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buyer side demand decides

2018 LA Housing Outlook

2018 Will Test the Fundamentals, Strength & Depth of the LA Home Buyer Pool

Key Themes:

  1. Low Inventory - The Familiar Story

  2. The Only Ratio That Matters: Wage Growth vs. Income Growth

  3. Rising Mortgage Rates

  4. Wildcard: Historic Correlation of Rising Interest Rate Cycles & Recession

Summary:

2018 will in many ways be an economic case study that will determine how strong the fundamentals of our market are and how robust buyer demand will remain. The run up in home prices will be tested as interest rates are slated to rise.

Built into our local LA and California state housing markets during the growth years of 2012 until now or the end of 2017 were strong fundamentals. For example, everyone who purchased a home in those years could afford their mortgage and had at least 5-10% down and in many cases more. Buyers with large amounts of personal savings, low interest rates and affordable mortgages are the least likely to walk away from their homes. However, Low inventory is now a threat to prices, which may keep some or many buyers on the side lines with fears of over paying for a home or with little to no available options continue to keep renting.

Rising interest rates and home prices will continue to further add downward pressure on buyer demand.

The fed has cautioned may times that they will raise the Fed Funds rate and Overnight rate, which are two rates that determine the interest rate at which banks lend to each other. It’s important to note that the rates the Federal Reserve controls do not tie directly to the US mortgage rate . This will have further test buyer side market demand.

Some say the new tax cuts will be equalized by SALT deductions & others believe the cuts will fuel more growth. The trifecta of increases in mortgage rates, lower inventory, and higher home prices will most certainly test the resilience of the Los Angeles buyer poole.


At some point, a supply problem becomes a demand problem” — Joel Singer.  Low inventory remains one of the biggest threats to our local economy.  Currently, there is about a 3 month supply of homes across the state.  Inventory peaked in 2008 with a 16 month supply.

As we start the new year, we continue to see, in most markets, inventory levels of 6 months or less. What does this mean? If no new listings hit the market, the current inventory would be exhausted in less than 6 months. Most areas are averaging about a 2-3 month supply of active listings.

The SoCal market remains ultra-competitive.  60% of properties receive multiple offers, average 14 days on the market, and 28.5% sell above asking price.  In 2005, the average home received 5 offers.  See infographics at the link below.

  1. Los Angeles County remains the most under built county in California when comparing the number of new jobs vs. new building permits.

  2. Only about 28% of Californians can afford to purchase a home.

  3. Cash buyers make up 22% of all California sales.

  4. California remains an extremely tight labor market with unemployment at historic lows.  Is it time to ask for a raise?  Possibly.  Job growth is slowing likely due to the lack of available workforce and skilled labor.

  5. During the recession, 1.3 million jobs were lost in CA.  Since January 2010 until approximately now, 2.4 million jobs have been added to the state economy, which is a net increase of about 1.1M jobs.

2018 will be a stress test to the strong fundamentals that have been built into our market during the growth years of 2012 until today. Low inventory is now a threat to demand either because it’s causing price to appreciate too rapidly or because the low inventory mix is causing more and more buyers to stay put on the sidelines to see what happens.

Low Inventory Remains A Familiar Story


Wage growth vs. home price appreciation. In a balanced market, incomes should theoretically grow at the same relative percentage as home prices. Locally, median and average home prices have increased 8X fast than median and average income. Currently, at the the national level, home prices are increasing 2X faster than income. This is not sustainable. Low housing supply remains the biggest

The Only Ratio That Matters

  1. Los Angeles County remains the most under built county in California when comparing the number of jobs vs. new building permits.

  2. Only about 28% of Californians can afford to purchase a home.

  3. Cash buyers make up 22% of all California sales.

  4. California remains an extremely tight labor market with unemployment at historic lows.  Is it time to ask for a raise?  Possibly.  Job growth is slowing likely due to the lack of available workforce and skilled labor.

  5. During the recession, 1.3 million jobs were lost in CA.  Since January 2010 until approximately now, 2.4 million jobs have been added to the state economy.

  6. The median price in LA county spiked in September 2007 at $625,812.  Currently, it is floating around $565,000 or 8% below its previous peak.

  7. From 2016 to 2017, the average amount of available homes between 1M- 3M fell about 10%.  However, the number of available homes above 3M increased 1.3%.

  8. The cap of the state and property tax deduction in the new tax reform bill increases the cost of owning a home, which could lead to fewer sales transactions as the tax incentives of being homeowner diminish.  This may lead to further tightening of the housing supply in California.  However, this may be offset by the reduction in Federal income taxes and increase in standard deductions.  Consult your tax advisor.

  9. Sellers are not moving as often.  The average seller lives in their home for 11 years, which is down from 5 years in 2005.

  10. 76% of investors purchasing real estate in California are choosing to rent out their investments while 24% are fixing and flipping.  

  11. Turnover rates remain at historic lows both in the US and California.  In 2006 the turnover rate was 7%.  It is currently about 4.6%.  Homeowners are choosing to stay put due to fewer incentives or capital gains, higher interest rates, low property taxes and the “where do I go?” problem.

  12. Sales volume increased by 3% from 2016 to 2017.

  13. The median sales price in LA was up by 10% in 2017 when compared to 2016.

  14. The Dow Jones Industrial Average superseded 25,000 for the first time in history.

  15. Somewhere between 400k – 700k of potential housing units, which used to owner-occupied have now been converted to rentals as owners are choosing to rent instead to sell.

  16. International buyers are now 3% of the market vs the peak of 8% in 2013.

  17. Net cash gain to sellers is averaging about $200k per sale, which is comparable to the previous 2005 peak.

  18. The rate of Californians moving out of the state is the highest since 2007, which is about 28% of the market.

Rising Interest Rates:

While many began ringing the bell and warning others that rising interest rates would be a threat to the markets, home mortgage rates have continued to remain at historic lows. However, the Federal Reserve has been clear vocally about their intent to raise the Federal Funds Rate and the Discount Rate, which mostly affects banks but trickles down to the rest of the economy. We expect to see FED to continue this trend and raise both the Federal Funds Rate and Discount rate to curb off inflation as the economy continues to grow.

Dec 16, 2015 — 0.25–0.50 | Dec 14, 2016 — 0.50–0.75 | Mar 15, 2017 — 0.75–1.00 | Jun 14, 2017 — 1.00–1.25 | Dec 13, 2017 — 1.25–1.50

This will continue to affect homebuyers and home sellers locally as low inventory increases prices and decreases affordability, and higher mortgage rates makes it more expensive to borrow. If the average 30 year mortgage rate rises to over 5% in LA, what will this do to the local housing market? It depends, on how fast the rise happens or how gradual the changes occur. Likely, an interest rate increase of over 1.5-2% will see either flattening or a dip in home prices.

Wildcard: Rising Interest Rate Cycle & Recession

Periods of low interest rates help to create credit and asset booms in the following ways:

  • By encouraging more borrowing by consumers, businesses, and governments

  • By discouraging the holding of cash versus spending and speculating in riskier assets & endeavors

  • Investors can borrow cheaply to speculate in assets (ex: cheap mortgages for property speculation and low margin costs for trading stocks)

  • By making it cheaper to borrow to conduct share buybacks, dividend increases, and mergers & acquisitions

  • By encouraging higher rates of inflation, which helps to support assets like stocks and real estate

Many believe that when central banks set interest rates and hold them at low levels in order to create an economic boom after a recession (as our Federal Reserve does), they interfere with the organic functioning of the economy and financial markets, which has serious consequences including the creation of distortions and imbalances. By holding interest rates at artificially low levels, the Fed creates false signals that encourage the undertaking of businesses and other endeavors that would not be profitable or viable in a normal interest rate environment.

The businesses or other investments that are made due to artificial credit conditions are known as "malinvestments" and typically fail once interest rates rise to normal levels again. Some examples of malinvestments are dot-com companies in the late-1990s tech bubble, failed housing developments during the mid-2000s U.S. housing bubble, and unfinished skyscrapers in Dubai and other emerging markets after the global financial crisis.

Though it can be difficult to tell precisely which investments or businesses are malinvestments in a central bank-distorted economy, a quote by Warren Buffett is extremely applicable: "only when the tide goes out do you learn who's been swimming naked." For the purpose of this discussion, "the tide going out" refers to rising interest rates. The mass failure of malinvestments in an economy as interest rates rise typically results in recessions or banking/financial crises.

How will the housing supply shortage be solved or addressed?

  1. Due to affordability constraints and price appreciation in premier areas, look for spillover/gentrifying areas to be the next “hot” neighborhoods.  This is already happening in areas, no longer a secret, like Highland Park, Eagle Rock, West Adams, Baldwin Hills, etc.  Once a city, zip code, or neighborhood begins to exceed affordability, the halo effect will begin to take place.  To read about the Real Estate Halo effect and how to identify it, click here. 

  2. Higher density and key investments in public transportation.  LA must build up and average more units per lot.  If you look around to you see any expansive pieces of empty/vacant land? No.  At the state and local LA level, this is already being addressed by allowing owners to build granny flats and investment in public transportation like the LA Metro Rail.  Homeowners are now allowed to build a secondary accessory dwelling unit, even if their lot is zoned R1.  To read more about ADU’s and city requirements click this link.

  3. On the private level, we are already seeing key investments in the market by developers and even NY Brokerage firms, familiar with high rise buildings and or small lot subdivision and development, expanding operations in LA.  
        

What does this mean to you? 

Well, the answer depends on a myriad of possibilities, but mostly on what you’re short and long-term goals are, how constrained your budget is, the specific micro-market you want to purchase or sell in, and what your ideal living location looks like.  If you’re thinking about trading up or down, there is no better market to list in and dictate your preferred terms.