Why are California home prices surging ?
In the last 12 months, Los Angeles, San Francisco and San Diego single-family homes (SFH) have surged 19%, 22% and 28% respectively.
California is no stranger to volatile home prices, but why this recent surge ?
Lets review the drivers responsible for price changes ..
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Drivers that can increase SFH price
Demand increases that increase price:
1) Low Interest rates — mortgage rates are about half of what they were 5 years ago, reducing the income threshold required to buy a home. **
2) Strong technology IPOs, creating more cash for people to spend (including new Millenial households). **
3) Working from home — Covid has dramatically increased the % of people working from home. As people spend more time at home, they seek a comfortable, spacious home, increasing demand. **
4) Historically high savings (including Covid-driven spend reduction).
5) Institutions investing in single-family rentals.
Supply decreases that increase price:
6) Slow change in zoning laws — existing homeowners are averse to increasing housing density, preventing new zoning laws and additional housing stock from being built.
7) Construction labor and material shortages — Partly Covid-induced, this could be temporary.
8) Builder consolidation — the number of ‘spec’ builders has halved in the last 15 years.
9) Rent increases as a result of these supply drivers can push more people to own, and therefore become a demand driver increasing price).
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Drivers that can decrease SFH price
Demand decreases that decrease price:
10) Net Migration out of state— migration out of CA continues. This can have a direct effect if potential homeowners are move out and an indirect effect if renters move out (rents can go down, decreasing demand for ownership). **
11) Lower international investment — In the last decade, international investors have been active in California. That has slowed in the last year due to Covid.
12) Tighter lending standards — lenders have maintained tighter requirements on minimum downpayment and income levels. This was a result of the 2008 financial crisis and is more of a continuation rather than a meaningful change in the last year.
Supply increases that decrease price:
13) ADU approval by state — a recent bill signed into law (SB 9) allows construction of Accessory dwelling units (ADU). However, it can take years for a meaningful % of homeowners to construct ADUs and increase supply. This is related to #6.
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Now that we have identified pricing drivers, could we use these to predict what happens next ?
The most material drivers (marked with **) are 1 (interest rates), 2 (tech IPOs), 3 (working from home) and 10 (migration), with the other drivers having less of an effect.
Tech IPOs could moderate after a strong year, but rewards from IPOs will continue to increase cash available to buy homes. Working from home is also shaping up to become a permanent shift - more people will invest in their home as a space to live and work. So, unless interest rates rise meaningfully or more high-income migration happens out of CA, SFH prices have a strong foundation (pun intended:))
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References:
Clear Insights by Eric Sussman, Clear Capital;
Case-Shiller metro index time series from Federal Reserve of St Louis;
