Eric Geleynse
Tel:415.717.3355
eric@ggvalues.com
Lic.# 01413008
When it comes to the California real estate market, one thing most people would like to know is: Where are we now and where are we going? This article examines several key factors affecting the price trend in order to provide context to the current market and attempt an answer to this question. The basic conclusion is that we have seen the bottom in terms of price and the key factors affecting the forward price trend (it’s always supply & demand), suggest upward, not downward pressure on prices at this moment.
First, we have just been through the largest price spike and subsequent crash in over 30 years and probably much longer. The peak of the market was in May 2007 when the MSP (median selling price) of an SFR (single family residence) in California was $595k. That fell to $245k in February 2009 and has since recovered to $306k in April 2010.
The Previous Price Recession (1991 – 1997)
The point of inflection from the last real estate price-recession was in February 1997. At that time, the MSP for an SFR was $168k. Since then we have had a 10-year rise that took us up 254% and then down 59% over two years. Most recently, prices appear to have “bounced” off the bottom and are up 25% from the nadir. And yes, I did say “the bottom” which in my opinion, we have now seen. I base this on several key metrics that I believe are fundamental to real estate price trends:
- The Unsold Inventory Index (aka “Supply”)
- The Affordability Index (a key factor in “Demand”)
- Interest Rates (another key factor in overall affordability and therefore “Demand”)
Let’s look at these and track them through the last price recession and the recent 10-year price surge and subsequent crash. But first, here’s what the last real estate recession looked like. Prices rose modestly in the early and mid 80’s and then surged in the late 80’s. They formed a peak in ’89, dipped modestly and then re-peaked in 1991. After that we experienced a relatively long but mild price recession that lasted until 1997.
Unsold Inventory Index (UII)
This statistic is really a measurement of supply in the context of demand. Specifically, it measures the amount of time it would take to sell all of the homes currently on the market, based on the seasonally adjusted run-rate of sales over the past several months and years. The following two charts show us the unsold inventory index (UII) over the past price recession and then show us what happened through the surge and crash that occurred most recently.
While there is high monthly variance, we see market inventory was consistently greater than eight months during the period of declining and flat prices that occurred from May 1991 through February 1997. Prices inflected and began their 10-year rise starting in March 1997. In April 1997, the UII dropped below eight months and stayed there consistently for the next ten years! In fact, it was less than four months for virtually all of 1999 through 2005. Take a look:
Again, we see the inverse relationship between supply and prices. When inventory goes up, prices come down.
Clearly the inventory of homes for sale began to increase in 2006 and surged in 2007 in advance of the price declines. In the mild price recession of the 1990’s, we saw inventory levels consistently greater than eight months for many years. In this past cycle, prices did not begin to fall until inventory levels crossed this same 8-month threshold. Currently we see unsold inventory well below that point. In fact, the market low price-point was February 2009, when the UII had dropped back to 6.5 months from a peak of more than 16 months in 2008. The most recently reported number for April 2010 is 5.1 months, which does not suggest that inventory (supply) is putting downward pressure on prices.
First Time Buyer Housing Affordability Index (FTB-HAI)
While the UII is a measure of supply in relation to current demand, the Housing Affordability Index (HAI) attempts to measure demand. In fact, it is a proxy for demand since what it really measures is the size of the potential buyer pool for homes, not strictly speaking, the actual level of market demand. Nevertheless, this is an important window into market dynamics on the buy-side. Here is how the California Association of Realtors (C.A.R.) defines this index:
C.A.R.’s First-time Buyer Housing Affordability Index(FTB-HAI) measures the percentage of households that can afford to purchase an entry-level home in California. C.A.R. also reports first-time buyer indexes for regions and select counties within the state. The Index is the most fundamental measure of housing well-being for first-time buyers in the state.
The minimum household income needed to purchase an entry-level home at $246,270 in California in the first quarter of 2010 was $41,540, based on an adjustable effective interest rate of 4.33 percent and assuming a 10 percent down payment. First-time buyers typically purchase a home equal to 85 percent of the prevailing median price. The monthly payment including taxes and insurance was $1,380 for the fourth quarter of 2010. At $41,540, the minimum qualifying income was $3,910 greater than a year earlier when households needed $37,630 to qualify for a loan on an entry-level home.
Let’s track this index through the price recession of the 90’s, the 10-year price surge in the ’97-2007 period, followed by the crash, and then look at it today. Please note that C.A.R. changed the way they report this index starting in 2006. Instead of tracking it monthly, they switched to calendar quarters. The data in the second HAI chart reflects this.
The data is fairly intuitive. As prices decreased in the early 90’s, the percentage of households that could afford a home increased. Then, as prices increased starting in 1997, the percentage of people who could afford them declined.
Affordability is in decline during the period when prices are increasing and rebounds when prices drop.
In some respects, this last chart documents an incredible fact that most people now know anecdotally. If we consider affordability in 2006 and early 2007, we see that nearly 90% of the market could not afford to buy or own an entry level home. But we also know that this did not stop them from buying! Obviously something had to give and it did… prices dropped by nearly 60% and affordability has since recovered.
The most recent measure published for Q1-2010 shows an affordability index of 66%. This is higher than it has been for most of the last 22 years for which C.A.R. has records. It means the size of the potential buyer pool is near an all-time high, which in turn suggests price support at these levels and some upward price pressure.
Interest Rates
While interest rates are an inherent component of the HAI, let’s quickly review where we have been and where we are now. For almost the entire decade of the 90’s, the national average interest rate was over 7% for a 30-year fixed rate loan. In 2000, rates began to decline after the tech bubble burst and dropped from the 8% range to the 6% range by early 2003. Since then they have channeled, for the most part, between 5.5% – 6.5%. Currently (early June 2010), the national average “spot rate” for a 30-year fixed loan is roughly 5%.
When compared with the interest environment of the 90’s era price-recession and the most recent price surge of the last decade, interest rates are more favorable and, if anything, are providing price support and/or price stimulation.
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