How to Ride the Tide of California Home Prices

For decades, California has been one of the best places to invest in real estate. A lot of people want to live there. And, unlike the problem with Florida - another real estate favorite -  demand for housing isn't complicated by speculation in future retirement property. That said, strong demand in California tends to create boom-and-bust cycles driven by the fortunes of different industries.

Aircraft in Los Angeles, the navy in San Diego, finance and the Internet in San Francisco, computers and then biotechnology in Santa Clara county - all graft their rise and fall on top of a steady stream of in-migration from other states and abroad.

Homes in many California markets were high-priced well before a surge of sub-prime lending produced the great crash of 2008, so it's no surprise that prices dropped sharply at that time, but - and this is the important point - not nearly as much as in other boom markets like Arizona and Florida. The underlying appeal of living in California always produces a fast recovery.

In the past three years home prices have risen again - 25 percent in the LA area, 33 percent in San Francisco, similar amounts throughout California. And Local Market Monitor forecasts that increases of the same magnitude should be expected over the next three years.

When home prices rise like that, they eventually become unsustainable. That's the situation now in LA and San Francisco. That doesn't mean they'll fall any time soon - we do expect them to go higher for several years - but it does mean they have less room before eventually topping out. In such over-priced markets, it's difficult to buy rental property at a reasonable price - the ratio of home price to annual rent is too high. In LA that ratio is 26, in the city of San Francisco it's 44; a ratio of 20 is usually the highest you want to go.

In these markets, therefore, it's difficult to buy and rent out single-family homes; investment in rentals means apartment buildings. Or you can flip homes.

In other California markets, prices have risen briskly off the bottom but - because the crash was harder in these places - there's still plenty of room before prices get too high. These markets are of two types. Some, like Stockton and Modesto, were built out as cheaper alternatives to the near-by larger, expensive centers. Some, like Redding and Bakersfield, are currently mired in a poor local economy that may or may not recover anytime soon.

The investment strategy differs according to the kind of market you're dealing with. In the Stockton type, close to the larger centers, demand is almost certain to return - both for single-family homes and for rentals. Your main concern is that the physical structure you buy, probably put up in a hurry ten years ago, is in good shape.

In the Redding type, you'll need to spend more time assessing the economic prospects, how long before things turn around? - in California, markets don't die, they just transform - and in such markets it's best to invest at the higher end.

There are always investment opportunities. And in California there always seems to be another chance.

Bay Area Tops Nation in Home Bidding Wars

Amid rising interest rates and widespread concerns about the cost of housing, one might expect the Bay Area’s real estate market to run out of steam.

Apparently, that’s not happening.

In February, the fiercest bidding on homes took place in the Bay Area, according to a new national report from Redfin, the real estate brokerage. In San Jose, 63 percent of homes sold above list price, followed by 62 percent in San Francisco and 59.1 percent in Oakland. Among all U.S. markets, those were the three highest shares of “over asking” bidding. Next in line were two markets in the state of Washington: Seattle with 49.3 percent and Tacoma with 36.3 percent.

February’s fastest-moving markets were, in order, Seattle (with about half of all homes pending sale within 12 days of being listed); Oakland (where homes typically spent 15 days on market); Denver (18 days on market); San Jose (21 days); and San Francisco (28 days).

Still, industry observers point to an underlying problem: The housing supply is low in much of the country, and that doesn’t make for a healthy market in the long term.

Nationally, the number of homes for sale declined 12.9 percent in February on a year-over-year basis. It was the third consecutive month of double-digit drops in inventory, Redfin reported.

The number of homes for sale fell year-over-year by 12 percent in Oakland, by 5.3 percent in San Francisco, and by 2.0 percent in San Jose. (Sacramento inventory practically fell off a cliff — down 25.4 percent from a year earlier.)

With “low-tier” affordable homes in particularly short supply around the nation, first-time homebuyers are struggling to get a foot in the door. That’s because, with inventory at such low levels, competition persists: Those buyers who remain in the game keep putting upward pressure on prices.

Taking all of this under consideration, Nela Richardson, Redfin’s chief economist, painted a half-rosy picture of the current market.

“The total level of home equity reached a new peak at the close of 2016, according to recent Fed data,” Richardson said. “While great for homeowners, continuously strong price growth across the U.S. since 2012 has posed significant challenges for first-time buyers, especially given such low supply in affordable price-tiers.”

But she pointed to a silver lining: “Rising prices and increased equity may tip the scales for homeowners who have been delaying their decision to move up,” she said, “which could add much-needed starter-home inventory to the market.”

Sales of Homes Priced Under $500K Plummet from Bay Area Inventory

The real estate site Property Radar reported that home sales overall dropped 9.4 percent across the Bay Area in 2016, a decline of 6,466 receipts. In San Francisco alone the decline was 11.2 percent.

Most of the damage was to the affordable category of housing stock: Those priced $500,000 or less.

In 2015, 18,945 such homes sold. In 2016 it was only 14,276—a whopping 24.6 percent decline—just over 62,000 homes sold across the region in total.

By contrast, sales of homes that cost more than a million dollars rose, albeit only by 1.5 percent to 19,277. Numbers for all categories of homes cheaper than seven figures declined year over year.

Casting about for some non-Property Radar figures, California Resource, a title company, recorded 110 home sales in San Francisco in January of 2017.

Of these, only 10 cost half a million dollars or less, with just eight more selling between $500K and $700K.

For January of 2016 the same database records 22 San Francisco homes for $500K or less, with two more inching in above the line at $505K and $502K.

Of course, a big part of the reason fewer cheap homes are selling is that fewer homes are priced comparatively cheaply to begin with.

Property Radar estimates that, even though sales are down and growth is happening only in the highest price bracket, median prices still went up over the year.

The site says that the average price for a single-family home in the region right now is $750,000, up from $730,000 a year ago. In San Francisco it’s $1.17 million, up from $1.15 million this time in 2016.

That’s higher but still largely in line with figures like the $1.15 million that Zillow estimates (up from $1.14 million a year ago) and Trulia’s $1.13 million, up from $1.05 million a year prior.

The most recent report from the Paragon real estate group estimates San Francisco’s median much higher at just over $1.3 million (up from $1.25 in 2016), but is closer to agreement with PR about the rest of the region, estimating a $765,000 median sale price today.

Of course, only magic can predict with complete accuracy whether apparent waning demand over the past 12 months will start to push prices down. Growth did noticeably slow all last year, even as it stubbornly insisted on rising by inches and degrees.

A Real Estate Growth Market or a Bubble? How to Tell the Difference

Home prices took a nosedive during the Great Recession that started in 2008. Prices fell in all local markets, but much more in some than others. And afterwards some had a better recovery than others. Why? And, more important, could we have predicted that?

Job growth is part of the story, but not a very useful one because nobody can predict which markets will have more jobs in the future. Furthermore, how come San Francisco and Denver had the same job loss in the recession, but home prices fell 20 percent in the former and only 5 percent in the latter?

Something else is at work here and we can capture it by comparing real home prices with the "income" price -- the price that balances with local income. It is what we at Local Market Monitor call the Equilibrium Home Price.

Then we see that San Francisco was overpriced 50 percent right before the recession, Denver only 20 percent. Markets that were the most overpriced before the recession -- many in Arizona, Florida and California -- also had the largest drop in home prices.

The income price has been a very successful forecasting tool for decades -- not just in this recession. When markets are overpriced or underpriced, home prices always return to the income price.

We can use this to our advantage in 2017 because some investment strategies have a better chance for success in markets that are overpriced and underpriced.

Overpriced Markets

You might think an overpriced market -- or one that soon will be overpriced because of big price increases -- is one to stay away from. But, as long as you avoid buying at the peak, these markets can have the strongest price gains. And overpriced markets don't necessarily crash afterwards -- most of the time they just level off. In these markets you're speculating, no question about it, but you can minimize your risk by paying close attention to the dynamics of the price changes and the state of the local economy.

First, the price dynamics. An overpriced market got that way because home prices accelerated, and the peak of the boom is reached after they decelerate -- they still increase but at a slower and slower rate.

Next, the local economy. Once prices do peak, a crash is only likely if the local economy is poor. If job growth remains reasonable, prices are most likely to just level off.

Underpriced Markets

Unless the market is dying -- a small market that has lost its only large employer -- home prices will eventually recover. But is it worth your while to wait? This, again, is a speculative proposition. But the payoff can be good because recovering prices will not just return to the income price, they'll probably shoot well above it because of shortage of housing.

In short, look for underpriced markets where prices are in fact rising again, and make sure the rise in prices is linked to better job growth.