Changes in Luxury Real Estate Often Are a Sign of What’s to Come for Rest of the Market

High-end real estate does not always play by the same set of rules as other sectors of the market. The wealth of investors who purchase luxury properties protects them, to an extent, from the economic fluctuations that influence the buying and selling decisions of ordinary homeowners.

“At the luxury end, buyers are a little more insulated,” said Skylar Olsen, director of economic research and outreach at Zillow. “The idea there is that they’re not exactly cash strapped, and are making financial decisions for the benefit of their lifestyles.”

Luxury real estate doesn’t react the same as sectors further down the market to changes like rising mortgage interest rates—but that doesn’t mean it’s entirely immune from external forces.

Luxury buyers should not necessarily assume that reports about the health of the overall real estate market presage changes to come to the high-end sector. Instead, it is often the other way around: fluctuations in luxury real estate serve as a sign of what’s to come further down the market.

“I would rather argue that they have a forerunner characteristic,” said Thomas Veraguth, head of global real estate strategy for UBS Wealth Management. “When average homes are lingering on the market longer, often the luxury market has already turned. This is because the luxury market is less liquid and then tends to be more volatile.”

This comparative lack of liquidity means the luxury market’s health is not resistant to fluctuations in the stock market, demand from foreign investors, and other political and economic factors.

Ms. Olsen agreed that rather than reacting to changes unfolding in the overall market, luxury sectors can serve as predictors of what is to come.

“The luxury market often starts slowing down sooner because it doesn’t have the same bubble dynamics [as the rest of the market],” she said. “It also returns to normal faster. And normal is a slower pace, which we forget because the past 10 years have been so crazy. The market normally doesn’t appreciate that fast.”

Stock Market Fluctuations

The recent volatility in the stock market has discouraged some would-be home buyers from making purchases, according to the Mortgage Bankers Association’s seasonally adjusted index with mortgage applications down by 2.5%, and luxury real estate markets, too, can show sensitivity to these fluctuations.

But investors at the high end don’t always respond to stock market swings in the same way other home buyers do. Rather than discourage investors from buying property, volatility can encourage some to seek out more stable avenues for investments in real estate.

“When people have more wealth because of stock gains, they have more money to spend on luxury homes,” said Daryl Fairweather, chief economist of Redfin. “But if some luxury buyers think the stock market isn’t going to do as well, there may be an increase in investment in real estate because it’s seen as a safer place to put money.”

Even in times of economic crisis, the luxury sector tends to bounce back more quickly than others. After the financial crisis of 2007 and 2008, for instance, high-end real estate saw a relatively speedy recovery.

“Luxury still has its own bubble, but it recovers faster, and there’s not as much foreclosure,” Ms. Olsen said. “It’s generally owned by people with deeper pockets, and the people who had stock portfolios suffered quite a bit during that time, but it didn’t last as long.”

However, if the stock market’s downward swings become particularly pronounced, wealthy investors may be dissuaded from making large purchases. Furthermore, buyers in particular regions are more dramatically affected by stock market swings than others.

In the Bay Area of California, for instance, tech industry employees tend to be compensated in stock more than professionals elsewhere, so their wealth takes a bigger hit when the Dow goes down.

“If you work for Intel, Apple, Google, a lot of your compensation is coming from restricted stock,” said Richard Green, director of the USC Lusk Center for Real Estate. “The whole city of San Francisco is a luxury housing market, and it’s a place where the stock market really matters.”

Today, said Lawrence Yun, chief economist of the National Association of Realtors, while the stock market is volatile, it’s also up substantially from two to three years ago, which could be positive for luxury real estate. In fact, analysts say, a decade of gains has lessened the impact of recent fluctuations on investors’ returns.

Foreign Investment

In many high-end real estate markets, foreign buyers account for a substantial percentage of transactions. In the U.S., 50% of all residential real estate transactions come from international investors from five countries: Canada, the U.K., Mexico, India, and China. In Miami, 80%of home purchases are attributed to overseas investors.

When buyers from abroad are compelled to slow their investments, therefore, it can send shock waves through the luxury market.

“Today, we have at the top an emerging market fragility and more regulation on capital export, especially in China, that further limit the purchasing power of a different class of foreigners,” Mr. Veraguth said.

Indeed, the Chinese government is exerting stricter control over its citizens’ investments in properties abroad, which is anticipated to slow Australia’s luxury real estate market. And a July report from NAR found that foreign investment in U.S. real estate has declined this year, with investors from China, Canada, the U.K., and Mexico spending less on American properties than they did in 2017.

Mr. Green said that the United Kingdom, too, is experiencing a slowdown in foreign investment.

“We’re seeing in London that there’s less money going into the top of the market,” he said. “The Chinese are calling their money home, and Russia again has been struggling economically, which certainly influences the luxury market.”
In addition to stricter government regulations, changes in exchange rates can also dissuade foreign buyers, Ms. Fairweather pointed out. In Florida, for example, a survey of realtors found a correlation between the strength of the U.S. dollar and a drop in international investment.


Sales data released in market reports does not always precisely reflect the health of the luxury real estate sector, experts say. The most recent S&P CoreLogic Case-Shiller report, for instance, found that nationwide, home prices have continued to rise, albeit at a more moderate rate: by 5.8% in August, compared to 6.0% in July. Redfin, similarly, reported that in September, sales prices saw the smallest gain—2.1%—since February of 2012.

However, experts say, this is representative not of a worrisome portent of trouble to come to the luxury sector, but rather a normalizing of a previously very fast market.

“Because the luxury market is much less liquid than further down the market, it does tend to lead to [luxury homes] spending longer times on the market,” Mr.. Green said. “But you don’t always see that reflect in the price. It’s censored data, because the sellers are not desperate. If they don’t get the price they want, they just don’t sell it.”

High-end real estate is still subject to the economics of supply and demand, but when supply outpaces demand, luxury homeowners have the ability to simply wait for a shift in trends.

There’s also a smaller pool of potential buyers of these properties—but nevertheless, Ms. Fairweather said, inventory of high-end real estate in the U.S. is generally tight.

However, there is a handful of cities where luxury development booms have led to oversupply.

“Even if buyers are buying, if the supply is greater, prices are not appreciating,” NAR’s Mr. Yun said. “It’s happening in New York City, where the supply is overwhelming.”

There is a similar dynamic at play in Miami and Chicago, where the percentage change in the value of home prices reflects a widening gap between median and luxury homes. In Miami, Ms. Olsen said, the market as a whole saw an 8% increase in sales prices, while the luxury sector had only a 3% rise; in Chicago, the market as a whole went up by 5%, and the luxury sector only 0.4%.
This gap, though, may indicate a return to normalcy after years of unusually high appreciation, rather than an oversupply problem.

“I hesitate to call it oversupply. If it means homes are not appreciating as fast, and people can make calmer decisions, that’s actually normal. That’s what it’s supposed to be,” Ms. Olsen said. “It definitely has changed from what it was from three years ago, when things were going gangbusters.”

Interest Rates and Taxes

High-net-worth investors are, to an extent, insulated from the rising mortgage interest rates that are impacting other home buyers.

“Mortgage interest rates have very little bearing. People in the luxury market may get a mortgage for financial management purposes, but they can also pay in cash,” Mr. Green said.

However, the sweeping changes made to the U.S. tax code are expected to cause ripples across real estate market sectors. At the high end, new limits on deductions for property taxes and mortgage interest could dissuade buyers from investing in states where property and income taxes are especially high.

“Property taxes are very important for people buying expensive real estate,” Mr. Yun said. “Compared to before, there’s now a measurable tax burden for buying those expensive homes. The upper end of the market is not immune to that.”

Reforms made to the SALT (state and local tax) deductions impact high-net-worth individuals living in states in the U.S. with high income taxes, as they are more likely to itemize and deduct these taxes. Congress has reduced the size of the deduction taxpayers can take, which is anticipated to most heavily impact high earners.

“This is wildly significant for people who make over $200,000 a year,” Ms. Olsen said. “People in coastal, high-tax markets are certainly going to feel it. It might affect their willingness to pay for certain things. In the New Jersey and Chicago luxury markets, for instance, that will be rough.”

These changes to the tax code may persuade some buyers to take a wait-and-see approach before making any new investments.

Source: Mansion Global