High housing costs push Millennials out of California
Young people and lower-income households can’t afford the high house prices in California, forcing many to move out of state.
Yesterday I provided an update on the local housing market. The data in my reports show the market is relatively affordable, but this affordability is not spread equally across all buyer categories. Due to the chronic shortages of housing supply that inflates California house prices and rents, lower income and young buyers looking for entry-level housing find it very difficult to buy. So while California house prices are as affordable as they were in the 90s, since this problem has persisted since the 70s, entry-level buyers face the same problems today than they have for the last 40+ years.
I see nothing in California politics or the economy that’s likely to change this situation, and the problem pushes lower income workers out of the State, ultimately forcing everyone else to pay more for basic goods and services.
By Tim Logan, April 30, 2015
If you’re a 20- or early 30-something and want to buy a house in Southern California, well, good luck.
Barely 1 in 4 homes on the market in Los Angeles and Orange counties is affordable to the typical millennial household, according to a new study from real estate website Zillow. Among the 96 largest housing markets in the U.S., only Honolulu had a lower share.
Most housing markets across America are not supply constrained; therefore, when someone gets a job and can afford a house, a local homebuilder will add supply as needed. Under those circumstances, the median income generally affords a median priced house. Once supply gets restricted, as it is in California, then the entire market gets distorted. The new household must compete with existing households for a fixed supply. This forces everyone to substitute downward in quality and ultimately it pushes the lowest rungs of the housing ladder to double or triple up or leave the area.
Zillow came up with the number by crunching a trove of listings and income data for households headed by people ages 23 to 34. It calculated monthly payments on those listings and estimated how many the median-earning millennial household could afford — defined as spending 30% of income or less. Nationwide, it found millennials could afford 70% of listings. In L.A., it was just 26%.
There are two main reasons that number is so low in the Southland, said Skylar Olsen, a senior economist at Zillow: high home prices and relatively low incomes.
“L.A. is just one of those areas where income growth has not been very strong and yet housing price growth has been fast,” she said. “L.A. almost always comes in at the top of the list for un-affordability.”
California is accustomed to restricted supply inflating house prices. When supplies are limited, as they are now due to the presence of so many underwater borrowers stuck in the purgatory of cloud inventory, the substitution effect forces buyers at every price level to buy a lower quality house than they otherwise would. At the very bottom of the housing ladder, those buyers who can only afford the least expensive properties get priced out by higher wage earners substituting downward.
In this case, the Southland fared worse even than several pricier markets, such as San Francisco. That’s in part because incomes are lower in Southern California, but also because there’s less diversity in housing stock, with fewer lower-cost options. Inventory is tight, she said, and most new construction is geared to the high end of the market.
This poses a big challenge for the region’s economy, said Christopher Thornberg, founding partner of Beacon Economics in Santa Monica. If young people can’t afford to buy a house in Southern California, some will leave the area, he said, especially middle-class and working-class families.
“You end up with a situation where you lose the worker of tomorrow,” Thornberg said.
Ultimately this becomes a major economic drag. First, businesses find it harder to expand because they have to pay very high salaries to justify the cost of living. Second, everyone must pay more for basic goods and services because higher wages drives up the cost of everything. And in the end, most of this money ends up flowing to lenders and owners of real estate.
That’s something Adam Britten is already wrestling with. A 25-year-old with a “good job” as a marketing strategist, he’d like to buy a house someday but is not sure if he’ll be able to do it in Southern California.
Friends in cheaper markets have houses “with yards!” Britten said, and they’re building wealth. When he’s looked at houses in the Southland, he said, he just gets depressed.
“It’s not a realistic goal at this point in my life,” he said.
Unless he is willing to buy a tiny condo in a bad area, homeownership probably isn’t a realistic option for him. Further, many others in their 20s with good jobs have high debt levels making homeownership difficult to attain.
Down the road, Britten said, he’ll stay in Southern California if he can land a job that pays enough to buy a house. But if he can’t, he said, he may well move on.
“I would look into relocating to a place where the cost of living is more closely aligned with the average salary for my profession,” he said.
Those places do exist.
This is why drives people out of California. When workers realize the high salary doesn’t provide them a high quality of life, many will chose not to take the job, or if they do, the end up leaving in a few years because they know they will never own a house, and they will spend $4,000+ on rent for the rest of their working lives — only then to be forced to move for cheaper housing in retirement. Who wants to sign up for that?
Zillow found that 70% of homes nationwide are affordable at the median millennial income in those respective markets. In regions such as Pittsburgh, St. Louis and Buffalo, N.Y., the figure tops 80%. Closer to home, 53% of listings in the Inland Empire are affordable, twice the share in coastal Los Angeles and Orange counties.
But buying a house far to the east comes with trade-offs, Olsen notes, trade-offs that young buyers may not find appealing.
“You pay more in transportation costs, gas and time,” she said. “Time is valuable. That’s time you could spend relaxing, or earning money.”
This is the ageless dilemma of Coastal California. Homebuilders call it “drive until you qualify.” Every OC worker chooses between a condo in Orange County or a house in Riverside County.
If Millennials do return in 2015, it will largely be due to low mortgage rates. As I stated in Bold California housing market predictions for 2015, everything depends on mortgage rates.
If mortgage rates remain below 4.25%, both sales and house prices will rise next 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 well.
If mortgage rates settle between 4.25% and 4.75%, sales will be down while prices drift slowly upward. A reduction in sales volume always proceeds price, and as long as mortgage rates stay below 4.75%, the pressure on pricing won’t be enough to overcome the inventory restrictions of cloud sellers.
If mortgage rates rise above 4.75%, sales volumes will be severely impacted and prices may drift gently lower. The increased cost of financing will not allow buyers to bid high enough to support current prices. The discretionary sellers active in the market will be forced to lower their prices if they want to sell. The activity of these few discretionary buyers will cause prices to drift down at higher mortgage rates.
If mortgage rates rise above 5.25%, the housing market will be a catastrophe. Homebuilders won’t be able to sell anything, homebuilding unemployment will rise, triggering a recession, and the housing market will experience record low sales volumes and prices 5% or more below today’s levels. I consider this scenario very unlikely largely because the federal reserve would never allow it. They will start buying mortgage bonds again before they let housing kill the recovery.