One
of the earliest phenomenon that occurred during the housing bubble
was the ascension of home prices that led to housing becoming
unaffordable relative to incomes. This was especially acute in
California coastal cities and spurred outflows to Riverside and
Sacramento, which then in turn became overdeveloped epicenters of the
housing bubble and subsequent burst.
The
cascade of markets across the nation from affordable to unaffordable
was a key signal that prompted us to warn of the coming housing
downturn. It now appears that this first symptom has cropped up once
again, as almost all of California’s coastal cities are now reading
as unaffordable according to our calculations.
Home
prices along the California coast have rebounded spectacularly from
their trough, with all the major coastal cities seeing gains of at
least 21 percent, and San Jose, Orange County, Oakland, and LA seeing
gains of at least 30 percent. Despite that robust growth, prices are
still well below their all-time peaks, with L.A., Oakland, and San
Diego home prices still more than 20 percent below their highs.
Despite
the discount in prices, affordability proved temporary for the Golden
State, as the lack of income growth and rising mortgage rates has
made home prices unaffordable once again at these levels. Only San
Diego measures out as affordable and that is by a very slim margin.
The
lack of wage recovery during the economic recovery has been a
persistent feature, owing to high unemployment, and every major
California coastal metro saw median family income lower at the end of
2012 than in 2007 when it peaked.
Even
San Francisco and San Jose, the epicenters of the social media and
tech boom that has occurred, have seen incomes fall 3.3 percent and
2.1 percent, respectively, from their 2007 peak. San Diego has seen
incomes fall 7 percent, and L.A./Orange County has seen incomes fall
4.3 percent from their peak.
In
addition to a lack of wage growth, mortgage rates have risen
significantly over the last several months. Conventional 30 year
fixed mortgage rates hit a low of 3.49 percent at the end of 2012,
and have been climbing since, measuring 4.59 percent most recently in
October.
The
rise in rates by more than a full percentage point has been rapid,
and coupled with strict underwriting standards already in place, has
made buying a home increasingly difficult for many. Though mortgage
rates remain below their pre-recession level, it is not enough to
offset the lost income from the recession.
While
it is possible for unaffordability to remain in place for some time,
especially in destination markets such as San Francisco and L.A., we
believe something will have to give to normalize the market. Last
time we saw this phenomenon, it resulted in people fleeing the coast
for more affordable inland markets, prompting development that
eventually got ahead of itself. We do not expect this to reoccur
given how many people were just burned by it and the fleeting
liquidity that exists in the housing market due to the preponderance
of institutional buyers. However, the status quo is unsustainable for
a long period of time.
Currently,
our up-to-the-minute auction data shows home prices easing in the
state, and this should be reflected in home price data that comes out
over the next several months. Traditional pricing metrics have a
several-month-lag owing to the long closing and reporting times of
traditional home sales. The easing in prices should help dissuade
concerns about affordability temporarily.
The
healthiest resolution, though, would be for the economy to kick it up
a gear, reducing the slack in the labor market and generating a rise
in incomes. This would likely signal a shift into economic expansion
and perhaps mean the whole episode is finally behind us.
The
other solution would be for mortgage rates to fall, but a significant
downshift seems improbable. Interest rates are already low and the
next Fed action, whether it comes sooner or later, is going to be a
de facto tightening of policy, which should bring rates higher.
As
we mentioned, it is possible for markets to remain unaffordable for a
period of time, but it is very hard to imagine significant, sustained
home price appreciation in the California coastal markets until
incomes begin to rise—something that has proved elusive throughout
this economic cycle.
For
more information contact
Jerry
Gusman
The
Gusman Group
(888)
213-4208
jerryggroup@aol.com
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