Zillow's take on the residential real estate market (and my response)

According to the San Francisco Business Times ("Zillow: Here's what everyone gets wrong about buying and selling houses"), the leaders of Zillow, the online real estate website, challenge what they call the seven myths of real estate in a new book, Zillow Talk: The New Rules of Real Estate.

While we shouldn't look at houses so much as an investment opportunity and more in terms of a place to live, ideally you can maximize the benefits of the place value of ownership while hopefully selling at a profit. The Zillow advice does touch on recent discussions here about place value, the real estate market, and long term returns, such as the difference between owning a house in Woodridge versus across the border in Prince George's County, or in more distant automobile-dependent locations further east.

The lessons:

1) The most important rule in real estate is location, location, location. Not true, they say. Instead, the most important rule in real estate is future location, future location, future location. The authors say home buyers eager to maximize their returns must look 10 or 20 years down the road to assess what will happen to the neighborhood. 

2) Buy the worst house in the best neighborhood. Wrong! The house will always be the worst house in the neighborhood, and buyers in a great neighborhood are likely to look past your ugly duckling when you go to sell, meaning the price gains on these "worst houses" actually underperform their surrounding neighborhood rather than being carried along with them, Zillow found. Instead, the authors advise a shopper to buy the worst house in the hottest neighborhood — and to do so within the first five years of the neighborhood getting hot.

-- I think that this advice is more dependent on the quality of the house.  It comes down to distinguishing between what we might call the place value of a neighborhood vs. the house value.

If the house value lags the market because the house doesn't have good bones, then the advice might be accurate.  But if the house has bad bones, but is in a good neighborhood, and it can be improved at a reasonable cost, and the buyer knows what they are doing and can afford to do the necessary renovations, such a house can be recovered.

But from the standpoint of economic return, the advice to "buy the worst house in the hottest neighborhood" is pretty good.

But that strategy doesn't always work either, and success is dependent on how long the real estate market remains hot and strong.

During the run up to the 2008 crash, when it happens we were shopping for a house, I was shocked at how there were so many badly renovated or problematic houses for sale, the outlandish asking prices, and the massive interest in these obviously defective properties--the open houses were jammed with people hot to buy and ready to make an offer. They were in fact aiming to buy the worst house in the hot neighborhood.

But those houses, unless they can be fixed--and the cost to do so likely was considerable--likely don't maintain their value when economic conditions and especially mortgage underwriting standards change.

Unfixed in not unfixable except at high cost, these "worst houses" are much harder to sell and likely don't appreciate in value nearly as much because there is a difference between place value and house value--both factors shape the price of a house.

At the end of the day, great place value can't overcome poor house value.  With tougher mortgage underwriting standards it's much harder for a wacked house to appraise at high values, so the houses can stay on the market for years.

It's not atypical for problematic houses to be pulled off the sales market and rented in the face of a failure to sell.

By contrast, during the bubble years, these houses sold quickly, warts and all.

3) Foreclosure discounts offer compelling investment opportunities. The authors say calculations of dramatic discounts offered in buying foreclosures often overstate the case. That's because the foreclosed property is usually compared to the prices of non-foreclosed property, an apples and oranges comparison, rather than other foreclosures in the area. ...

-- I think this a good point.  But what drives the value equation is whether or not the foreclosed house is located in a strong or a weak real estate submarket and if the house is in good or bad condition.

The discount is likely to be less in stronger markets.  But if there is a limited inventory, then maybe the discount doesn't matter so much as it's more about getting to live where you want when there are fewer opportunities to buy.

On the other hand, there aren't many foreclosures in strong real estate submarkets.  E.g., people were coming to DC during the downturn, expecting to find a $300,000 foreclosure property in Georgetown.  Nope, such opportunities didn't exist, although there were foreclosures sprinkled throughout the city.

But weak markets are not likely to regain their value, so a really cheap house in a submarket that is likely to remain depressed may not be such a bargain.  (Yes, you can buy houses for under $50,000 in Detroit, but don't expect such houses to rise in value for decades.  Plus the real estate taxes are hyper-onerous. Etc.)  But if you expect to live in the same place for years and price appreciation isn't as important to you and you have a good job, a hyper-cheap house can be a good deal.

4) Remodeling the kitchen, with a lot of fancy upgrades, is one of the smartest moves you can make to boost your home's value."Kitchen renovations, at any level, offer among the lowest return on investment of the home improvements we studied," the authors said. Instead, a modest bathroom makeover might have the biggest impact on your home's value.

-- Again, this depends on how much you spend and whether or not the kitchen is functional to begin with (ours wasn't--we only had the potential of 88 linear inches for counter space and half was taken up by a fridge and the other by a nice hutch that provided no real counter space), and how judicious you are about upgrading.

It's true that the more you spend and customize the harder it is to get back what you spend.  Plus unique features are more likely to be unappealing to future buyers.

The big thing that I have noticed with the real estate market in the past 7+ years is how people now are focused on move-in ready--they aren't interested in buying "a fixer upper."   So at the same time a house with a dated or dysfunctional kitchen can languish on the market for a long time.

On the other hand, doing a "bad renovation" or renovating without correcting evident dysfunctional elements is equally problematic.

5) List early in the year to catch the spring home-buying rush. Nope. With more home buyers starting their search online, it's better to list in late March, generally speaking, so your listing is near the top of search results. ...

-- This is an important insight about how the addition of the online information element to shopping for residential real estate has changed the nature of the real estate sales calendar.

6) Home ownership is the foundation of the American Dream. The authors argue that an analysis of Zillow's data indicates public policy designed to boost homeownership among low-income buyers has the opposite effect of lifting people out of poverty. That's in large part because less affluent neighborhoods, where many of these new home owners can afford to buy, experience lower appreciation and higher price volatility than more affluent neighborhoods, according to Zillow Talk's analysis.

-- I think this is an important point, which by happenstance has been a big topic of discussion in this blog over the past week, although I would say it isn't so much a difference between less affluent and more affluent neighborhoods, although there is no question that is an element, as well as race and semi-segregated real estate markets, but more about neighborhoods with either more or less place value.

Place value is built on a number of factors, walkability and transit vs. automobile-dependence, schools and public safety, in-city versus suburb, and is measured more generally by the determination of whether it is a "strong market" or a "weak market," at both the metropolitan and submarket (neighborhood) scale.

As h st ll pointed out in a response to my post on Woodridge as a hot DC neighborhood, while I am critical about the neighborhood's lack of a solid commercial district and automobile-dependence, buyers are attracted to the neighborhood because of large lots and the in-city location, and are not likely to be seeking walkability and don't lose much by not having a good neighborhood commercial district because they can drive to nearby activity centers with little inconvenience.

So the neighborhood is still attractive to people who want to live in the city, because they have different preferences than people who prefer walkable neighborhoods. Because it's in DC,  even being more comparatively automobile-dependent, the neighborhood is likely to be protected from the kinds of declines experienced by comparable areas in suburban locations.

However, I would argue that the factor driving the most price escalation in DC is walkability (what Christopher Leinberger calls "WalkUPs," walkable urban places) so that by comparison, Woodridge has a ceiling on price appreciation potential compared to DC's walkable and transit-centric neighborhoods.

Getting back to the point the authors, Spencer Raskin, Zillow's CEO and Dr. Stan Humphries, the company's Chief Economist, make about "more affluent" versus "less affluent" neighborhoods, it happens that I was at a conference this week and I ended up missing an entire workshop slot because I met someone who lives in Anacostia and we got to talking about what might be considered social and community capital issues in her neighborhood--and she wasn't talking about "long term" or poor residents, but the attitudes of newer, more affluent residents related to neighborhood improvement.


Lagging neighborhoods need (more) ongoing assistance when it comes to community building--not less or none.

But there aren't many good examples of focused programs.  One is the discontinued "Elm Street" program in Pennsylvania (it's now called Keystone Communities).  This program was designed to help neighborhoods improve, using the ideas of the Main Street commercial district revitalization program, but repositioned for the residential element of neighborhood improvement.

Another would be Minneapolis' now discontinued Neighborhood Revitalization Program, which was time-limited to 20 years, as it was created through a one-time tax increment financing program.

They found that neighborhoods, which were given money to focus and implement improvements, lacked the knowledge and organizational infrastructure they needed to be able to use the money well, so they created a big technical support and training program.

Chicago's historic bungalow revitalization initiative builds community and capacity through a variety of initiatives including an annual conference.

Preservation groups in Cleveland and Pittsburgh, with support of the city, have created extensive support systems for residents taking on (or needing) home renovation.

And the successor to Minneapolis' NRP, the city Neighborhood and Community Relations Office, sponsors an annual community engagement conference called Community Connections. Each year the conference has a different theme.

Atlanta's Park Pride park support organization does the same thing for parks advocates.  Their annual conference is a key tool in building the support and capacity for parks and placemaking in the city.)

Similarly, one of the biggest reasons I support urban historic preservation is because of its success in revalorizing urban neighborhoods in the face of decline by restructuring financial, social, and community capital.  National, state, and local preservation organizations have developed a large set of resources and at the state and local levels, typically offer technical assistance.

Note that many cities have "neighborhood engagement" offices.  But the open question is whether or not these programs re focused on citizen capacity building or are more political in intent.

For example, I argue that DC's programs in both the mayor's office and by councilmembers are more focused on building support for re-election rather than in developing the capacity of citizens and neighborhoods to organize and improve their conditions without having to be reliant on "government" to do so.  The difference is about self-help versus dependence.

7) The mortgage interest deduction is essential to the health of the nation's real estate market. The authors concede that they're taking on the third rail of real estate, and American politics, in calling the mortgage interest deduction ill-conceived public policy. The authors make the case that the federal government is essentially spending $100 billion in the form of lost tax revenue annually to help Americans living in homes that cost about $865,000. And yes, that includes many of us living in the Bay Area. "It's especially ironic that the (mortgage interest deduction) is consistently sold to the American people as a populist policy to help the little guy," the authors write. "In reality, it's the exact opposite."

-- It's true that the mortgage interest deduction provides far more help to the well off.  It also contributes to price escalation by providing subsidies to higher priced houses.  Means-testing the benefit, and targeting the benefit to areas that need a boost would probably yield more social return.