Why Are California Home Prices so High?

Are California Home Prices Going to Rise?

2021 was a pretty good year for the California’s housing market with big sales numbers and rising prices even as the supply of homes receded by a third. Each year, seemingly fewer houses are available.

The allure of the Golden State has always been too much to resist, for individuals and businesses.  Despite the social malaise and high taxes, buyers want to buy a home in this state. From those beautiful, golden beaches, to sunny skies to the incredible parks and recreation opportunities, there’s no end to lifestyle benefits here. Add on the highest paying tech jobs and the picture is complete for most.

Yet this American dream is barely alive for most young Californians and we’re wondering now if only a recession and housing market crash will save the day?

Like most parties fueled by plentiful cheap booze, the California residential market has gotten too raucous and out of control.

It seems demand for housing in the Golden State never ends. There are plenty of buyers discouraged only by prices and low supply, who are nervously waiting for a chance. Foreign buyers and investors are waiting too. Stats show huge interest in the California housing market from buyers out of state in the UK, Germany, and Asia.  Lower prices will only reawaken these crowds.

The average house price has peaked above $800,000 and average condo price has reached $600,000 dollars recently. The price per square foot has almost tripled in the last 9 years. Despite the drop in the last two months, many cash rich buyers are holding on, waiting for an opportunity to get back into the housing market. That might be 2022.

The pace of homes sold in 2021 was well up from 2020, not because of availability but due mostly to intense demand. Buyers are wary of projected big interest rate rises, but some feel the Democrats won’t raise rates because of the political and economic damage it would do.

 

We should look forward to the 2022 midterms and a possible Republican win and what they will decide to do. Will the Republicans undo all the regulations, taxes, and make it 2019 all over again?

“Assuming the pandemic situation can be kept under control next year, the cyclical effects from the latest economic downturn will wane, and a strong recovery will follow,” said C.A.R. Vice President and Chief Economist Jordan.

Most forecasters predict a strong, but delayed recovery in 2022. The world will recover too, and stimulus spending should rev up inflation further.

Specifically, What’s Driving Such Outrageous Home Prices?

The reasons for California’s extravagantly expensive real estate are many, but you’ll find one key source is underpinning the insane price increases. And while we’re seeing a dip in prices now, the economic recovery plus stimulus spending should only drive further price increases. The outlook is for rises until a recession ends the party.

Don’t expect home builders in California to save the day. According to FirstTuesday.com, single family house construction starts in 2021 were only at the same level as 2020. There were 59,000 new single family residential starts. Home construction has rebounded somewhat in 2021 up to levels equal to 2018.

FirstTuesday reports that 34,800 single family home starts took place in the April to September 2021 period, which is up 5,700 starts year over year (+20%).

Yet residential construction in California over the last few years is only about 35% of what it was in 2004. It is decidedly suppressed since 2008 and has not rebounded to meet new, higher demand. Politically and financially, there is no reason to believe builders will stick their necks out to build in the regulatory-ladled California housing market.

residential housing construction starts california. Screenshot courtesy of Firsttuesday.com

See more on journal.firsttuesday.com

Home prices across the state are forecast to rise another 5.2% in 2022 but sales may fall 4.8% due mostly to a lack of affordable properties available. Let’s discuss all that in this post. Please do share and remember that California’s residential market has incredible potential that could be unlocked.

The booming growth of the state’s population also allowed more businesses to launch and give California tremendous export power. It’s GDP has consistently risen to the point a few years ago where it had the world’s 5th highest in the world.

Today, the housing shortages are costing between $14 and $23 billion annually. And with homelessness on the rise, social program costs rising, and the tax base dwindling, the way Californians governments have managed the problem is leading a potential collapse.

But the fast improving prosperity seemed to be deposited only into the bank accounts of wealthy people, while the income and quality of living of most Californians lagged. It wasn’t long before California, stuffed with newly arriving Hispanic immigrants began to grumble and look for change.

Californian voters chose to go with the Democrat party to rectify the income disparity and make room for a better life for all newcomers. Unfortunately, the Democrat government at each level, State and local haven’t improved things.

In fact, during the past 10 years, fewer Californians own homes, and the restrictions against development are so onerous that most builders won’t hazard an attempt at building even if it was possible.

The state has been burdened by excessive regulations at every level, and while seemingly for keeping the health of the state, it’s actually an attempt to keep people out.

The Irresistible Allure of California

California’s attraction and power is its curse. The state has the most beautiful climate, scenery, largest economy, and diversity in business and people. Everyone would move to California if they could.

Its successes guarantee more people, more investment and more overcrowding.

So no matter how many housing units are built, it would simply attract more people. The NIMBYs those protectors of sensibility are alive, fighting hard, trying to prevent any kind of high density, lower income targeted development that would allow more newcomers to pour into the state.

These people don’t want the higher costs, high home prices, higher taxes, higher crime and social malaise, along with overcrowding and degradation of California’s communities, land and water. You can’t blame them for it, and the solution requires a better master plan, something no one is pushing for.

Governments have instituted permitting delays, review delays, environment review delays, and local growth limits, which make it impossible for most multifamily housing developers.

Home prices have jumped 150% on average and much higher in some counties because there simply aren’t enough houses, condos and apartments for everyone. The rate of construction is well below the pace needed (180,000 new units each year) just to house people already here. Of course, supply as you’ll read below is just part of the picture.

Home prices have climbed for a number of reasons, and they’d be much higher if not for companies and people moving away from the state. Many have moved to Arizona, Portland, and Texas, buying cheaper homes and enjoying a new start on their lives.

The success of Arizona and Texas is actually good for California. It draws away some of the sun seeking excess that creates inflationary prices in CA.

Growth Factors Powering Ever Higher Home Prices

Let’s begin the list of price boosting factors now.

Anti-Development Regulations

The state’s economy has been slipping, hit hard by the Covid 19 shutdowns, power outages, draughts, forest fires, and bad government decisions and spending that has crippled the economy and raised taxes significantly. Add on racial, wealth imbalance and other strife, and it’s no wonder supply solutions can’t be found.

Part of the planning and restrictions enforced by governments are low density requirements. Although, there has been resistance to even single family home building too. There have been bills presented and even laws passed to force local governments to comply with new home building growth, but they’ve all failed.

As in most housing markets across the US and Canada, decisions on land use and housing development has been left with local governments. They’ve been dominated by NIMBYs and anti-development activists, aided by endless green restrictions.

Urban Intensification

And large corporations in Los Angeles and the Bay Area drew jobs and people into very small urban areas of the major cities. Land is limited.  Without new high rises built to accommodate hundreds thousands of very well paid high tech workers, the competition for available housing supply rocketed. And house prices rose accordingly.

The unusual success of the Bay Area based tech monopolies Google, Facebook, Twitter, Linkedin, Salesforce, Tesla and others cemented the supply problem. And the work from home trend hasn’t resolved the issue as workers head back to headquarters in San Francisco, San Jose and the rest of Silicon Valley.

The Democrats show no signs of breaking up big tech, and even if they did, it might launch a new wave of entrepreneurial opportunity in California that could further improve its economy and demand for homes.

Pandemic Migration and Uprooting

Although the pandemic pushed some workers out into suburbs and outlying cities, it didn’t resolve the housing crisis, and served to raise prices in areas/towns that had little housing available. Building in those communities has been underwhelming, again due to development restrictions including those on multifamily development.

The pandemic uprooted a lot of people, some because they wanted to be safer from Covid 19 exposure, away from high risk urban areas, and others because they needed a home with a place to work (work from home). Displacement by itself generates demand. And with overcrowding, there are people living in unacceptably high density living quarters. That creates an explosion of people outward to find their own place (young people needing to find their own home).

The state also has a large number of homeless citizens, and thousands of them are working living in their cars. Providing homes for them will add a small amount of price pressure.

The Rich Have Plenty of Money

Due to the number of wealthy people in California, the ability and willingness to spend big means prices went up. The rich have been buying homes and prices at the luxury level have rocketed.

And the extra income from Federal Stimulus in 2020 helped low/mid income Californians try to buy the few affordable homes available and that supply has all but disappeared now in 2021.

Low Interest Rates and Easy Money

Record low interest rates have added fuel to the buy a house fire too and odds are they will only lead to high house prices given cash rich buyers still can meet downpayments.

Wages Are Rising and Jobs Reports are Strong

Wages in California are rising. For decades wages have dropped and the middle class has disappeared. If those lower income masses grow their earnings in the coming years, it will raise prices for rentals and encourage more rental real estate investors to buy properties.

High Cost to Build

California’s unusual terrain can add to housing development costs too. It’s a land of hills, mountains, and oceanfront landscapes that can challenge builders and make construction a challenge, thus raising costs.

When you add on high prices of lumber and steel and strict building code requirements, the final cost of homes in California has accelerated beyond what anyone could have imagined.

Millennials and Gen Z’s Starting Families

And a growing army of Gen Z’s and Millennial aged couples are looking to start new families puts huge pressure on the supply of townhouses and houses. This group is often mentioned in the FOMO (fear of missing out group of buyers) who are blamed for speculation and desperate purchases.

State Investment in Housing Dropped Off

State investments in affordable housing have dropped from over $1.3 billion to $500 million. New money for affordable housing is questionable.

Demand for Rentals Draws in Investors

Homes are being bought to rent out to millions of well paid renters who aren’t able to afford or find a house to buy. The rental property investment is a solid one, buyers must compete with rental investors who may have the means to outbid them.

Proposition 13 Adds to it

Proposition 13 is a California legislation that has made land use for retail more preferable for government than residential housing. It works to take land off the market and raise taxes for Californians (except those who have owned their properties for a long time).

The Lull Before the Price Storm in 2022

The last few months, we’ve seen an easing of the 15 year price trend and home prices are falling. But it’s taken a severe economic hit to achieve this price drop.

Now as we slowly leave the pandemic period, we find material supply shortages, labor shortages, fast rising construction worker wages, threats of higher interest rates and capital gains taxes, higher taxes, and a forecasted flatter economy in 2022.

The signals actually don’t add up to lower prices and a poorer economy, so I would counter the predictions of flat prices with prices rises above 10% for some areas, especially since prices are dropping a little lately.

Demand will not encourage builders to build more housing, especially rare affordable, lower priced homes.
The new infrastructure bill from the Feds will bring forth more easy money to encourage more competition for more expensive homes and more money to spend on them.

Will a housing market crash solve the matter?

You might think the situation is hopeless, but if California’s economy was to fail and residents left and fewer arrived, the home price problem would be eased. With higher taxes and a poor business environment, many more companies (e.g., Tesla) and wealthy business owners would leave.  Higher taxes is a factor going forward.

The Real Solution?

If Federal and state governments were to help California decentralize business and open up developments deeper into the interior of the state, this could ease the pressure on the San Diego, San Francisco, Los Angeles Metro areas. But are these governments addicted to their current sources of revenue in these cities?

With Los Angeles home prices, Bay Area home prices and San Diego home prices rising, they will simply run out of buyers to bid on them. It may have hit near that limit now, as long as current home construction continues.

A lot of Californians are asking when home prices will fall and they’re actually hoping for a crash. As mortgage rates rise, we’ll see demand drop. Rising interest rates have normally heralded in a recession to cool everything down quick.

It won’t be any different this time around.

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