In 1929, the world experienced the Great Depression, and from 2008 to 2009 it went through the Great Recession.
In 2016, however, it experienced the Great Correction.
Last year marked the first time in history that luxury homes prices scaled back rather dramatically, independent of downward economic pressure.
Overall change in the luxury goods market
Luxury goods, as a whole, are experiencing a similar reversal of the runaway luxflation — or continual inflation of the luxury value of goods — that, until recently, was unjustifiably raising prices to unreasonable levels.
While the cost of living a luxurious life has historically outpaced inflation by about 200 basis points (the Forbes’ Cost of Living Extremely Well Index (CLEWI) tracks annual luxury inflation), the effect over the last several years had been outsized.
According to BCG, sales of luxury goods rose 11 percent from 2010 to 2012 and seven percent in 2013, but the last several years have seen a relaxation of that rapid growth rate.
Bain & Company’s annual luxury study cited a more reasonable four percent growth rate for the luxury goods industry in 2016.
Consequences of ‘luxflation’
Inflation of luxury goods escalated so rapidly over the last several years that luxury consumers finally stopped to catch a breath in 2016. Interestingly, the pull back came at a time when this kind of consumer had more wealth saved than ever before in history.
Compass data showed a significant decrease in pricing and trading volume in many high-end areas, including Manhattan, Miami, The Hamptons and Aspen; inventories grew and asking prices dropped.
The impact of luxflation isn’t limited to the housing market.
Ralph Lauren’s glitzy Polo store in Manhattan recently closed its 5th Avenue doors. Even stalwart luxury goods retailer, Neiman Marcus, is experiencing major resistance from wealthy buyers who are tired of the rampant inflation of luxury goods.
The gap between price and quality is no longer being ignored.
Why consumers took a break from real estate
As someone who meticulously monitors the luxury goods sector for changes in luxury homebuyer trends, I’ve zeroed in on 10 reasons why wealthy consumers took a pause from purchasing real estate last year:
- Seller expectations have become over-heated. When pricing spirals upward without rhyme or reason, the wealthy become nervous, cautious and angry.
- Wealthy buyers live by the Warren Buffett’s investing rules: rule number one is never lose money, and rule number two is don’t forget rule number one. Fear of buying is anathema to the rich.
- Wealthy buyers can wait, and they have no problem applying caution at the tail end of a rapidly escalating cycle. A wait-and-see approach is safe and comfortable.
- 2016’s global political uncertainty was discouraging. Terrorist attacks fueled fear and shifted focus to the less materialistic aspects of life, which usually happens in cycles.
- While London’s Brexit vote caused shockwaves, its new high real estate taxes dampened the markets much further.
- Nationalism intimidated many foreign buyers. Combined with a very strong dollar, this trend took out a small but potent group of real estate buyers.
- The investor-buyer, who was focused on large capital gains due to soaring markets, saw the tail end of this luxflation and pulled back or pulled out entirely.
- Many investor-buyers who had been promised enormous rental returns on ultra-luxury homes started seeing an increase in inventory and a decrease in rental pricing.
- While the number of very wealthy people continues to grow, the volume of luxurious homes being built is exceeding the demand. Fortunately, it will take years to reboot production once this is absorbed, and another price growth cycle should emerge.
- Many real estate marketers, bankers and developers relied on averages in pricing, which were often mistaken. Averages offer poor insight and data, and they eventually become useless in most circumstances. Ignoring fundamentals and real-time insights leads to poor decision making in this hyper-specialized industry.
The correction
The good news is that the correction has already happened.
Unreasonable real estate prices — ones that were completely out of line with the quality of the product — have been corrected, and the corrections have been enormous in certain areas.
According to Compass data, New York’s Upper East Side saw home discounts as high as 25 to 30 percent, but other areas saw much smaller corrections.
Keep in mind that huge premiums will always exist for some properties, and justifiably so. But most outrageously priced homes were simply overpriced before the Great Correction.
In retail, online shopping has already put a stop to unrealistic retail pricing escalations, and the online consumer — abused for decades by never-ending price escalation — is now finding better prices and services online.
Properties priced at or below market sell the quickest, and some properties offer incredible opportunity that goes well beyond the absorption of a potential market downturn or interest rate hike.
Leonard Steinberg is President of Compass and part of The Leonard Steinberg Team. As a top producer, he has generated nearly $3 billion sales and is consistently named one of the Wall Street Journal’s top 10 agents in the U.S.
Connect with Leonard on LinkedIn and visit his Facebook page.
