Contributed By: Kenneth Lee, Managing Editor of Research Technology, Meyers Research
The California housing market is currently buzzing with activity that is centered around the Bay Area, Los Angeles, and Orange County. The Southern California housing market is picking up some steam heading into the busy home buying season. The Northern California market remains hot from the new tech boom. However, there are some headwinds that still remain like tight supply, low affordability, and a sluggish local economy. Outside factors such as stricter lending standards and regulatory hurdles are also having an impact.
Whispers of another housing bubble have started to swirl as many housing markets up and down California are booming again. The median single-family home price of $413,000 for the state is currently just 9% off of their all-time highs. However, the dynamics that are driving this current cycle of outsized home price appreciation are much different than those between 2004-2006. One big difference is the lending environment. Cheap money helped fuel the previous bubble while strict lending conditions are actually leaving out many would-be home buyers today. Investors are also playing a key role in driving up prices this time around but again there is a stark difference from then and now. Investors during the previous boom period were highly leveraged while most investors today are buying homes outright with cash. We have already started to see home price appreciation level off which is a healthy sign for the market. Home prices can be expected to stabilize some more as building activity ramps up in the months ahead.
Home sales came out of the gate relatively slow to start the year due to tight supply and low levels of affordability. Overall, sales are trailing last year by about 7% through the first quarter. The entry-level buyer is all but excluded from the market here which is one of the main reasons that sales are down. However, the luxury market remains hot and foreigners are still buying up California real estate. International buyers have made the housing environment significantly more competitive in California. Wealthy foreign buyers and institutional investors have been driving up local home prices for the past few years. According to data from the National Association of Realtors, 17% of all international home sales that took place in the U.S. last year were in California which is second only behind Florida. To drill down even more, Los Angeles and Irvine were two of the top-three destinations for Chinese buyers last year. Los Angeles also topped the list for top destination for both Indian and British buyers.
Buyers were starting to get priced out of the market as strong appreciation and rising rates dragged down affordability. Because of little new home stock, existing home prices were being inflated by high levels of demand. The Case-Shiller Index for February showed that San Francisco had the second-highest annual increase in existing home prices out of 20 cities while Los Angeles had the fourth-highest. Data from Zonda shows that eight out of the 10 least affordable counties in California to buy a new home are located in Northern California while Orange County and Los Angeles County ranked third- and sixth-lowest, respectively. Tim Sullivan, Practice Leader at Meyers Research says, “California is a tale of two cities in that the coast has seen a rebound in prices very quickly but many of the inland markets have not come back the same way. The good news is that we do not see an oversupply anywhere in the state. The issue we must monitor is affordability since rising prices and potentially higher interest rates will reduce buying power.”
Some much needed supply is finally starting to come online in SoCal. Over the past year, there has been a resurgence in master-planned communities throughout the region. Baker Ranch attracted 12,000 people at its Grand Opening which is evidence of the high interest that is currently out there. Other master-planned communities such as Rancho Mission Viejo and Playa Vista are releasing new lots and seeing steady demand. Demand is being driven by improving labor market conditions.
The E/P ratio shows that there are many counties throughout California where demand is noticeably outpacing supply. The E/P ratio uses employment growth as a gauge to show where supply is in relation to demand based on job creation. Both Los Angeles County and Orange County tout above-average E/P ratios that show demand outpacing supply even though these labor markets aren’t thriving as much as their NorCal counterparts. Areas like San Mateo and Marin Counties have very healthy job markets with limited building activity thus resulting in very high E/P ratios. The new tech boom fueled by companies like Facebook in San Mateo are driving demand for new housing stock which has prompted new home project offerings like Larkspur from the New Home Company. High barriers to entry in this market keep supply low which is why their E/P ratios are consistently higher than other areas.
The labor market is steadily improving throughout the state but the difference is that unemployment is significantly higher in SoCal than NorCal. The unemployment rate for the Los Angeles MSA is at 8%, which is on par with the state average but much higher than the national average, while the unemployment rate for the San Francisco MSA is under 6%. One key similarity is that the technology sector is a growth driver behind both the NorCal and SoCal job markets. Home prices in Silicon Beach have surged over the past year due to the burgeoning tech industry in SoCal and all the new start-up’s that are originating there.
Other factors that are affecting the local housing market are regulatory changes and distressed properties. FHA loan limits were reduced, and in some cases drastically, in virtually every county in California to begin the year. The biggest drops took place in NorCal and Central Valley markets. Merced County experienced the biggest percentage drop from last year with the county’s FHA loan limit falling 42.6% from last year to $271,050 in 2014. SoCal markets of Los Angeles and Orange Counties saw their FHA loan limits decline 14.3% to $625,500 while San Diego’s dropped 21.7% to $546,250 this year. A study by the Urban Institute listed the metropolitan statistical areas of San Jose, Stockton, San Diego, Riverside-San Bernardino, and Fresno along with the metropolitan division of Santa Ana-Anaheim-Irvine as the areas that would be most affected by lower loan limits.
As far as distressed properties go, they are the lowest they have been in eight years statewide. Bargain hunters and investors have been waiting with open arms for these properties to hit the market. According to data from Zonda, foreclosure sales are outpacing foreclosures which mean that the market is absorbing all these properties and they are not sitting on the market for a long period. Overall, foreclosure activity is on the decline which also means there is less of a pool to choose from. However, the foreclosure rates in the Inland Empire, Los Angeles, and San Diego metropolitan statistical areas are still amongst the highest in the nation for large metro areas so while the distressed market is no longer a major concern, it remains far from healthy either.
Photo Credit: Zonda, A Meyers Research – Kennedy Wilson Innovation
The cheap bargains are gone and investor activity is waning so future activity will be carried on the backs of primary homebuyers. The local housing market will be more dependent on an improving labor market and rising household income since homebuyers will need to feel confident about their financial situation. The main concern here is that the entry-level buyer is all but priced out right now which will hold back activity in the move-up segment. When additional supply comes online in the coming months, home prices should stabilize which will help more buyers gain access to the market and drive sales. Sullivan says his expectations for the remainder of 2014 and into 2015 are “Steady as she goes. Expect modest price appreciation while the consumer adapts and responds to new and better product and lifestyle options.”