Home prices have declined 40% – 50% over the last 3 years but how much lower can prices really go? The California job market is hugely dependent upon real estate so it is imperative to look at home prices as they relate to income levels. Remember there is a current unemployment rate of 12.4% and a huge underemployment rate of 23%, the second in the nation. Based on the chart below it looks as though housing is doing a little better than employment which is surprising given California’s employment dependence on the housing industry.
What is interesting is that employment kept increasing for 2 more years after the real estate bubble burst from 2007 through around 2009. Right now you see employment hovering around 1998 levels while home prices are around 2003 levels showing a lost decade in home prices. Home prices are no longer driving employment, and it is safe to assume that it should be the other way around given the increased risk standards given from the banks for financing and large amount of foreclosures looming, limiting the increase in home values. An increase in employment and spending power is the only thing that is going to stabilize home prices. The buying power is simply not there for California home prices and the only way for the prices to go is down. Simply put, mortgage brokers, real estate agents, contractors and most people that are in the real estate industry were making 3 times more than they are now. This reduces their purchasing power significantly.
To give a clearer picture of how employment is moving check out the unemployment benefits payout chart below which shot up from close to $6 million in 2009 to above $20 million currently. It only dropped slightly due to the people who have been on unemployment for 99 months and exhausted their benefits.
There is no way there will be a California housing recovery until employment turns around. It just does not make economic sense unless the banks start giving out liar loans again! This is why the mortgage brokers were making 6 figures in the first place with a high school diploma and no real education of the industry. This increased the overall economy by those high paid workers increasing their spending habits causing an increase in GDP during that time. California was making a ton of revenue so why in the world would they stop the corruption? This reinforced even more corruption because everyone was making a boat load of money and turning a blind eye to the truth, that all of this growth was artificial. Then you have tax credits and government bail outs trying to re-create the environment because so many were making so much money which did nothing but prolong the problem. We see this in the continued decline in housing after the tax credits went away.
Now I am sure you are hearing the rumors that only high tier housing prices will decrease but that is simply not the case. They are still inflated. See the chart below showing home prices at all levels still being overvalued.
Of the lower tier prices declined 51% while middle tier declined 37% and higher end properties declined 28%. Currently total MLS California inventory is at about 164,000 but if you include the shadow inventory of defaulted homes you are looking at approximately 462,000 homes. The banks have just not begun to foreclose on them yet. That would increase supply by 282%, and what does economics tell you about increases in supply without an increase in demand? It tells you that prices have to drop. It is really difficult to modify these homes when they have dropped as much as they have and reports show that in reality only 10% of these homes will actually be able to be modified. Home prices should actually decline in California even below historic trends because it is the weakest employment market since the great depression. That coupled with the bad consumer sentiment about buying homes now and the fear that they have about the current California real estate market is a combination for further price reduction. Pretty incredible if you ask me. This is exactly why I don’t buy property in California right now. I would rather buy in markets that have better economic indicators, are business friendly and you can get a better return on your money due to cash flow. People tell me all of the time, I buy in California because it has always had appreciation and it will appreciate in the future. But not a single one of them can tell me what evidence they see for market appreciation. All I see is a decline in California real estate prices or at least stagnate prices at best for the next 2 decades. Go ahead and invest in California if you want, but don’t expect price increases just because they historically increased without understanding the economics underlying the market. And don’t say I didn’t warn you. Also, thanks to Dr. Housing Bubble for some great information, it’s always top notch and data driven.