navigating uncharted Waters

by: Robert Rodriguez

Q2 -Q4 Outlook 2019

 

A Narrative of Contradictions

  1. Despite slow GDP increases, The United States is in its 10th year of economic growth.

  2. Despite unemployment being at record lows, homes are more affordable than ever.

  3. Despite the fact that income can’t catch up with the rate of appreciating home prices, wages are booming.

  4. When interest rates were predicted to boom in 2015, they spiked at the end of 2018 and then came back down in the past few weeks and have remained steady.

  5. In the last week of 2019, the Dow Jones Industrial average dropped from ~25,000 in the first week of December to just over 21,000, or almost 20%. Despite this drop, it is now back over the 25,000 mark, as of yesterday.

Many believe that this is the beginning of the end of this expansion. However, the markets aren’t exactly collapsing. In fact, the fundamentals to run this economy are stronger now than the beginnings of previous downturns.

Is this another classic case of “The Boy Who Cried Wolf?” Are there economic storms on the horizon that no one can foresee? We are now sailing in uncharted waters in a market that’s recovering from a “once in a generation downturn.”

Key Themes:

  1. California Will Never Know Normal

  2. Active Yet Disciplined Investors

  3. Policy and Zoning need Innovating

  4. Wildcards: The Stock Market & Natural Disaster

Alternate Considerations:

1) A Bargain in a Global Marketplace

2) Slow Price Growth Good for Sales Side Activity

3) Low Inventory a Double Edged Sword


1. California Will Never Know Normal

Who wants to be normal?

Cheap money results in overbuilding, a highly inflated economy, emphasis on price appreciation instead of value creation, excessive inflation, and too many speculators. While California remains one of the stars in the US economy, the fundamental nature of supply and demand cannot be ignored.

Supply is much easier to track than demand. Put simply, housing supply is the number of homes available for sale. Shortage of inventory is a symptom of a problem and not the cause.

There may be no better market for homeowners to sell and trade properties. As we see interest rates start to creep up and inventory begins to rebalance, there is no better time to make a move than in 2019.

Even though there was demand, the lack of inventory in high-end markets didn’t allow for a lot of the “move-up” buyers to sell and move up, which forced them to stay put. This forced a lot of the “lower” buyers to have minimal options, creating a cascading effect of inventory shortage.

We are already aware that the higher-end of the market ($3 million and upward) is thawing. With clients feeling richer from the economic growth and the low interest rates, we anticipate more deals happening in this market. However, the impact of the higher-end thawing should not be marginalized; it will do wonders to rebalance the rest of the market, providing options and opportunities for move up/down buyers and sellers alike.

We project that in 2019, the total number of transactions across different price points will rebalance and create a healthy domino effect over time.

The biggest threat to normalization will be the psychological disconnect between sellers who price too high and buyers who offer too low.

Uncertainty (fueled by contradicting market signals) has become the “new normal” for Angelenos. This market is constantly on the move. Will there be one or more corrections in the coming year(s)? It’s very likely, but the math and circumstances should matter more. The most recent “Great Recession” is what many economists refer to as “a once in a lifetime buying opportunity." I’m sorry, you likely won’t see a crash like that again.

In the past year, we have seen a healthy trend of inventory-balancing across markets, where supply and demand are starting to find common ground. Months Supply of Inventory (MSI) is a good metric to track the health of inventory. A low MSI signals a seller’s market, while a high MSI signals a buyer’s market. A balanced market is indicated by an MSI of 6 (months). New inventory is coming, albeit slowly. It is crucial to note that in a more balanced market, there will be less overall volatility in both pricing and emotions, which will be smoother sailing for everyone: the buyers who are searching for a competitive advantage and the sellers who turn around and become buyers themselves.

What we’re watching: Synchronous Buyers & Sellers. As the market slows in the the 2M -4M range, owners of homes in the 1.2-1.8M range (which is considered entry level in most LA premier areas), are primed to sell and trade up. Contingent offer on your listing? It may make sense.


2. Active Yet Disciplined Investors

Investors are still active, yet extremely disciplined. It is important to understand the investor psyche, as they generally have a higher Real Estate IQ than the Average Joe, and they often know how to unlock value in recalibrating markets.

We see three factors that draw investors to real estate: (1) Market Sell-offs, burst bubbles, etc. that result in a price drop and allow for smart value acquisitions. (2) Low cost of capital gives investors options to raise capital, build, refinance and profit in risk-adjusted ways. (3) Prolonged Seller’s Markets excite investors, as it allows them to acquire, develop/restore properties all while knowing they still have the advantage as sellers for the disposition of their investment.

If there are immediate changes to one of these factors, investors still stick around, but they become very disciplined and hug their math. The only thing that has changed in this equation so far is the year-after-year price appreciation, which affects the overall cost of property acquisition. As long as the characteristics of a seller’s market exist (low MSI, low inventory, strong demand, continuous price appreciation) and cost of capital (general interest rate environment) stays low, investors will remain active but will stay close to their spreadsheets.

What we’re watching: The Halo Effect.

How should you prepare financially? First, you have to smile. Next, check the weather. It’s probably 72 & sunny. Smile one more time and be grateful that you live in such a fiscally insulated economy. Finance, insurance, real estate, healthcare, advertising, the entertainment industry, the largest port in the US, and a full-blown international tech hub are many reasons why we are much more likely to survive a downfall.


3. The Real Culprit: Zoning

Venice Beach is an extreme example of what has been happening in wealthy urban enclaves across the U.S. that are resisting new housing development.

Venice Beach, along with other local LA areas, are some of the hardest places to build in the US. It’s easy to understand what motivates anti-growth homeowners. Their financial interests are aligned against large developments or allowing the supply of residences to grow over time. On the flip side, if you purchased a multi-million dollar home in a quiet neighborhood and propositions to build large multi-family developments, this would alter not only the density, but the landscape of your idyllic area. So who is right?

It’s easy to understand what motivates anti-growth homeowners. Most of them moved to a given neighborhood because they liked it at the time. Of course, they changed Venice Beach when they arrived, preventing future growth in the process. This pretty much guarantees that over time, this geographically small and desirable enclave by the ocean will lose its bohemian vibe, ending up as a neighborhood for the increasingly old and very rich, like Laguna Beach, La Jolla, and Carmel-by-the-Sea.

This will play out. LA must densify, as growth is a key ingredient to continued growth and wealth creation for every micro- and macro- economy.


4. Wildcard

Natural Disaster

It’s been 25 years since the Northridge earthquake. If you have not had your home's foundation retrofitted or inspected for earthquake safety, we recommend you do so as soon as feasibly possible. If you need a foundation specialist referral, feel free to reply to this email and I’ll send a few over.

  1. Many friends, colleagues, and clients either didn’t live here or have possibly forgotten how bad the damage was in 1994. Freeways collapsed, thousands were homeless, the national guard came in and erected tents, and the housing market took more than two years to recover. This link from LAist shows what the city looked like after the shake.

    According to the LA times, 18 months after the earthquake, foreclosures were up 19% in the San Fernando Valley and the average price per square foot was down 34%. Adjusted for inflation, the quake caused over $45 billion in total damage, $30 billion in property damage, and more than $15 billion in economic damage, according to a report by Moody’s. The question isn’t if, but when this will happen again. If you’re curious about what you should do to prepare, visit readyla.com or this link.



Keep these in mind.

Historically, The Five Causes of an Economic Recession have been.

  1. High interest rates, which limits liquidity.

  2. A stock market crash - the sudden loss of confidence in investing, which can drain capital and create a bear market.

  3. Falling housing prices and sales. This is what triggered the Great Recession.

  4. Asset Bubbles or Speculation - i.e., when the price of internet companies, houses, stocks or companies become inflated beyond their sustainable value. As investors seek to pull money out and consumer confidence drops, businesses and individuals curtail expenditures in an effort to trim costs, which means GDP falls and unemployment rises.

  5. Slow down after a war, which is caused by a sharp drop in the demand for war related goods and government spending.

Economic Influencers to Also Consider

A Bargain in a Global Marketplace

There are two sides to every story. As business and residents leave in droves after cashing in their nugget of California gold, other firms and residents enter our economy, bringing cash they’ve made from selling their gold. Even though a portion of the cash influx of cash is coming from San Francisco, these are not the 49ers and they aren’t brining gold - I’m talking tech.

When Northern firms see our commercial rental rates, they smile and ask where can they sign. Others, like Netflix, just buy the building. We have a booming economy, sectors primed for more growth, the 2nd largest port in the world, an established entertainment industry with roots across the globe, and now a tech scene that proves that it's cool to say that you’re coding the newest online based service or are on Apple’s create team.

The LA real estate scene won’t be a bargain forever and the landscape is a tough one to navigate.

I started my LA real estate career in 2006, and I’ve only known a market constantly on the move. As home sales cool, we predict that GDP will grow and unemployment will remain at (or below) current levels. With the recent announcement from the Federal Reserve signaling a hold, we predict for rates to remain relatively the same or slightly higher.

Slow downs in price growth can be healthy for sales activity.

In mid October of 2018 we saw a real world case study. In other words, proof that if mortgage interest rates spike, many buyers are priced out of the market instantly. This causes home prices to self-adjust without any significant change in inventory levels. The Federal Reserve raises interest rates to protect the value of the dollar against inflation. However, this limits liquidity in the market, and money becomes more expensive to borrow and the rate of return more attractive.

Low inventory is a double edged sword.

Gone are the days of 7 or 8 buyers bidding on a home. Pricing strategy, presentation, timing and key insight on launch dates matter more now than ever before. Low inventory is a symptom of a greater problem.

What we’re watching: Job creation, wage growth, and the influx of start up capital and tech related job creation in the Los Angeles area. 56B was the total tech and startup spend in LA in 2017. 2018 numbers not available.

Our Process and Research:

In order to know where you’re going, you have to know where you’ve been. Since 2014, my methodology for these reports has not changed. In fact, 8 of the 11 sources, which I credit at the bottom, have remained unaltered and still serve as my primary sources for these outlooks. The more I read, the clearer it got — we are sailing in uncharted waters.