below. I also see greater transaction costs in the form of higher capital gains. Also, for those property owners who are not sheltered and make more than $200,000 per year, I foresee higher annual income tax bills.
The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of the SFAA or the San Francisco Apartment Magazine. Jim Forbes is a real estate investor, broker and activist. He can be reached via email at jim@urbanforbes.com or visit www.urbanjmf.com. Copyright © 2004 by the San Francisco Apartment Magazine. All rights reserved.