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| Los Angeles 1986 - 2016 |
Home Prices in LA County Likely to Rise Another 40% Over Next Four Years
I apologize in advance. We are going to go into the tall
weeds for this post. Evaluating the direction of any market is difficult,
whether Tesla stock, Apple bonds, coffee beans, or Bitcoins. It is easy to get
burned even if you’ve done your homework.
Housing is at least as complex as any market you might think
to invest in. Most homes are purchased for the purpose of setting up a
household for years into the future. In fact, the length of time that
homeowners remain in a home is one huge factor in reducing current market
supply, thereby driving up prices. We will speak primarily to the the
owner-occupier in this post, but the information will apply equally to
investment purchases.
Where to start? Let’s begin with history. The Los Angeles
residential real estate market is famous for wild swings. Everyone whose has
lived here for more than a couple of decades will tell stories of the house
they should have purchased (e.g. Venice in 2001.)
However, regardless of the swings, the LA market has moved
ever upward. Each correction is followed by a new top. Of course, each top is
followed by a selloff of 30% or even more.
First observation: We are not at a new top. We are just now
reaching parity with 2007 in nominal terms. When adjusted for inflation we are
still 12.4% below 2007. No one knows how far above the old top we will go, but
30% would not be unheard of. Thus, we might have more than 40% to go before
reaching the top.
How is the Spring 2017 market doing? Generally, other than
an economic crisis, there will be some evidence of topping as homes take longer
to sell, or sellers start dropping their price. As of this writing, the average
days on market in LA County is 40 days. It is common in flat markets for homes
to average 90 days or longer to sell. Continued shortages of quality properties
for sale or rent in Spring of 2017 suggest a continuation of the strong market.
Moreover, due to permitting difficulties and a lack of
places to build, it is unlikely that even bullish builders can flood the market
within the next 30 months.
Second observation: The lack of supply is going to continue, and will drive up prices and
rents for at least another 3-4 years.
What about affordability? We’ve all read the headlines that
LA residents can’t afford these rents and/or purchase prices. Read a bit further
and you’ll find out that LA is undergoing a massive demographic shift. Those
who can’t afford the prices are moving out. Those who can are moving here from
colder and less interesting places.
LA is now a World Class City like London, NYC, or San
Francisco. The tech folks are moving in to LA, because the nerds are just like
everyone else. They love sun, beaches, snow boarding, and night life. The
gentrification of DTLA is absolutely stunning in the transformation and the
pace of change. With two incomes in the six-figure range, you can afford a lot
of house. So the incomes of the folks who live here don’t need to go up. The incomes
of those moving in need to be high enough to afford the housing.
Third observation: Affordability has not been tested yet. The
stats don’t tell the entire story.
The wealth effect. We are currently undergoing by far the
largest transfer of wealth in human history. Baby boomers are inheriting from
their parents, and many are already “helping” their kids and grandkids just
like earlier generations. If grandma makes a big enough down payment, the
monthly payments are more affordable. Expect this factor to only get bigger and
bigger over the next decade.
Another huge wealth effect is the amount of equity currently
in homes. After the meltdown of 2008, the equity has shot up with many
homeowners owning their properties outright. When it is time to move, these
folks have all cash or a very large down payment. Once again, the affordability
isn’t in question based on income.
Fourth observation: If you have enough wealth, you don’t need a
lot of income to afford a home. If you have wealth and income, you can afford a
lot of home.
In addition to an influx of US citizens from Seattle, San
Francisco, Silicon Valley, and other tech hot spots, Los Angeles is a draw for
those seeking to immigrate into the US. If you pay close attention while
walking down the local mall, it doesn’t take a rocket scientist to see that the
ethnic makeup of Los Angeles is heavily made up of recent arrivals.
Some of these folks are coming for school. Others because they
have employment offers or want to establish a business here. Some are merely
attempting to offshore some of their wealth. Foreign buyers have represented a
large part of the purchases over the current boom.
Fifth observation: There is no expectation that the lure of LA will be over any time soon.
We are a land of immigrants.
A consistently accurate way to measure housing prices is to
take a look at the housing price compared to the rental income that home could
provide. This makes great sense as residential real estate investors will move
out of the market place if this ratio doesn’t make sense. Moreover, the “crowd”
seems to sense when it makes more sense to rent or more sense to buy on a
purely economic basis.
The LA market tends to fluctuate between 15 and 24 on this
formula. If the rent is $5000 a month, that would be $60,000 a year. If you multiply
that by 15, that home is worth $900,000. If you multiply by 24, the home is
worth $1,440,000. The current price to income ratio in LA is 17.1 according to
Zillow. Once again, this suggest that we are far from overpriced.
Obviously, one can make the argument that both rents and
prices are too high, and LA is experiencing a bit of a building boom in
apartments right now. However, no pundit I’ve read seems to think this boomlet
in apartments will solve the shortage.
Sixth observation: Landlords are still able to get higher rents, and that is currently keeping
the ratio quite acceptable. If rents stagnate, then it could be evidence of a
top.
Less closely tied to the value of residential property, but
still a factor, commercial, industrial, and raw land do impact overall real
estate values. If homes and apartments are hard to find right now, these three
categories are almost non-existent in LA County. This means builders have no
place to build. The one exception is retail, but because office and commercial
is so tight, retail properties that come on the market are often converted to
employee or warehouse space.
No one who knows LA has any doubt that there is little land
that hasn’t been built on. The ocean and the mountains have set the limits, and
like other similar cities, this land limitation will also drive up prices. OC’s
prices are already higher than LA, and the Inland Empire is where folks are
heading who can’t afford LA.
Seventh Observation: Alternative ways to increase supply are not viable. If supply doesn’t
increase, and demand remains steady or goes up, prices must follow.
Mortgage interest rates continue to sit close to historic
lows. Someday they are likely to go up to historic averages around 5.5% - 6%.
There is no doubt that this will put downward pressure on prices as the cost of
the mortgage will affect affordability. If this increase is slow enough, the
impact may not be substantial. A 1% increase on a $1,000,000 home with 20% down
adds about $650 per month to the cost. This would suggest that prices might
have to drop 10% to offset the interest.
Our earlier assessment was the prices will go up another
40%. If interest rates go up by 1 or 2%, this might result in prices only going
up 20% or 30%. Historically, at some point, there will be a 30% correction.
Eighth observation: Interest rates on mortgages will probably go
up, and this will affect sales prices.
Buying high seems like such a bad idea, but if you are
buying for the long term, even if you might move to another home in the future,
your initial purchase price will have little to do with your long term economic
benefit.
Huh?! I don’t blame you. It took me a while to get my arms
around this one. As long as you stay in a purchased home, you will not “realize”
a profit or loss. Say you buy a home for $500,000, and it drops in price to
$350,000, but you don’t sell. Later the home goes up to $480,000 and you sell.
You lost money, but you now take your stake (down payment), and you are
investing in the next home in the same market condition of the one you’re
selling. Somewhat depressed. So you sell at a bargain rate and also buy at a
bargain rate.
In the opposite situation, you might sell for $700,000, but
all the homes you hope to buy have also gone up 40%. You sell at a high price,
but you have to buy at a high price. The only time any of this matters is when
you sell the last time and leave the market.
Ninth observation: If you plan to own a home or a string of
homes over the next 10 – 50 years, don’t worry too much about where the market
is today.
What about the economy? We are part of the strangest economy
in the last 70 years or longer. We have very slow growth, but it has been
protracted over the past 7+ years. While this created long term problems for
many workers who were unemployed or underemployed, we seem to have now reached
some kind of stable growth, with low inflation, and employment at good numbers.
Since we have not seen wage growth even at “full” employment,
one has to suspect that many in the workforce are still substantially
underemployed in both their position and hours. If the economy continues this
anemic growth rate, those with good jobs and decent income and wealth may
continue to love the economy (see the stock market.) However, this would not be
good for those who are still underemployed or who have given up.
On the other hand, if the economy starts to grow at 3%,
there should be better jobs and hours, creating a demand push on wages. This
will help many to afford more rents and higher home prices. Either way, the
economy looks to be our friend for the next several years when it comes to
demand for housing.
Tenth observation: Crazy things happen (1999, 2008), so the economy could always spin
downward. Right now that seems to be the least likely of scenarios.
Summary: If you are thinking of buying a house, whether it
is your first or your 10th, the primary motivation for moving now is
the interest rates. Buy before they go up!! As noted in the 9th
observation, it won’t matter in the long term if you overpay. But as noted in
the first eight observations, there is little likelihood that home prices are
going down any time soon.
As noted above the market for homes is extremely tight with
very little supply of better homes in the better neighborhoods. That’s why you
should call Belle Tsai to help you find the perfect home for your needs. Belle
has been active in the West Los Angeles real estate market for almost 30 years,
and more recently has also found good options in Mid-Wilshire and along the 10
Fwy. Call her today at 310,738.7118
