People have a hard time understanding that low interest rates in today’s market are largely a reflection of a negative outlook on the economy. Central banks around the world are more concerned about financial assets and the secondary impact on real estate is just that, secondary. The market took a beating last week and you get people saying “hey, at least rates will be low for that $700,000 crap shack!” This is the kind of isolated California logic that puts people into a bubble regarding macro trends. It is also the same kind of reasoning that caught so many people off guard during the last crisis. We recently noted that the L.A./O.C. rental market is the most overvalued in the nation. Why? Because local incomes don’t justify current prices hence the 2013 mania brought on by outside money forces (i.e., domestic investors, foreign money, etc). That money pulled back this year. Now you have locals blowing through wads of cash and all it means is people consume a large portion of their pay to live the SoCal lifestyle. A fake it until you make it approach supported by debt. We see this trend permeate into small homes in select zip codes as people go haywire just to get in even if the home is not exactly a “player” home. Today we take a trip to Culver City.
It should come as no surprise that the L.A. and O.C. housing markets are the least affordable in the entire nation. That is right, even more unaffordable than San Francisco or New York. Why? Because even though New York and San Francisco have higher rental costs, people make more money. Should be common sense but it should be apparent that people in SoCal like stretching their budgets. It might be the Hollywood allure of “acting” rich instead of actually being wealthy. Fake it till you make it. Hence the broke older homeowners with their boomerang adult-children coming to live back home. Rents are paid by net income. There is no extra mortgage leverage that you can squeeze out of a rental payment. You either make the monthly payment or you don’t. And seeing this data simply confirms that many in SoCal would rather act the role of being rich instead of taking steps to being wealthy.
If the American dream means owning a home, many younger Americans are opting out of that dream. Part of the reason may be a generational shift in having smaller families and a growing number of dual income no kid (DINK) households. That is part of it but a bigger reason is many younger Americans are financially in poor shape and unable to buy. Many are now part of a growing renter class. The recent Census data shows no reversal in this trend. Why would it? Many young Americans are also carrying high levels of student debt and in high cost areas like California, 2.3 million young adults are living at home with their parents because of financial challenges. This change has also impacted home builders since there is less of a need for large new homes when the demand is more for affordable rentals. Builders are keen to see this and that is why multi-family building permits are way up. What impact will this trend have on the housing landscape of America?
There is little arguing that Santa Monica is prime Westside real estate. Some would like to believe that somehow Pacoima, Compton, or Lawndale are somehow new prime markets but there is little dispute that Santa Monica is fairly elite when it comes to SoCal housing. I enjoy Santa Monica and given prices in the market, I’m sure many feel the same way. But for those not in the area, they might find real estate prices downright insane in this niche market of California. California has an affair with boom and bust cycles when it pertains to real estate. We’ve had a nice run and now the euphoria is wearing off. I’ve noticed though that in Santa Monica and Pasadena, I’m seeing the term “condo alternative” popping up more often. Usually the condo alternative title is used on an ultra-tiny property with an ultra-high price. Tiny flips are easier to rehab and turn around simply because of the size of the property. There is only so much you can do with a place the size of a dorm room. Let us take a look at a condo alternative in Santa Monica.
In ancient home buying times, the vast majority of home purchases came from regular families looking to buy a home. When I say buying, I mean committing to a 30 year mortgage financed by a bank. This was the traditional mechanism of keeping the real estate machinery moving. Since 2008, a large part of the buying power has come from “all cash” buyers that simply did not require a mortgage. This has been a dramatic shift in how home sales work. It is interesting to see real estate agents unhappy about this arrangement as well because volume has crumbled. Also, many of the early deals were done via REOs at banks and auctions which were largely off the market for most regular buyers unless you had the funds to purchase a large block of single family homes. So with big investors pulling back from the market, it is no surprise that regular American families simply cannot compete. One good indicator of this is to actually look at applications for mortgages. What we find is that demand for mortgages is simply not there.