Familiarity with these ten factors will enable you to address questions your clients may ask about the real estate market, especially about real estate values and where they may be headed.
By David Girling
GIRLING REAL ESTATE INVESTMENT GROUP
Rising home prices and rents, reduced housing affordability, and limited inventories dominate the headlines. Home prices, rents, affordability, and home ownership are all interrelated, and each will be examined separately. Inventories are still constrained, and although not on the current Dave’s Top 100 list, the Dow Jones Industrial Average is again at all-time highs, in large part because of the still-low yields in the bond markets.
As with previous editions of Dave’s Top 10, these ten factors convey different messages about real estate. Some are positive for the housing market, others are negative, and still others fall somewhere in between. As REALTORS®, we need to read past the headlines and make sense of the facts for our clients. The goal of Dave’s Top 10 is to give you some tools to address questions that may arise because of economic and other factors mentioned in the news.
- Tax Reform
The effect of Trump policies on the housing market has been minimal thus far, but housing tax benefits are under close review at both federal and state levels. Suggested changes include doubling, as part of the Trump plan, the standard deduction and eliminating state and local tax deductions. “The mortgage interest deduction and the state and local tax deduction make homeownership more affordable,” commented Bill Brown, president of the National Association of REALTORS® (NAR). “By doubling the standard deduction and repealing the state and local tax deduction, the plan would effectively nullify the current tax benefits of owning a home for the vast majority of tax filers.”
Other initiatives include State Assembly Bill 71 (Chiu), which would disallow the mortgage interest deduction for second homes and create split tax rolls (residential versus commercial).
Takeaway: Some lawmakers view housing tax benefits as subsidizing the wealthy. Tax changes are coming, and the impact of these changes on home values and on the potential home buyer’s decision-making process could be significant.
- Interest Rates
For the past three or four years, the Federal Reserve has employed a monetary policy that has kept interest rates low (see Figure 1). Rates have climbed since the election but are still near historical lows. The expectation was that Trump policies would lead to higher rates, but that has failed to materialize because so little has been accomplished in Washington. Although the Fed has embarked on a tapering program, many economists do not expect a “shock” so long as incomes are not outpaced by any increase in rates.
Figure 1. For the past three or four years, the Federal Reserve’s monetary policy has kept mortgage interest rates at historical lows; however, rates have increased slightly since the 2016 presidential election.
Takeaway: One of the effects of increasing mortgage interest rates is a loss of purchasing power. The rule of thumb is that a one percent change in rates equals a 10 percent loss or gain in purchasing power. As REALTORS®, we should be able to convey to our clients exactly how an increase in rates may impact them financially.
- Housing Inventories
Continued low housing inventories have added support to home values. According to Attom Data Solutions, homeowners are staying put longer, an average of 9.2 years in California and 10.3 years in Orange County. Historically, the average has been 6 to 7 years. I believe that inventory levels will not improve significantly and that turnover will remain low for several reasons. Some homeowners were affected by the 2007 crisis and may still have negative equity. Other homeowners are reluctant to give up low mortgage rates, do not want to pay higher property taxes, or fear they will not find an adequate replacement home if they sell the one they currently own. Also, homebuilders are underperforming, which means that the home supply is inadequate. And many single-family homes that might be listing candidates were purchased by investors during the past few years and have become part of the rental pool.
Takeaway: Low supplies and high demand will continue to support home prices for the foreseeable future. This is a basic economic principle.
- Housing Affordability
According to the California Association of REALTORS® (C.A.R. ) Housing Affordability Index (HAI), the percentage of California home buyers who could afford to purchase a median-priced, existing, single-family home as of the second quarter of 2017 was 29 percent. The number was even lower for Orange County at 21 percent. Assuming a conventional, 30-year fixed-rate mortgage with a 20 percent down payment, typical home buyers would need to earn $110,000 and $158,000 per year to afford a median-priced home in California and Orange County, respectively. The corresponding housing payments (including principal, interest, and taxes) would be $2,770 and $3,950 per month.
The HAI peaked at 56 percent at the beginning of 2012 and has dropped since home prices started to appreciate, with the median price in California more than doubling since February 2009 (see Figure 2). The median price for a home in Orange County has risen more than 80 percent in that same period.
Takeaway: Affordability is a big concern for most economists, and the situation does not appear to be improving. Ironically, higher interest rates made affordability levels even lower before the mortgage “meltdown”; however, affordability was not an issue then because of the ease of obtaining credit. Recall, for example, low teaser rates, no money down, and negative amortization loans.
Figure 2. According to the CAR’s Housing Affordability Index, affordability for California and Orange County peaked at the beginning of 2012 and has dropped since homes started to appreciate.
Another driver of affordability is rents. They have increased in parallel with housing prices, growing 4.8 percent year over year in Los Angeles according to Apartment List. Rents in Los Angeles are also rising faster than they are in other cities. The yearly increase is higher than the statewide average increase of 4.2 percent. Nationwide, rents are up just 2.9 percent in the same period.
Takeaway: Renters are future homeowners. Do not overlook them.
- U.S. and California Homeownership Rates
Across the United States, the homeownership rate stands at 63.6 percent, having peaked at 69.2 percent in 2004 and reached its lowest level of 62.9 percent in the second quarter of 2016 (see Figure 3). According to Lawrence Yun, NAR’s chief economist, “There are fewer homeowners today compared to a decade ago, while renter households have risen by 8 million.”
Takeaway: California ranks 49th in homeownership according to C.A.R. As a result, state lawmakers are under pressure to find ways to enable homeownership.
Figure 3. Across the United States, the homeownership rate peaked at 69.2 percent in 2004 and currently stands at 63.6 percent.
As older generations downsize and sell, millennials (defined as having been born in the early 1980s and the late 1990s through the early 2000s) will fill the void. However, because of the high cost of housing, accumulated student debt, low wage growth, and lifestyle changes (delayed marriage and childbearing), they have yet to purchase homes to the extent that their age segment has done historically.
Takeaway: Do not overlook members of this important population segment. Putting time into understanding and educating them about the benefits of homeownership will pay dividends for you in the future.
- Foreign Investment
Foreign investment and low interest rates were two of the main reasons that the real estate market recovered. Despite a strong U.S. dollar, which causes U.S. real estate to be viewed as more expensive, foreigners continued to purchase U.S. homes.
Lawrence Yun says, “While the strengthening of the U.S. dollar in relation to other currencies and steadfast home price growth made buying a home more expensive in many areas, foreigners increasingly acted on their beliefs that the U.S. is a safe and secure place to live, work, and invest.” This observation is borne out in NAR’s recently released 2017 Profile of International Activity in US Residential Real Estate for April 2016 to March 2017.
Foreign buyers purchased $153 billion of residential real estate, up from $102.6 billion, and a 50 percent increase. This volume represents 10 percent of the dollar volume of existing home sales, up 8 percent from the previous period. The top five countries (51 percent of total) to invest in U.S. residential real estate were China (20.7 percent), Canada (12.4 percent), the United Kingdom (6.2 percent), Mexico (6.1 percent), and India (5.1 percent); and the average price for a home purchased by a foreign buyer was $536,9000 versus $277,700 for the average U.S. home. Florida, California, Texas, Arizona, and New Jersey accounted for 54 percent of the total volume by foreign buyers, and 44 percent of these buyers paid all-cash.
Takeaway: Foreign investors continue to impact the U.S. real estate market, and REALTORS® need to stay focused on this segment of buyers.
- Home Prices and Home Sales
Price appreciation for median-priced homes in California and Orange County, as measured by the year-over-year change for each month, has leveled off in a range of 3 to 6 percent since 2014 (see Figure 4). This trend continues with the latest results of the major home price indices, including the S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index, which showed prices increasing 5.5 percent annually in April.
Figure 4. Price appreciation for a median-priced home in California and Orange County has leveled off in a range of 3 to 6 percent since 2014.
Graphs such as the one shown in Figure 5 and indices like the Orange County Home Price Index (OCHPI) can help REALTORS® understand the relationship between current housing prices and peak levels in their focus areas. The OCHPI, which was first introduced in the July/August 2016 issue of OC REALTOR® (see pages 50–53), includes median prices for standard home sales in Orange County since January 1, 2006, in the following ten Orange County cities: Anaheim, Costa Mesa, Fullerton, Huntington Beach, Irvine, Mission Viejo, Newport Beach, Orange, Santa Ana, and Tustin.
The OCHPI enables REALTORS® to compare housing values in a specific area. In the second quarter of 2017, this index resulted in a value of $750,000 for a standard home in Orange County. For purposes of the OCHPI, a standard home is defined as a single-family detached home that measures between 1,800 and 2,200 square feet and has three bedrooms and two baths. For more information about this index and the associated methodologies, visit http://www.girlingreig.com/blog/category/sc-research-group/.
Figure 5. In June, the California and Orange County median home prices were $555,100 and $795,000, respectively, up 6.9 percent and 5.4 percent from the previous year according to CAR.
Takeaway: As prices continue to rise, affordability will be negatively impacted, especially if home price appreciation outstrips wage growth. In addition, values in some areas of California are approaching, or have surpassed, peak levels. REALTORS® need to understand the relationship of current prices to peak levels in their focus areas.
- Delinquency Rates
According to CoreLogic’s latest Loan Performance Insights Report, 4.5 percent of U.S. mortgages were in some stage of delinquency in May 2017, representing a 0.8 percentage-point decline from 5.3 percent in May 2016. Delinquency rates continue to decline; however, they are still higher than they were before the “mortgage meltdown.” An alternative measure of delinquency rates is the Delinquency Rate on Single-Family Residential Mortgages, Booked in Domestic Offices of All Commercial Banks (see Figure 6).
Takeaway: Delinquency rates are worth watching to see if the present downward trend continues.
Figure 6. The delinquency rate for the first quarter of 2017 was 3.90 percent compared with the peak rate of 11.36 percent, reported for the fourth quarter of 2009.
And the Number One economic factor REALTORS® should be following today is—
- Disruptive Technologies
With the advent of Zillow, Trulia, social media, and many other technologies, the real estate industry has been turned upside down in the past few years. These disruptive technologies have forced REALTORS® to reexamine how we do business and, in many instances, to make drastic changes in the way we interact with clients. The latest development is the initial public offering filing by Redfin with its billion-dollar valuation. All brokerages are watching closely because it could have significant implications for our industry.
Compass Real Estate Group, a luxury real estate brokerage startup with 1,200 agents, is also leveraging technology and recently opened an office in Newport Beach. This company is watching the Redfin IPO closely in anticipation of its own filing. Both Redfin and Compass are examples of the many technology solutions that have surfaced over the past few years. They all warrant examination.
Takeaway: REALTORS® should keep a watchful eye on these new technologies and adapt their business approach to the changes that result. Otherwise, they may be left behind.
David Girling completed his undergraduate work at the University of Southern California and earned the degree of Master of Business Administration from the Anderson Graduate School of Management at the University of California, Los Angeles. In 2008, he formed Girling Real Estate Investment Group (Girling REIG) with his father, Bing, and has more than thirty years of experience in the financial services industry. Dave and Bing are also affiliated with Villa Real Estate.