California housing enjoys strong fundamentals but faces potential headwinds
Housing fundamentals are strong, but if they get too strong, rising mortgage rates will spoil the fun.
Signs of a strong economy are all around us. U.S. retail sales rise, and inflation posts largest gain in four years. Unemployment is near historic lows, and Trump plans to dump fuel on the fire with a massive infrastructure spending program.
The US Housing market is poised for a strong start in 2017. The underlying economy was strong enough for the federal reserve to raise interest rates again in December. Unemployment is low and wage growth is picking up, so more qualified borrowers are likely to become buyers in the days ahead. Further, with mortgage interest rates still very low by historic standards, the demand for housing as expressed in dollars borrowers can put toward a purchase is near record highs.
The conditions as described above will likely lead to robust sales and strong price increases this spring — assuming rising mortgage rates don’t ruin the party.
Median sales price drops below $500,000 for first time since March 2016
While winter time usually means a decline in home sales, California just saw its first increase in home sales between December and January since 2012, a sign that the Golden State could be in for a strong housing year.
… closed escrow sales of existing, single-family detached homes in California totaled a seasonally adjusted annualized rate of 420,100 units in January.
That’s up 2.1% from the 411,430 level in December 2016, and up 4.4% when compared with home sales in January 2016 of a revised 402,220. …
If mortgage rates remain below 4.5%, both sales and house prices will rise strongly this year. The economy is improving, and with an improving economy will come increased demand. If this demand is amplified by super-low rates, housing will do very well. Our first data point of the year bears this out.
CAR President Geoff McIntosh suggests that the high prices in markets like San Francisco is driving buyers to seek lower priced options in nearby cities.
“California’s housing market continues to be defined by the higher-priced, coastal markets and the less expensive, inland areas that still offer access to major employment centers,” McIntosh said.
“For example, eroding affordability and tight housing inventory are pushing buyers away from the core Bay Area markets of San Francisco, San Mateo, and Santa Clara and into less expensive bedroom communities, such as Contra Costa, Napa, and Solano,” McIntosh continued. “In Southern California, an influx of buyers from coastal employment areas into the Inland Empire drove healthy year-over-year sales in Riverside and San Bernardino.”
I am very bullish on the Inland Empire this year. Pressure from high prices in Orange and LA Counties will push potential homebuyers to the Inland Empire, and with the FHA loan limit rising 6.4% this year, borrowers will be able to raise their bids. Combine those technical facts with a strong economy, and you have the recipe for strong sales and continued price increases.
While the current market conditions look promising for California, CAR’s senior vice president and chief economist, Leslie Appleton-Young, notes that rising interest rates could hamper the state’s housing economy.
“January’s sales increase was likely boosted by rising interest rates, which have risen sharply since the election and have given buyers an incentive to get off the sidelines and close escrow before rates go higher,” Appleton-Young said. “Yet, future anticipated rate hikes will increase the cost of homebuying and could have an adverse effect on affordability and future home sales.”
The improved economy will bring out the interest rate hawks at the federal reserve. Personally, I believe the federal reserve will allow the economy to run hot, but for the first time in a decade, we may actually see two (or more) rate increases in the same year. Higher interest rates, but more importantly higher mortgage rates will take away the punch bowl before the party gets started.
The economy is better than investors currently believe
If the economy shows continued resiliency, investors will retreat from their safe-haven buying and move into riskier asset classes. The exodus from 10-year treasuries and mortgage-backed securities will push mortgage rates up, acting as a headwind to housing.
Many analysts would like to believe strong job and wage growth will overcome the increasing costs of mortgage debt. It won’t. The math simply doesn’t favor it. Each percentage point mortgage interest rates go up, wages must rise 12% to compensate. Strong wage growth would be 4%, not 12%. It would take three years of very strong wage growth just to compensate for 1% higher mortgage rates. The federal reserve liked the math when they needed lower rates to reflate the housing bubble, but the math makes raising mortgage rates very problematic.
The positive forces working on the market now will buoy the market for at least part of this year. As I stated above, these conditions are unique and subject to change with the winds of the broader economy and the financial markets. Don’t be surprised if a sudden rise in mortgage rates spoils the party.