Will beach community home ownership premiums increase without end?

Coastal community real estate is more expensive relative to rent than it’s ever been. A bubble perhaps?

premium on premiumVery expensive real estate dominates Coastal California communities. The narrow strip of land within a mile or two of the ocean is one of the most desirable climates in the world, and many people of great wealth want to live there.

The wealthy have done very well over the last 30 years, and the concentration of wealth at the top is so high that the richest 1% of Americans own 42% of all the wealth in the country. As the rich get richer and as other opportunities for investment wane, many are competing for the limited number of prime beach properties, sending prices into orbit.

Will this go on forever, or is there a limit to how much more a beachfront mansion is worth relative to the houses of the plebes? More on that later.

Housing market update

I will be speaking tonight at JT Schmids about the housing market. If you want an interactive question and answer to go along with this presentation, I invite you to attend. Sessions begin at 5:30.


When Congress passed the Dodd-Frank financial reform, one of their goals was to stabilize the housing market to avoid the volatility that imperiled the banking system. Surprisingly, they did a very good job.

After the crash, house prices quickly reflated back to equilibrium price levels determined by income and rent. Without affordability products, lenders can’t enable buyers to push prices any higher, slowing sales as prices rise. Though realtors, homebuilders, and others who make a living off transactions may consider this a bug, it’s actually a very desirable feature of the Dodd-Frank reform.

If I had no knowledge of the past beyond one year, and I looked at the data now, I would conclude the housing market is stable and healthy.

  1. The cost to own relative to rent is as good now as any time in the last 28 years.
  2. House prices are tethered in a tight range near historic norms.
  3. The rate of home price appreciation mirrors the growth in rent and income.
  4. All measures have been stable for more than a year now.


Taking a longer-term look, the bubble and downside overshoot is obvious. Further, the price level where home prices hit the affordability ceiling was predicted in advance by this analysis, and prices have remained tightly bound to this expected price level.


Whether one examines house prices relative to rental parity above, or cost of ownership relative to rent below, the same picture emerges.


California house prices are notoriously volatile, but we have been hovering in a stable range for home price appreciation for 30 months now.


The rate of rent growth mirrors the economic comeback, and it’s been in a stable range for five years now.


The analysis assumes the 1993-1999 period was a stable baseline. This was a period between housing bubbles when toxic loan products were scarce, so the true equilibrium of affordability shines through. This explains why the home price appreciation stopped abruptly when this price level was reached in 2013 and remains tethered to this day.


Because the cost of ownership relative to rent is so favorable, the rating system still maintains this is a good time to buy a house.


The rent and resale growth in nearly every community in Orange County is within a stable range, reflecting strength in the underlying economy.


House prices are relative to rent reflect the countywide norms with a few notable exceptions. The beach communities are generally overvalued and poorly rated, which means the cost of ownership relative to rent is much higher there now than in the mid 90s. Since this is not occurring anywhere else, it must be something specific to these communities that’s causing it. And, no, it’s not because everyone wants to live there.


While the beach communities are certainly desirable, this desirability is also reflected in very high rents. For house prices to be high relative to that benchmark, something else must be going on.high_end_air

Over the last six years, the federal reserve held long-term interest rates near zero. This policy nearly eliminated any cash returns on available investments: savings account pay just over nothing, 10-year Treasuries recently hit 2%, and bond yields are extremely low across the spectrum.  Relative to these investment alternatives, high-end residential real estate — with it’s historically low cash returns — is a better investment; therefore, wealthy people buy expensive homes and inflate prices. Couple that with the money flowing in from overseas, and ultra-high-end residential real estate is doing relatively well.

But what happens if real estate isn’t the best alternative? What happens with the rest of the economy does improve and investors find competing opportunities with better returns? Wouldn’t the wealthy sell investment homes to pursue these better alternatives? And wouldn’t that outflow of money put pressure on high-end prices?

Over the next several years, we are going to find out.

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