Back on January 10 when I wrote the post “Are we witnessing a market melt up? on my two subscriptions sites JubakAM.com and JuggingWithKnives.com I noted that I didn’t feel that I could move on to rebalancing individual portfolios until I’ve dealt with two more big potential problems for investors in 2018. The first of those big potential problems was the possibility of a market melt up. The second is the possibility that the recently passed tax cuts will depress housing prices or at least the rate of growth in housing prices. That’s a big deal for any discussion of asset allocation in our portfolios because for most of us our house is by far our biggest asset. Many of us are counting on the growth in value of that asset to fund part or all of our retirement. Anything that slows the appreciation of that asset will result either in a tighter budget in retirement or the need to increase savings now or–most pertinent for this discussion of asset allocation–a shift of money into riskier asset classes that might provide incrementally higher returns that would make up for the slowdown in the appreciation of our homes.

I think this is a topic to raise because it is so potentially important. But it’s also a frustrating one because at this stage–the bill was passed so recently–no one knows what the effect on home prices will be or how widespread that effect might be. Will any slowdown in home appreciation be limited to the high-home prices areas of the country that will feel the biggest impact from reductions in how much in local taxes and mortgage interest can be deducted from federal income taxes? Or will the impact on those geographies spill over in some way into a more generalized slowdown.

I hate raising a question and then not providing an answer. But that’s where we are on this issue.

The two provisions of the Tax Cuts and Jobs Act that are germane to this issue are first, a reduction in the mortgage interest deduction for newly purchased homes (and second homes) to loan balances of $750,000 or less from $1 million. Interest on home equity loans will no longer be deductible unless the money is used for home improvements. And, second, a new cap on the deduction for state and local income tax, sales tax, and, most importantly for this discussion, property taxes at $10,000.

Not all of these provisions affect everyone equally–the removal of the deduction on home equity loan interest does and is likely to change the way homeowners draw down equity in their houses–and it will most seriously affect homeowners in areas with high housing prices (and big mortgages and big property tax bills. But these areas do represented a huge portion of the national total. According to Zillow the 10 most valuable metropolitan areas account for 36% of the total value of U.S. housing.) But this bill does tamper with the great American homeowners money machine. And the effects aren’t clear yet.

But they’re likely to be major if only because the homeowners money machine is so pervasive and so powerful. In 2017, according to Zillow, the value of the U.S. housing stock rose by 6.5% (or $2 trillion) to a U.S. total of $31.8 trillion. That’s exactly the annual trend of 6.5% from 2013-2016 according to the Corelogic Home Price Index .

Before the tax bill passed Freddie Mac was projecting that home values would climb by a lower but still hefty 4.9% in 2018. The reasons for the decline? High mortgage rates would damp demand and an increase in the supply of new homes would take some pressure off home prices. These aren’t long term trends, of course, just the normal ebb and flow of housing prices.

But the tax bill might accelerate a trend in the housing market. From 2013 to 2016, the last period covered by the Federal Reserve’s every-three-year assessment of consumer finances ownership of primary residences in the United States fell from 65.2% of families owning a primary residence in 2013 to 63.7% in 2016. This decrease continues the decline from 2004 when the homeownership rate peaked at 69.1%.

Add the already existing long-term trend toward lower home ownership to the likely long-term trend toward higher mortgage interest rates to the possible long-term downward pressure on home prices in the most expensive U.S. markets, and you can see why the National Association of Realtors sees a possible decline in home prices in 2018.  You need to factor persistently low inflation into this trend too. If you subtract inflation from the nominal historical gains in housing  prices, you’ll see significant declines in real housing prices in the 1970s and 1980s. We don’t need a repeat of the prime mortgage catastrophe of 2007-2008 to produce a period of stagnant or lower housing prices.

This potential trend is important because housing is such a lynchpin of family portfolios. According to the Federal Reserve the 2016 mean level of all household assets (among families with any positive assets) was $189,500. Most of that–for the median family–was a house with an asset value of $185,000.  (That figure is deceptively high since it doesn’t subtract mortgage debt. By the Fed’s count only 58.5% of home owners have any equity on their homes. But the market value is what appreciates and what makes (or made) taking out a mortgage a good strategy in most housing markets.)

In contrast to the asset value of a home, the median value of financial assets per U.S. household is extremely modest. It was just $23,500 in 2016.
Now I’d guess from the fact that you’re reading this that your household has more than that in financial assets. But think about what a lower rate of appreciation in the value of your home would do to the retirement value of your portfolio. And the extra pressure a lower rate of appreciation in the value of your home would put on the returns you need from the financial assets you own. Certainly talk to your family planner about this issue. And watch carefully to see what the Tax Cuts and Jobs Act will mean over the next few years to the asset allocation in your TOTAL portfolio.

Okay this finishes, for the moment, my thoughts on big issues that might change asset allocations in 2018. I’ll now be moving on to rebalance my Perfect 5 ETF Active Passive Portfolio today.(I’ve made that a Post of the Month on my JugglingWithKnives.com subscription site. Which means even non-subscribers can read the update.) And my Dividend Portfolio tomorrow.