October 1, 2017 - 1 comment.

The State of the Property Market – Are We in a Bubble?

It’s probably one of the questions I hear most: “Are we in a bubble?”

Home buyers are growing timid as interest rates increase and the price of Orange County (and Southern California) homes continues its seemingly never-ending trajectory that began in 2012. With the pain of 2008 still fresh in people’s minds, more and more consumers are fearing a repeat.

That fear, for the most part, is based on one factor alone: home prices. Taken by itself, the run up in home prices over the last 5 years would seem to mirror the same run up that occurred prior to 2008 and legitimize any concerns consumers have regarding another bubble. It looks the same, right? So, isn’t it fair to assume the same outcome may happen? Not at all.

Most ‘bubble chatter’ I hear centers around home prices and home prices alone. This is misleading for a number of reasons, foremost among them being that a lot of other important factors are being ignored, such as inventory. There’s also been a change in context since the 2008 bubble collapse. The Dodd-Frank legislation, passed in 2010, transformed the regulations governing the lending industry – one of the primary culprits in fueling the 2008 crash. Leading up to the collapse, some lenders weren’t even verifying income, employment or assets. These NINJA loans – as they are known (No Income, No Job, no Assets) – opened the door for fraud and allowed a lot of Americans to purchase a home when they weren’t in a financial position to do so.

2008 was a huge market correction for this fraud. The housing market was built on a lie and that lie came tumbling down. The housing market of today is not built on a lie. It’s built on well qualified buyers (thanks to Dodd-Frank) and responsible homeowners – many of whom bought their homes in the immediate years following the crash and have since built up tremendous equity.

So, what exactly is the state of the market, then?

Inventory has plummeted since 2008 and it’s currently at an all-time seasonal low. There was a momentary increase in inventory after the housing bubble collapse really set in and people started losing their homes to short sales and foreclosures. This created a large distressed property market and investors swooped in from around the country to grab Southern California real estate at killer prices. This investor activity nearly cleaned up the distressed market, though. Today (as of this writing) there are currently 119 distressed property listings in Orange County, while in 2008 Orange County’s distressed market peaked at 8,253 listings[1]. Low distressed inventory indicates a healthy, strong market. Right now, the greatest contributor to high prices is and has been low inventory.

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A lot of homeowners also saw their equity in their homes wiped out in 2008, and we’re just now at market levels that would place these homeowners in the same equity position they were in right before the crash. This matters because the majority of homeowners sell their homes to move into a larger, more expensive home[2]. They need the proceeds of their current home sale to afford this new home, and they can’t make this move until they’ve built up sufficient equity to do so. This stymies inventory levels as homeowners wait longer to sell as they rebuild the equity they lost and then some.

And finally, and probably one of the most over-looked factors in the current Orange County market, is foreign money. Southern California, and Orange County in particular, saw a huge influx of foreign cash in recent years. In a July 18th article, the Los Angeles Times reports that “California made up 12% of foreign-purchased homes in America by dollar volume, tied with Texas and second only to Florida...” In some Irvine communities, especially the newer ones, as much as 80% of home sales are going to foreign buyers.[3] Foreign money matters because it skews the price to income ratio. Orange County home prices have been accelerating faster than Orange County salaries because the acceleration is being fueled in large part by foreign money. This impacts some areas more so than others, but does certainly have the effect of pricing out buyers who simply can’t compete with foreign cash and driving up prices.

So, here’s the recap of these factors:

  • Low Inventory
  • Equity Position
  • Foreign Money

Taking these factors into consideration, there is a price bubble in Orange County and the economics of it are fairly simple. Prices are high – plain and simple. Homeowners and Realtors® understand the market enough to know they can push pricing and they do (including yours truly). But this isn’t a bubble in the sense of what most people compare it to – 2008 – and I certainly don’t think there’ll be any ‘bursting’ this time. The market is perfectly healthy and I think it’s getting healthier. Buyers can still buy homes for a reasonable, fair price in plenty of communities. But there does need to be a correction and I think it’s coming.

As interest rates rise more buyers will drop out of the race, lessening the current demand for housing. Inventory will stabilize and most likely increase over the next few years to a balanced level, especially as more and more homeowners come into the equity position that they need to sell their home and move up. Foreign money is starting to play less of a role – especially with new currency-exchange regulations China implemented in 2017 that restrict its citizens from using foreign currency to buy overseas properties. Sure, loop holes will be exploited but I still think we’ll see a decrease in foreign money activity.

In terms of current prices – well, they’re right where they’re supposed to be, with a few micro-based exceptions. Normal appreciation for single family homes in the US is around 3.6%. California outpaces that by 2-3 points usually. If you take one of the most reputable housing indices – the Case-Shiller Home Price Index – you get a bird’s eye view of price trends since 1890:

Now, let’s assume there weren’t market corrections – most notably the 2008 correction that sent the global economy scrambling – and factor in the annual 3.6% increase. The trend would look something like the red line below, and would suggest that we’re in the right ballpark when it comes to home prices.

My anecdotal experience tells me the market is already beginning to transition. Whereas a few months ago a new listing could be expected to receive multiple offers in just a few days, that same listing today is waiting weeks to receive one offer. Buyers are already feeling the pressure of interest rates, and so are sellers who are still choosing to push the limits on pricing their homes.

The future of the market, in my opinion, is good. We need prices to stabilize and we need to return to appreciation rates that are commensurate with income growth and inflation.  And I’ll back up my confidence in the market with the fact that I’ve been personally active with purchasing investment properties. If I thought the future of the market was bad, I wouldn’t be snatching up properties right now.

If you have any questions about real estate just leave a comment below or contact me now.

[1] California Regional Multiple Listing Service, Inc.

[2] National Association of Realtors® Profile of Home Buyers and Sellers 2016

[3] http://www.doctorhousingbubble.com/irvine-foreign-money-cash-real-estate-stonegate-cemetery-great-park/

Published by: Andrew Vagley in Property Market