Housing Market Revealed 2006 – Is The Party Over For Real Estate?

Prior to 2000, the real estate market and the economy were always cyclical. For instance, the US housing prices tended to weaken as the GDP and employment prospects declined, particularly during the recessions of 1980 and 1990. The economic downturn of 2000-01 defied many predictions by having the opposite impact on real estate prices. Over the past five years, real estate prices have increased approximately 10%, outperforming equities by a wide margin.

Historically, real estate has been viewed by many as a good hedge against inflation. During the last five years however, real estate prices have exceeded the rate of inflation by a gross margin.

Given the significance and size of the U.S. real estate market, our analysis will focus on U.S. real estate, which is currently quite representative of markets around the world.

U.S. Real Estate

In 2005, America’s real estate boom was strong, with prices up by 13%. But there were signs that the market was weakening. Sales of existing homes fell this January to the lowest in nearly two years. Meanwhile, the number of unsold homes rose to the highest level since 1998. In addition, new homes continue to be built at the fastest pace since 1973. In other words, while the supply of housing is at the highest level, demand for homes has fallen dramatically, rendering a downward price adjustment inevitable.

Due to the low interest rate environment, affordability ratios are still within historical ranges, although they’re approaching a 14-year low. On the other hand, other ratios that disregard the interest rate level (e.g., home price to rent, home price to disposable income) appear to have escalated.

The Supply / Demand Imbalance

In general, we see no evidence that the supply factors are positively affecting the prices. For example, the rate of population growth has not increased significantly and the supply of land available for housing remains largely unchanged. In fact, research by Goldman Sachs reveals that U.S. residential investing is at the highest level in 40 years, yet new household formation is growing at its slowest rate.

Based on the experience of the last few years, we may see a fundamental shift in sentiment, favoring home ownership. Up to now, most of the baby boomers nearing retirement have decided against downsizing their homes and opted for the financial security of their current houses instead.

Other Asset Classes

Financial exposure to real estate is generally a good thing as long as it is a reasonable proportion of one’s assets, and the investment environment is favorable (e.g., not in the midst of a bubble or heading into a decline). In a diversified portfolio, real estate investments can be a very good diversifier due to relatively low correlations with other asset classes.

Contrary to popular belief, holding a diversified portfolio of various asset classes (with a large equity exposure) has been a much better investment than buying a house during the last 30 years. For instance, a dollar invested in real estate in 1975 would grow to $6.07 while it would turn into $36.14 if invested in the S&P 500. However, in calculating the exact returns one must factor in taxation and deductibility of interest rates.

The Failure of Risk Management

As rising house prices lift the market value of collateral on banks’ existing loans, banks are willing to lend more, pushing prices higher. In effect, banks have an incentive to lend when property prices are rising, and to pull out when prices fall, leading to extended boom and bust cycles.

For the past few years a number of researchers have pointed to the non-sustainability of the housing market, comparing it to the high-tech bubble of 2000. Barring any fundamental change, the primary question remains why real estate prices have defied this historical market relationship for so long, and whether will they will ever reach the tipping point.

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Where Housing Conditions in Southern California Stand in 2016

What kind of urban future can the residents of South California hope for the coming year? Here’s what’s in the upping according to market trends and planning designs. There are going to be higher prices and increased congestion with an accompanying degrading quality of life. As acerbic author of “Dr. Housing Bubble” blog puts it: You may as well look forward to becoming ‘los sardines’ in a future of relentless cramming and out-of-sight prices.

Both factors are at fault here: The relentless demand for housing and the willingness of the hugely rich to continue forking out money to paying for building that would take less wealthy three lifetimes to accumulate. Single family homes today cost a nice plot in heaven. A plot in San Francisco – a shack really – would cost as much as a mansion outside Houston, or even a nice home in Irvine or Villa Park. Choice family homes in Irvine, Manhattan Beach and Santa Monica are almost as bad. Of course there are locations in California’s poor cities and farmlands, where prices are static and you have more breathing space. But do you want to live there…

Even in these poorer neighborhoods, the state has approached the problem of housing affordability by subsidizing the construction of affordable housing through bond funds, tax credits, and other resources. But these programs have historically accounted for only a small share of all new housing built each year so they, too, cannot meet the housing needs of a majority of South California’s working and lower middle class population.

Market forces – overseas investment, a strong buyer preference for single-family homes and a limited number of well-performing school districts – are the second factor that results in this cramming and high pricing specter. And then there’s California’s planning regime which rejects areas that are not “Green’ enough (at least not ‘Green’ enough to them) and they hop for ever-denser development at the expense of single-family housing in the state’s interior.

Many areas of high-density cities like Los Angeles are seeing construction of massive skyscrapers – rather tower-like monstrosities – in a few selected “transit-oriented” zones. Planners say they aim to stop short of super-density. The wealthy will still have their backyard play sets, barbecues and swimming pools. Which brings us to another point:

The gap between wealthy and poor (or less disadvantaged) in South California has never been larger

The poor live in one area. The lifestyle of the wealthy and housing prices maintain the distance. The Legislative Analyst’s office (LAO) which is the California Legislature’s advisory agency, had this to say:

Housing in California has long been more expensive than most of the rest of the country. Beginning in about 1970, however, the gap between California’s home prices and those in the rest country started to widen. Between 1970 and 1980, California home prices went from 30 percent above U.S. levels to more than 80 percent higher. This trend has continued. Today, an average California home costs $440,000, about two-and-a-half times the average national home price ($180,000). Also, California’s average monthly rent is about $1,240, 50 percent higher than the rest of the country ($840 per month).

Property prices over the past two years in prime areas in South California such as Orange and Los Angeles counties have risen at a rate more than 10 times the relatively paltry increases in weekly paychecks. Now you can’t buy a house in Orange County or West L.A. without a triple digit income and in LA central forget it. Surrounding areas are not much better.

The biggest losers are working or middle class families (who happen to be mostly minorities) who want to bring up families in nice areas with loads of grass and field. Unfortunately, most of them are forced to relinquish such dreams. Aside from South Los Angeles having become a high-density population, it will take them lifetimes to accumulate enough money to buy a “sardine can” in this city.

Until now, the younger middle-income homeowners, particularly families, lived on the outskirts. In 2015, reports showed that homeownership rates are more than 25 percent higher in the Riverside-San Bernardino area than in the Los Angeles-Orange County area. Minorities in these areas also do much better. The homeownership rate inland is a quarter higher among African American and Asian households. The rate for Hispanics is nearly half again higher than in Los Angeles-Orange.

But now housing prices have soared – are soaring -and these areas are becoming unaffordable too. Three of the most crowded areas – based on people per room – are in Los Angeles County: South Los Angeles, the Pico Union area near downtown L.A. and Huntington Park. Southern California trails only Miami, Fla., for the highest percentage of residents who spend 40 percent or more of their incomes on rent or a mortgage.

In short, Southern California has become notorious as one of the highest priced, density crammed spots of the nation. Living there now costs two and half times the national average, and rents are 50 percent higher in these areas than in the country as a whole. Homeownership rates now stand at 48th among the states.

Where do we go from here?

Some inventive and aspiring people who want to fix or buy a home have found a way out by approaching lenders in the alternative commercial or residential sector. Shunned by banks because of poor credit history or trustworthiness, but still wanting to live in LA, these middle class individuals have approached alternative sources for their loans.

These commercial or residential private lenders (otherwise called hard money or bridge investors) offer the advantage of evaluating the borrower’s property rather than his credit history which means that if the borrower has a particularly promising house that he or she wants to hook, the lender may extend proceeds for the borrower to make the sale. The process is fast and convenient. Many find that it takes less than a week. There is some credit evaluation but hugely less than the banks conduct and the entire underwriting process is preformed in as timely and convenient as possible. That is one of the advantage of approaching hard money or private lenders; the system is personal. The lender meets the borrower’s needs.

The high rate of balloon and interest do dissuade many potential borrowers, but south California is glutted with money lenders which make it possible to ferret out negotiable prices.

Put it this way: If you are one of millions of people who want to find a home in the “sardine city” and maybe escape cramming – there’s one other option for you. Private commercial or residential money lenders otherwise known as hard money or bridge investors.

How about it?

Recession, Inflation & Housing – Home Prices Fluctuate, Real Estate Market Responds to the Economy

Amazingly, financial reporters still are reluctant to say the American economy is in recession (which it most obviously is). Hence when inflation fully shows its ugly face, expect housing prices to catch up with oil which already accounts for the dying dollar (a currency no longer carrying much weight with OPEC as a basket of currencies is being embraced and the Euro and yen are taking preeminence).

Undoubtedly inflation and the recession caused by it shall weigh heavily on the Fed and we the American people. Since it seems financial reporters are usually about a year or two behind the actual occurrences in the market (that is reporting them honestly to the general public), always choosing to use colorful and positive language, it may be another year or two until we see the true signs of inflation in the real estate market. A big spending, pro-inflation government however will always prove inflationary when it comes to U.S. currency (since this sneakily reduces their repayments).

The U.S. economic forecast remains bleak to say the least. Latest reports released show that consumer-level inflation remains steady, while the housing slump shows no signs of improvement.

The U.S. consumer price index (CPI) rose 0.3% in March while the core rate, which excludes food and energy prices, was up 0.2%, following flat readings in February.

Energy prices are rising at a 17.0% year-over-year pace. Gasoline prices rose 5.2% and are up 26.0% from a year earlier.

Recent inflation reports underscore and highlight the the Federal Reserve’s ongoing challenges. “Ongoing hefty gains in headline prices will continue to needle (policymakers) despite the Fed’s near-term focus on economic risk, as the Fed faces an inflation problem that may have greater shelf life than the problems in the financial industry,” says Action Economics.

U.S. housing starts plunged 11.9% to a 0.947 million annualized rate in March, though after an upwardly revised 1.075 million pace in February (1.065 million before). Markets expected a more modest fall to 1.003 million. Starts are down 36.5% over last year. Permits fell 5.8% to a 0.927 million pace, and are down 40.9% over last year.

Contracts for housing will remain dismal as the recession deepens and the media hype dies down to the tune of reality.