This post is a brief note about something I stumbled across, in the Town of Vienna 2024-25 proposed budget, while doing my homework for the just-prior post.
Hmm. With the notable exception of a few chunks of row houses built on formerly commercial property, this essentially refers to tear-downs. That is, the practice of buying small houses, tearing them down, the putting up the largest house that can legally be built on the resulting lot.
So I wonder if this might be a real slowdown in Vienna’s tear-down boom. If so, it’s been a long time coming (Post #1617). But it just might be a consequence of a general slowdown in home sales.
The end of free money and unlimited tax breaks.
The 2008 bursting of the Bush-era housing bubble resulted in an almost unprecedented decline in U.S. house prices. The bubble is the little hill in the middle of the blue graph of average U.S. housing prices, below. The decline in housing prices is the downhill side of that bump.
Source: Federal Reserve Bank of St. Louis.
And that was when the tear-down boom took off in Vienna, VA. That is, the start of an era when developers began purchasing essentially every small house that went up for sale in Vienna. Then tearing down the existing, sound housing, and replacing those houses with McMansions, defined in this case as the largest houses that would legally fit on those lots. With some caveats, that’s evidenced by the big increase in new housing permits in Vienna starting in 2009.
Source: Various Town budgets. Most of the underlying documents are no longer available on the Town website, as the link to the budget document archive is now blank. The main caveat is that there have been three large developments of townhouses on land formerly zoned as commercial, that presumably add to those totals in some of the later years. But, broadly speaking, I think this is a reasonable representation of “the teardown boom” in Vienna.
Oddly, there’s a real element of cause-and-effect there. But it’s not obvious why a bust in housing prices would cause a boom in tear downs. Particularly when housing prices didn’t actually fall in Vienna, they were merely flat for a few years.
To understand why the housing bubble lead to our teardown boom, you have to recall what happened as result of the bursting of the housing bubble. Fifteen years ago, we witnessed the near-collapse of the U.S. banking system. To the point where the Federal Deposit Insurance Corporation (FDIC) ran a negative fund balance, due to the wave of bank failures (below).
Source: FDIC, , courtesy of the Federal Deposit Insurance Corporation (FDIC), s
In order to rescue the U.S. financial system, the Federal Reserve did two things. First, it moved a lot of dubious bank assets onto its own balance sheet. Second, it depressed U.S. real (inflation-adjusted) interest rates very close to zero. (During the financial panic itself, there were brief periods when U.S. Treasury Bills (T-bills) had literal negative interest rates, something that had not occurred since the Great Depression.)
Below, you can see that 7% mortgages were the norm just prior to 2008. But following that, mortgage rates of 4% and lower became the norm.
Source: Federal Reserve Bank of St. Louis.
The point of that zero-real-interest-rate Federal Reserve policy was to give banks time to repair their balance sheets. But a huge side-effect was that the Federal Reserve fed the U.S. economy “free money” for more than a decade. During that post-bubble-bust era, you could borrow money at very nearly the underlying rate of inflation. If you could find an asset that kept pace with inflation, and a bit, the more money you borrowed to buy such an asset, the more money you made.
That 15-year era of free money came to an end with the post-pandemic inflation of 2022. Mortgages interest rates have gone back to their pre-bubble norm of around 7%, and there they have stayed.
Separately, housing had many unique, almost-unlimited tax advantages that were reined in started around 2018. If you go back to the pre-2018 period, for the typical buyer, for their residence:
- Capital gains were tax-free.
- Mortgage interest was fully tax-deductible
- Property taxes were fully tax-deductible.
But a lot of that changed around 2018, as I detailed in Post #1617. New limits were imposed on deductibility of mortgage interest and property taxes. As a result, the carrying cost anything over about $800K of house suddenly got a lot higher. Like so, from that post:
The combined effect of the increase in mortgage rates, and the loss of tax advantages, was to raise the carrying cost of a big house by about 86%, relative to what it had been back in 2017. As shown below.
Throw in any type of slowdown in house price increases — for which we are way overdue, given that housing affordability is worse than it was at the peak of the 2000’S housing bubble.
Source: Federal Reserve Bank of Atlanta
And all of a sudden, buying the biggest possible house is no longer the no-brainer that it used to be.
In round numbers, after taxes, the monthly payment on $1.4M house is very nearly twice what it was seven years ago.
… or are there just fewer houses to tear down?
One alternative explanation of the decline in housing permits in Vienna is a general decline in home sales. If houses don’t go on the market, builders can’t buy them and tear them down.
Nationally, far fewer houses have been sold, of late.
Source: Mortgage daily news.com.
That also appears to be true for Fairfax County, VA as a whole, of which Vienna is part. (Don’t be fooled by the scale of the graph of home sales below. It only spans five years, and the peaks and troughs from two years ago are about double what they are for the most recent year.
Source: Redfin.
So, while I would like to think that the teardown boom is winding down due to economic forces, the observed decline in building permits in Vienna may simply be due to a lack of raw materials. Plausibly, declining sales of existing homes means that fewer can be bought for teardowns.
Summary
One way or the other, the number of new houses built in Vienna last year was the lowest in more then a decade.
That said, up to now, there seems to have been an unlimited appetite for huge houses here in Vienna. And, while my limited analysis says that the price appreciation on those big new houses is slightly less than on existing older houses, its only slightly less. Prices for those are still going up.
On my block, those new homes are now pushing $2M. Assuming I can do the math right, even after all tax sheltering, with a 7% mortgage, that’s an after-tax cost of about $130K per year. If the rule-of-thumb is that housing should cost no more than 30% of gross income, that implies you’d need a household income well in excess of $400K/year to afford one. And, while incomes like that aren’t hugely unusual around here, it’s not like they are thick on the ground, either.
I just have a gut feeling that a lot of folks bought McMansions during the low-interest-rate period prior to 2022, and maybe during the period of maximum tax advantages prior to 2018. And that current pricing still reflects those conditions. And that, if current interest rate and tax policies persist, at some point, it’s going to be a real question of sell-it-to-whom, as those folks try to move on.
