Marginal Utility

by Tom Bozzo

Not surprisingly, yesterday's Wisconsin State journal ran (A1, above fold) Ford Fessenden's NYT article listing college towns including Madison and Ithaca among the metropolitan areas least exposed to subprime lending. The theory advanced by Bruce Katz of Brookings sounds more-or-less right to me:

“Those housing markets are not superheated... And salaries are pretty good for faculty and research assistants [i.e., staff, not graduate student RAs]. So wages and housing prices are more in sync than in the rest of the country.”

Certainly, the UW and the state government provides plenty of middle-to-upper-middle class employment; Madison has relatively little in the way of old money and the super-rich. It's also an example of a limitation of the OFHEO house price indexes. Rapid sprawl has helped hold down prices in the postwar suburbia, much of which has seen little or no appreciation in the Case-Shiller sense; while some central neighborhoods boomed enough to price us out of them, older neighborhoods have gone from being priced well below replacement cost to mildly below, and remain affordable relative to the New Urbanism developments in the 'burbs.

Needless to say, the real estate-industrial complex would like to pathologize the situation. In late September, Stephen Elbow of the Capital Times (our usually progressive afternoon paper) wrote a lengthy and seemingly unironic article on the rapid growth of seven-figure housing in the area. In the hitherto unposted "Luxury Housing: The Rich Spend Drunken Sailors Under the Table," I'd written:

The article has two main lessons for the careful reader.

First, exurban McMansions are terrible investments. We're regaled with the story of investor Wayne Sweeney and his 5,700-sf house in the Town of Middleton, for which he reportedly paid $1 million nine years ago. Elbow writes:

When it was built, Sweeney's home was assessed at $880,000. Now it's assessed at the $1 million he paid for it, but on the open market it's likely to fetch more. Both the investor and the homeowner in him are pleased.

If Sweeney wants to spend a lot of money on a big house and hire Blackwater Lawn Care to fight World War V against 1.5 acres of potential weeds, then for the most part that's his funeral. [*] But as an investment, the house is not so good. A gander at the top end of the Town of Middleton listings suggests "more" might be $1.2 million or so on a good day. Subtract $72,000 in commissions and whatever Sweeney has spent to improve and maintain the place [**], and you have something like $1 million. In contrast, you could have turned the same $1 million into 1.26 million in (federal) tax-free money market investments, picked up another $250,000 (after tax) in the stock market even weathering the bust, and who knows what in alternative investments.

But wait, what about the the taxes?

And being inveterately cash-conscious, he doesn't miss the taxes he paid on his last three homes on Madison's near west side.

"The taxes here are great," he says.

In 2006 he paid just over $13,000 in taxes, and he estimates he would pay more than twice that if the same house was in Madison.

At the city mill rate, 2006 taxes on a house assessed at $1 million would have been $19,700 — more than the Middleton taxes, for sure, but far less than twice as much, unless of course the Madison location made the house worth more. It's impossible to tell from the story exactly what Sweeney's net investment is, but late-90s Madison prices were such that it's likely a mid six figure amount, which would pay the difference in city taxes forever, or nearly so.

Moreover, Sweeney bailed out of the very Madison neighborhoods that exhibited the greatest bubble-like appreciation before the run-up in prices really got underway.

As for the tendencies that keep many Madisonians less house-poor:

[Builder Hart] DeNoble says the relatively recent boom in luxury housing was overdue, stalled in part by an innate stinginess among Madisonians when it comes to housing.

Then it gets personal:

"People in Madison tend to spend not as much of their income on housing as a lot of other parts of the country," he says. "And I'm not just talking the coasts."

He reels off a string of cities -- Minneapolis, Chicago, St. Louis, Cleveland -- from which some of his past customers have moved and been stunned at the area's low housing costs.

Cleveland and St. Louis? Ouch. But is it me or does this smack of Lyle Lanley and the monorail?

"I had a customer from Cincinnati and she said, 'I can't find anything on the market that we like. There's hardly any homes in our price range,'" he says. "They wanted to spend $1 million."

Unfortunately, fewer customers seem to want to do that these days. Elbow reported that Town of Middleton residential starts have plummeted from a peak around 100 "a few years ago" to 31 in 2006 and 11 in 2007 through the September publication of the story.

Now cue the class warfare!

For such customers, the town of Middleton has become a safe haven where property values are protected from the corrosive effects of more moderately priced housing.

"I think customers are smart enough to know that if everything else in the neighborhood is $550,000 to $650,000, you don't want to put a million in your house because when it comes time for resale you're never going to get it," he says. "The neighborhood will I don't want to say drag you down, but it will."

Those darn mid-career professors, doctors, and lawyers, always ruining things for everyone else.

[*] It could be objected, and indeed I do object, that suburban development is underpriced and hence over-provided.

[**] Rules of thumb suggest a couple percent of the house price per year, which hasn't been wildly off in my experience with much less expensive houses.

Labels: Housing Bubble, Madison