Kevin D. Shelburn | September 21, 2022
My real estate newsfeed is a myriad of doom and gloom these days. That’s everything from a housing bubble, slowdown, market correction and the big “R” word, R E C E S S I O N. And not just any recession, you’re supposed to worry about three separate ones:
1.) a tradition recession. Marked by two consecutive quarters of negative GDP. Economist Peter Schiff thinks we are already in one, and have been this entire year.
2.) a housing recession. according to the National Association of Home Builders, we entered this territory in August 2022.
3.) a growth recession. (yes, that’s also a thing), where the economy expands less than the Fed’s ~2% GDP target while we simultaneously experience an increase in unemployment.
What should today's headlines look like?
Great question. I realized we're missing an accurate long-term outlook of the Los Angeles housing market based on historical analysis, basic economics and reliable housing indicators.
What does your prediction entail?
That the proverbial “perfect storm” is brewing. The implications of which will be felt for years, if not a decade. Our current economic environment will trigger a massive shortfall of available homes. With near zero supply, expect real estate values to hit new heights, sooner than you may think.
Let’s dive right into these factors and understand the future we are creating for ourselves, and why I expect to see substantial home appreciation in West Los Angeles and many other coastal markets.
Factors Leading to Low Supply
Golden Loans: Without a doubt, this is the single most important item that will stifle inventory for years to come. “Golden Loans” is a reference to consumers who either bought or refinanced their homes post-COVID yet prior to the recent rate spike, who secured interest rates below 4.0%. Just how many loans are 4.0% or below? According to research firm Black Knight, 71% of California homeowners have a rate of 4.0% or less. What exactly does that mean in the broader scope of things?
It means homeowners with Golden Loans won’t part with their homes in exchange for today’s interest rates. That effect increases exponentially as interest rates rise. Most borrowers, roughly 90%, opt for 30 year schedules, according to Freddie Mac. Therefore, the “Golden Loan Phenomenon” isn’t going away anytime soon. In fact, it’s already here. We’re currently in low supply with low demand atmosphere, which is why values are hovering at their all-time highs.
Tax Basis. Further compounding Golden Loans is the fact that our property taxes are based on our purchase price, which is then capped at a 2.0% annual increase, thanks to Prop 13. So on one hand consumers love their loan and on the other they are grasping their property tax basis. Purchasing a new home ruins both, unless you are covered by Prop 19.
Access to Capital via HELOC’s. Home Equity Line of Credits (“HELOC’s”) are generally available to homeowners with untapped equity. These lines of credit are in the “second position” - behind your 2.0% - 4.0% Golden Loan. Research already shows consumers flocking to this scenario. Cash out refinances in Q1 2022 were down 30% due to surging rates, yet home equity lines were up 30% quarter over quarter, the largest volume in 12 years, according to Black Knight. A refinance - whether “cash out” or traditional - triggers a new loan at today’s less desirable rates, yet a HELOC allows a homeowner the ability to maintain their Golden Loan and have access to the equity within their home. Golden Loans + HELOC’s = a win-win for homeowners.
“Current homeowners have irreplaceable debt, a favorable tax basis and access to capital through home equity lines of credit.”
High Cost to Construct. Know anyone who has remodeled or built a home recently? How was that experience? How often did they gripe about the cost? Here are some startling numbers from the Commerce Department or National Association of Home Builders:
(a) The average cost to build a single family home jumped 42% in just three years, from 2018 - 2021.
(b) Construction costs are up another 19% year over year
(c) Wood, plastic and composites have risen 110% since 2010.
With builder costs higher than ever; a rising interest rate environment and consumer perception of a softening market; is it fair to say we will experience builder pullback? Absolutely. It’s already here. What’s the result? Less inventory yet again.
Construction Labor Shortage & Supply Chain. Let’s pretend for a second we live in a world where demand surges and new home construction, which, according to Forbes, accounts for just 5.0% of all sales in Los Angeles, ramps up. Great. Ready, Set…Don’t Go Very Far. Why? Because we don’t have enough labor to tackle the projects. Nor are we able to have our materials arrive in a timely manner. Take a look at these statistics from UC Berkeley’s Turner Center for Housing Innovation:
(a) Between 2006 - 2018 employment of carpenters dropped 30%
(b) Reinforcing iron and rebar workers dropped 52%
(c) Cement masons & concrete finishers dropped 18%
(d) Drywall and ceiling tile installers dropped 23%
(e) 40% of the skilled labor force are over the age of 45 (aging out)
(f) Nationwide Trade, Transpiration and Utilities had 1.96 million jobs unfulfilled in April, and 979,000 quit their jobs - the highest of any industry, according to the Bureau of Labor Statistics.
“Even if we were in an 'all systems go’ building environment, we can’t go very far without skilled labor and materials.”
Warren Buffet once said, “short-term market forecasts are poisonous and should be kept in a safe place, away from children and also from adults who behave like children…” I think that's applicable to real estate as well, but in light of all the dismal headlines I felt it was necessary to make an “educated prediction." Therefore…
I expect prices in West LA and coastal CA to be relatively flat over the next 12 months. They could be up or down a few points, but nothing substantial in either direction. However, once demand returns, even in the slightest bit - whether that’s in the form of inflation getting under control, an end to the War in Ukraine or the Fed lowers the Fed Fund Rate: expect buyers to come out of hiding, only to find themselves dejected by the amount of available inventory. The relationship of supply and demand will be completely out of whack. Seller’s will need top dollar in order to retire their Golden Loans and lose their tax basis. It will be “deja vu all over again” for those who remember 2021. Expect multiple offers, cash offers, closings well above asking prices, and home values reaching new heights.
About the author: Kevin Shelburn is a 20-year real estate and wealth management specialists with a BA from UCSB. He is an active member of the LMU Real Estate Advisory Council and licensed real estate broker for Shelburn Realty Group in Mar Vista.
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