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Real Estate
THE HOUSING MARKET: ARE WE REALLY SEEING AN END TO THE DOWNTURN?
Another hopeful sign of a turn in the East Bay economy is found in housing markets. Almost four years have passed since housing prices peaked and home sales began to plummet. Builders were a little slow to respond to falling demand, but by the beginning of 2007 applications for new residential building permits had fallen off a cliff. Over the past year residential construction has been lower than at any time during the last three housing cycles. Picking a turning point in residential construction is always a risky proposition, and the data are not yet admitting of a clear signal that East Bay housing is in the throes of an incipient recovery. Hanging over this market is the potential for reductions in government employment in the near term. Nevertheless, there are a couple of hopeful signs that we may be at the bottom.
First, the 2004-2006 exuberance in housing markets drove prices to unsustainable heights above fundamental norms. Housing is an investment and therefore must carry a positive return. After adjusting for inflation, the historical return in the East Bay (1975-1995) was about 0.6% per quarter. If the return is calculated through 2002 it is slightly higher. Sustained appreciation above those returns is only possible if immigration adds substantial incremental demand to the housing market. The 2004-2006 incremental demand was not from a larger population, but from speculative purchases based on anticipated continued appreciation. The subsequent wave of foreclosures resulted in an unprecedented decline in home prices in the East Bay. This leads us to our first sign of a turn in the market. If one invested in a home in the East Bay in 1975 and sold it today, the home would have earned almost exactly the 1975-1995 average rate of return and less than the 1975-2002 average rate of return. In other words, all of the excess in price appreciation from the speculative bubble has now been wrung out of the market.
Second, home sales are picking up. Sales were at a low in the first quarter of 2009 and have since climbed back to 2006-2007 levels. They are not robust, and the trend is not clearly up, but the last three months has seen more home sales activity. Clearly prices, interest rates and incentive programs are helping, particularly with first time home buyers. What is encouraging though is the reduction in inventory. There are various estimates of inventory available, but the best estimates all suggest that inventories in the coastal areas of California are now at very low levels. So, low inventories, buyers in the market, little new construction coming onto the market, and prices which now make East Bay housing affordable once again all bode well for a near term turn in real estate and residential construction.
There is one important caveat to this optimism about East Bay housing. In the eastern portion of the region and further into the Central Valley housing was constructed for those who could not afford to live close to their work and who were willing to pay the price of long commutes for home ownership. These communities find themselves with substantial inventory and it is unlikely that residential construction will begin to recover during the early part of the incipient economic expansion.
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