Thursday, December 8, 2016

Los Angeles Housing Bubble Is Nonsense – Even When You Include Climbing Interest Rates

 Proof in four charts

The headlines scream: “Housing Prices Unaffordable in Los Angeles” or “When Will the Bubble Burst in LA Real Estate.” A quick survey of major national economic journal articles about housing in the US, and especially in the popular urban centers, will reveal a consistent tone of fear.

The argument is something like this. Prices are almost back to 2006/7 levels that were unsustainable and resulted in a crash. Interest rates are likely to be continuing up under pro-growth Trump economy, and combined with super high prices, residential real estate is bound to head straight down.

But, there are serious problems with this logic. The following four charts should be all you need to debunk the fear mongers.

1.    The real (inflation adjusted) price of homes is not near the top in 2006/7.  The chart below shows the average prices for the US and Los Angeles over the last 30 years.

2.    The affordability issue is answered by this chart. Here you have a comparison of price to income. Substantially lower than 2016/7.

3.    Finally, we have the buy vs rent chart. If you can afford the rent, you can afford the house. Moreover, the rental value compared to the cost of the underlying property value drives investors to buy. As can be seen in this chart, there is a very long way to go to 2006/7 levels.

4.    This one is a bit more complicated; however, all of the pricing issues above are based on current interest rates. Thus, if interest rates go up, affordability goes down. What is shown in the next chart is that the last bubble had interest rates (30 year fixed) of around 6%.  Therefore the purchases during the bubble were at those levels, not current levels of around 4%. While affordability will be a factor as prices go up and interest rates go up, both can go up and still not create the kind of bubble we saw in 2006/7 any time soon.

 While there is no realistic way to incorporate all of this information into some real number that would represent a certain top in the market, it is pretty clear that prices can increase more than 20% even if interest rates increase to 6% without hitting the unsustainable levels of 2006/7.

Final note – Prices and wages are expected to go up 3% per year in the next couple of years. So housing prices can go up 3% per year from these levels in addition to the 20% slack identified above.

Caveat – Housing prices may go down next month or next year due to known reasons or reasons that will only be visible in the rear view mirror. This article only intends to demonstrate that the home buying public is not yet stretched to the extent that they were in 2006/7.

If you are in the market to purchase a home, need to sell an existing residential property, or both, please call Whit Prouty to discuss current market conditions in the area of your interest. The consultation costs you nothing. Call Whit at 310-962-6942