San Jose

The U.S. Housing Market: Despite a Demographic Push, Proceed With Caution


With California housing markets having decidedly shifted since the summer, the looming question is what comes next. Since 2014, Pacific Union has partnered with John Burns Real Estate Consulting to forecast the market for the upcoming three years. At our November 2017 forecast, we suggested that the John Burns Home Value Index would reach a plateau in 2018 (which we named a “table top”) and maintain that level through about 2020. The major difference between the current peak and the previous peak seen in the mid-2000s is that the current peak resembles a table top, while the last peak was characterized as a “mountain peak” — a peak followed by a large decline.

Source: 2017 Pacific Union Real Estate and Economic Forecast

A lot has happened since our last forecast, but our predictions remain similar.

While our annual forecast event has been postponed to the first quarter of 2019 as a result of the merger with Compass and the wildfires, I recently attended the JBREC annual summit in New York City, and here are the key takeaways.

  • While concerns over the housing market’s strength are rising, the major tailwind is the demographic force. With U.S. millennials numbering 44 million, that generation’s largest age bracket (4.7 million people) will turn 32 years old over the next couple of years, thus creating a huge wave of potential homebuyers.
  • Online buyer behavior suggests that sales will remain solid in markets in the South (such as Charlotte, Houston, Raleigh, and Atlanta) but will decline in West Coast markets and some Northeastern markets, with California home sales expected to post a 2 percent to 7 percent decline over the next six months.
  • Interest-rate hikes following strong price growth over the last year took a large bite out of affordability, making it the biggest concern for California housing markets.
  • While technological advancements have the potential to reduce construction costs, supply constraints outweigh any potential savings in the short term.
  • Affordability constraints are likely to drive builders to pivot down in price to smaller, higher-density, lower-specification homes in slightly less desirable locations. Also, builders are more likely to construct single-family rental properties.
  • Average annual price growth in six California metropolitan areas is projected at 6 percent in 2019 and 3 percent in 2020 before declining by 0.3 percent in 2021.

Long-Term View

Demographic Trends Are Propping Up Long-Term Demand

  • With U.S. millennials numbering 44 million, that generation’s largest age bracket (4.7 million people) will turn 32 years old over the next year, which is the median age of first-time buyers in the U.S. Considering a combined total of about 6 million new and existing homes sold annually in the U.S., millennials have the potential to create a huge wave of first-time homebuyers and account for a much larger share of total housing demand. First-time buyers currently comprise about one-third of all homebuyers.
  • These demographic forces suggest that 1.25 million more households per year over the next 10 years will need housing, which means that 1.375 million new units per year need to be built to meet demand through 2025 (including owner-occupied properties, second homes, and replacement of teardowns).
  • However, after 2025, America’s aging society will reduce the need for housing production since seniors create supply when they pass away or move into assisted-living facilities or their children’s homes. Thus, the net growth of new homes will decline to 230,000 units per year.

But Supply Constraints Make Homes Increasingly More Expensive

  • At the same time, meeting current demand has become increasingly more difficult, as builders take a large risk when buying raw land to entitle in their respective regions.
  • Based on a JBREC survey, buying raw land is perceived by builders as twice as risky as buying a few home-builder stocks, leading to fewer builders willing to make purchases in the current housing cycle.
  • In addition, builders face large labor shortages, which will not abate considering the nation’s aging demographics and immigration restrictions, both of which will lead to much higher construction wages.
  • However, technological advancements in the construction industry — such as building information modeling software, 3D printing, robotics, off-site technologies imported from overseas, and smart homes — have the potential to reduce costs dramatically.
  • Still, many costs will continue to increase:
  1. Lot shortages will keep land prices high.
  2. Labor shortages will keep building costs high.
  3. Inflation and potentially tariffs will keep materials costs high.
  4. Regulation-related costs are high in California.
  5. Significant off-site cost reductions for nicer single-family homes are years away.

Short-Term View

2018 Slowdown

  • Nationally, sales of newly built homes have been slowing all year, with a 13 percent year-over-year decline in October, bringing annualized sales to 553,000 new single-family homes, or 40 percent of the projected 1.3 million needed to meet demand.
  • What led to 2018’s slowdown:
    • Mortgage rates rose by 88 basis points this year, from 3.95 percent in January to 4.83 percent in October, resulting in at least an 11 percent increase in payments without accounting for price appreciation.
    • With price appreciation, Californians’ monthly mortgage payments are up by as much as 25 percent year over year:
      • Silicon Valley, up by 25 percent
      • San Francisco, up by 19 percent
      • The East Bay, up by 17 percent
      • Los Angeles, up by 14 percent
      • Nationwide, up by 13 percent
  • Each 100-basis-point increase in mortgage rates reduces borrowers’ purchasing power by about 7 percent.
  • The impact on affordability is vast, as 44 percent of American households earn less than $50,000 per year and the median U.S. income is $63,000.
  • In the Bay Area, the current minimum annual income required to purchase a median-priced home is more than $202,000, up from $90,000 in 2012. The median household income in the Bay Area averages about $100,000 in the eight local counties excluding Solano.
  • In Los Angeles, the current minimum annual income required to purchase a median-priced home is more than $112,000, up from $54,000 in 2012. The median household income is Los Angeles County is currently about $65,000.
  • Newly constructed homes cater to affluent homebuyers, with 60 percent of public builders across the U.S. now constructing homes with average prices higher than $400,000. In Los Angeles, the median new home price is $682,000, while in the Bay Area, it ranges from about $760,000 in Sonoma County to $1 million in Silicon Valley.
  • Only 24 percent of American renters can afford the median-priced new home today, and just 31 percent can afford a resale home.
  • And while there have been more listings on the market in recent months, inventory is still below average across all price tiers, especially for the most-affordable range, which is almost 50 percent below the average.
  • Lastly, the housing market’s performance and the current slowdown is not a nationwide trend — sales of existing home remain strong in the relatively affordable South.

What to Expect in the Months Ahead

  • The economy will remain healthy, boosted by low unemployment, continued hiring, and wage increases, but the rate of growth will slow.
  • Mortgage rates will likely reach 5.5 percent by the middle of 2019, leading to fewer home sales.
  • Historically, increases in mortgage rates when the economy was strong have generally had a small impact on activity, leading to a 7 percent to 10 percent decline in sales.
  • Online buyer behavior suggests that sales will remain solid in the markets in South (such as Charlotte, Houston, Raleigh, and Atlanta) but will decline in West Coast markets and some Northeastern markets, with California home sales expected to post a 2 percent to 7 percent decline.

What to Expect Beyond 2019

  • Rising rates will slow move-up homebuyer activity, with an 11 percent decrease in total home sales.
  • Mortgage availability has improved, though credit scores and proof of employment play a critical role (unlike during the early 2000s).
  • Affordability constraints are likely to drive builders to pivot down in price to smaller, higher-density, lower-specification homes in slightly less desirable locations. Also, builders are more likely to construct single-family rental properties.
  • The risk of a recession increases, with a 48 percent probability of a downturn within two years and a 64 percent chance within four years. Fifty-nine percent of economists forecast a recession in 2020.
  • However, housing risks vary by market:
  1. California housing markets generally rank normal to higher risk, with no market nationally categorized as very high risk.
  2. Affordability is the primary risk.
  3. A huge upside in the current housing market is homeowner equity, currently at $190,000 inflation-adjusted per U.S. owned household.
  • Other risks:
  1. A rapid acceleration in interest and mortgage rates shaking consumer and business confidence
  2. A decline in foreign buyer activity due to immigration policy or emerging market factors (such as currency, trade policy, local stock markets, or economic fluctuations)
  3. Immigration restrictions: There has already been a pull-back in H-1B visa approvals, which are critical for the tech sector in California; holders of these visas are also participants in local housing markets
  4. Excessive debt burdens (government, corporate, and consumer); if interest rates spike, they would have trouble repaying debt
  5. A stock market correction that could rattle consumer confidence and result in in job losses
  6. A “black swan,” or an unforeseen geopolitical event that triggers significant volatility in financial markets and the economy

California Outlook

  • The chart below shows the John Burns Home Value Index four-year outlook for median home price appreciation in six California metropolitan areas and/or divisions. The numbers indicate the average annual rate of growth or decline.
  • Because of affordability pressures, all six markets are projected to see notably slower price growth over the next three years.
  • Four of the six markets are forecast to see negative growth in 2021 of no more than 1.3 percent. However, all markets will see at least a 5 percent additional cumulative increase in 2019 and 2020 before the reversal in 2021.

Source: John Burns Real Estate Consulting

Taken together, with input from JBREC and the nation’s largest home builders, our final takeaway is that buyers and investors should proceed with caution but proceed nevertheless.

Selma Hepp is Pacific Union’s Chief Economist and Vice President of Business Intelligence. Her previous positions include Chief Economist at Trulia, senior economist for the California Association of Realtors, and economist and manager of public policy and homeownership at the National Association of Realtors. She holds a Master of Arts in Economics from the State University of New York (SUNY), Buffalo, and a Ph.D. in Urban and Regional Planning and Design from the University of Maryland.

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Bay Area Households Are the Nation’s Best at Sticking to a Budget

  • San Jose residents ranks as America’s best for living within their means, thanks to having the country’s lowest debt not related to housing and smallest revolving credit usage.
  • San Francisco places No. 2 for budget consciousness, with annual incomes that are more than $30,000 higher than the national median.
  • Homeowners in all six of the California cities included in the analysis have mortgage-debt-to-income balances higher than 100 percent.

A woman in front of a computer calculating her budgetAlthough San Jose and San Francisco were once again the nation’s two most expensive housing markets in the third quarter, residents of those cities have their borrowing habits very much under control.

A few months ago, a survey from CareerBuilder found that nearly 80 percent of Americans are living paycheck to paycheck to meet their expenses. To find out where consumers are the best (and worst) at living within their financial means, LendingTree examined August 2018 credit data from its user base and compared it with household-income numbers, ranking 50 U.S. cities on a 100-point scale.

San Jose tops the list of places where residents have the best control of their finances, notching a total score of 73.6. The city has the lowest amount of non-housing debt in the country, at 23.5 percent of income, as well as the lowest revolving credit usage of 27.3 percent. Additionally, San Jose millennials owe an average of $18,000 in debt not related to housing — $5,000 less than young people nationwide — and have the country’s lowest student-loan balances.

San Francisco ranks No. 2 for budget-conscious residents, scoring a 70.6. The City by the Bay had the country’s second lowest nonhousing debt and credit-usage numbers behind San Jose, a respective 27.7 percent and 27.4 percent.

Of course, when judged by mortgage debt as a percentage of income, Bay Area residents do not fare as well. San Franciscans’ mortgage balances equal 123.9 percent of their earnings, while San Jose homeowners have a housing debt-to-income ratio of 107.0 percent. In fact, homeowners in all California cities included in the list have mortgage balances that are more than 100 percent of their yearly earning: Los Angeles (121.0 percent), Sacramento (126.5 percent), and San Diego and Riverside (both 131.1 percent).

So why are residents of America’s most-expensive places to call home so good at managing their finances? High incomes are partially responsible; as LendingTree points out, the median annual income in San Francisco is about $88,000, compared with the national median income of $55,300. The fact that Bay Area residents tend to have higher education levels helps them earn such large incomes in a region with plentiful, high-paying technology jobs.

LendingTree offers some common-sense tips for prospective homebuyers who are fretting about their spending and budgeting habits, starting with consolidating debt and regular credit-score monitoring. And besides creating a monthly budget and paying bills on time, consider refinancing student, automobile, or mortgage loans to get a more favorable rate.

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How Long Will a Home Purchase Impact Californians’ Credit Scores?

  • The average American can expect their credit score to decline by 15 points after buying a home, with the total recovery time taking about 10 months.
  • San Jose and San Francisco homebuyers have exceptionally high credit scores but will need to wait roughly a year before their ratings return to normal.
  • Making on-time mortgage payments will help boost new homebuyers’ credit ratings, as will the diversification of their accounts by owning real estate.

San Francisco homebuyers have some of the best credit scores in the country, but they also face one of the longest roads to recovery after completing their real estate purchase.

A new analysis by LendingTree Chief Economist Tendayi Kapfidze examines how much buying a home affects credit scores in 50 major American metropolitan areas and the length of time that it takes ratings to return to their prepurchase averages. U.S. buyers can expect their credit scores to decline by an average of 15 points after they buy a home over a period of nearly five months. After that, the recovery begins and takes another five months for credit scores to return to the baseline.

Of the six California housing markets included in the report, San Jose fares the best when it comes to credit recovery. Before buying a home, San Jose residents boast credit scores of 725, the highest of any of the cities included in the study. Post-purchase, Silicon Valley credit scores fall to 711 for an average of 149 days before taking 173 days to recover, ranking it solidly in the middle of the country.

San Francisco homebuyers have almost as good of credit as their counterparts to the south, at 724, and they can also expect their scores to dip to 711 over a period of almost exactly six months. Once the 196-day recovery time is factored in, San Franciscans will need to wait one year and 10 days for their ratings to normalize, ranking it near the bottom of the list at No. 47.

The other Golden State cities included in LendingTree’s analysis also appear in the lower half of the rankings when it comes to total credit-recovery time: No. 39 Los Angeles (347 days), No. 40 San Diego (348 days), No. 44 Sacramento (357 days), and No. 48 Riverside (375 days).

As Kapfidze explains, the reason that Americans’ credit scores fall when they purchase a home is fairly logical: As the biggest purchase that most people will ever make, a real estate transaction adds a large amount of debt to one’s balance sheet. Once new homeowners have proven that they can swing the monthly house payments in a timely manner, their credit ratings gradually improve, boosted by the fact that having a mortgage helps diversify a credit portfolio.

Of course, having a good credit score is key to getting a home loan in the first place, and younger homebuyers could stand to improve their ratings to maximize their chances. Another recent LendingTree study reports that millennials have average credit scores of 634, the lowest of all generations. And earlier this year, Experian published an analysis finding that more than 60 percent of millennials lack a prime homebuying credit score.

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San Jose, San Francisco Home Price Gains Accelerate in the Third Quarter

  • Home prices in San Jose and San Francisco were up by a respective 16.9 percent and 11.6 percent year over year in the third quarter, ranking them among the 51 percent of U.S. housing markets where price growth is accelerating.
  • Los Angeles, Santa Rosa, and Vallejo saw home price growth cool from the same period last year.
  • Home prices in San Jose are nearly 60 percent above their pre-recession high.

Nationwide, annual home price growth was the slowest in more than two years in the third quarter, but the Bay Area’s two largest housing markets countered that trend, with appreciation higher than it was at the same time last year.

ATTOM Data Solutions’ latest quarterly report puts the median sales price for U.S. single-family homes and condominiums at $256,000 as of the third quarter, up 4.8 percent year over year for the slowest rate of annual appreciation since the second quarter of 2016. In a statement accompanying the report, company Senior Vice President Daren Blomquist attributed cooling price growth to declining affordability, which has been exacerbated by rising mortgage rates.

Nearly half of the 150 U.S. metropolitan areas that ATTOM Data Solutions tracks saw annual price growth decelerate in the third quarter when compared with the same period last year, a list that includes Los Angeles, Santa Rosa, and Vallejo. Los Angeles’ $640,000 median price was up by 5.8 percent from the third quarter of 2017, down from the 8.2 percent growth observed in the previous year. Santa Rosa saw only a slight cooling, with the $629,000 median price up by 9.4 percent compared with the 9.5 percent annual gains recorded in the third quarter of last year. In Vallejo, home prices rose by 7.6 percent to $425,000 after increasing by 11.0 percent last year.

San Jose and San Francisco were among the 51 percent of markets where annual home price increases accelerated when compared with the third quarter of last year. San Jose‘s $1,130,000 median sales price was up by 16.9 percent from the third quarter of 2017 after registering 13.7 percent appreciation the previous year. In San Francisco, prices rose by 11.6 percent to $865,000 after growing by 8.4 percent during the same period last year.

Home prices in San Jose are now 57 percent above their prerecession high. Prices in San Francisco have surpassed their precrisis peaks by more than 20 percent, while Los Angeles and Santa Rosa are up by more than 10 percent from previous highs. Vallejo home prices are still about 6 percent below their prior peak.

Nationwide, home sellers netted returns of 32.3 percent since the time of purchase, up slightly on both a quarterly and yearly basis. As in the first two quarters of 2018, San Jose and San Francisco led the nation for seller returns, a respective 108.7 percent and 77.3 percent more than original price. Santa Rosa also ranks among the top five housing markets in the nation for returns, with sellers gaining an extra 67.9 percent from the time of purchase.

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Down Payments Rise, First-Time Homebuyer Activity Falls in 2018

  • First-time homebuyers have accounted for 33 percent of transactions in 2018, down slightly from last year.
  • U.S. homebuyers are making median down payments of 13 percent, up from 10 percent in 2017.
  • Like last year, 95 percent of Americans started their home hunt online and 87 percent used a real estate professional during the purchase process.

A pen and calculator sitting on a stack of $100 billsU.S. homebuyers are dropping the largest down payments in 13 years in 2018, while student debt and deteriorating affordability continue to hinder more younger Americans from entering the real estate market.

Those are two key finding from the National Association of Realtors’ 2018 Profile of Home Buyers and Sellers, which says that first-time buyers have accounted for 33 percent of home purchases this year, down from 34 percent in 2017. First-time homebuyer activity has been sliding for three years, a trend that NAR Chief Economist Lawrence Yun says is exacerbated by a severe inventory shortage of starter homes.

Yun points to other familiar factors that are preventing more younger Americans from purchasing homes, including rising mortgage rates and student debt. Nearly one-quarter of homebuyers of all age groups report having student loans at a median of $28,000. Forty percent of first-time buyers carry student debt, with a median balance of $30,000. NAR also found that half of the 13 percent of homebuyers who are having difficulty amassing a down payment are repaying student loans.

Saving for a real estate purchase is even more difficult this year, with the median down payment at 13 percent, up from 10 percent in 2017 and the highest since 2005. First-time buyers are making median down payments of 7 percent, up from 5 percent last year. Nearly 60 percent of homebuyers funded their down payments with their personal savings.

Prospective California and Bay Area homebuyers should plan to sock away more than the national average to purchase real estate here. In a recent study of borrower data on its website, LendingTree found that Golden State homebuyers made average down payments of 21.44 percent — $97,809 — in the third quarter, the most in the nation. And this summer, a report from ATTOM Data Solutions estimated that the median down payment in the San Jose metropolitan area was nearly $300,000, while San Francisco buyers were forking over $180,000.

While first-time buyer and down-payment trends have shifted moderately from 2017 to 2018, the way that Americans shop for and purchase homes has not. For the third consecutive year, 95 percent of homebuyers began their search on the Internet, while like last year, 87 percent used a real estate professional to seal the deal. Only 7 percent of home sellers decided to market their properties themselves, the lowest number recorded since NAR began tracking that statistic.

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