Bruce Norris is joined again this week by Selma Hepp. Selma is the senior economist for the California Association of Realtors, a statewide trade organization with more than 100,000 members dedicated to the advancement of professionalism in real estate. Selma directs the activities of the association’s research and economics group. She oversees the research and analysis of housing markets and economic trends, member and consumer surveys, and the impact of real estate related regulatory and legislative policies. She earned her Masters degree from SUNY at Buffalo and a PhD from the University of Maryland.
Selma just opened up the California Association of Realtor’s favorite word: affordability. Bruce said we came from numbers he had never seen before in 2011 and 2012 hovering in the mid-50s. Currently we are at about 32% in terms of affordability. We are back at a health range in the historical average. It’s is helpful to have it where it works out for this to be the median affordability. At 32%, it depends on if you are going down from a higher number. For Bruce, 32% is a very healthy affordability since you have a history of getting much lower. If you are going up from affordability that is lower on your way up, normally that accompanies markets that are not doing well. At the end of the day, affordability is just a math computation on how much people are willing to pay on a property and the going interest rate. You can have a very high affordability and still not have people want the product called real estate.
Selma said we dropped about 20 percentage points in the last couple years. In the process, with each drop in percentage points and affordability, we lose about 120,000 households that can qualify for a median-priced home in California. With 20 percentage points, we are talking about 2.4 million people who cannot qualify for the median priced home in California. However, when you compare house payments and qualifying income from the peak until now we are still technically in an affordable environment. At the peak, mortgages and house prices were different. It is very relative when we talk about this and you have to look at now in comparison to the peak. We have lost 2.4 million households that cannot qualify due to the income they are supposed to have depending on the median income. It also has to do with increasing mortgage interest rates. Inside the 2.4 million homes has to be existing homeowners.
Selma said they look at first-time homebuyers, and the calculation for this does not assume they are able to come with 20% down. With those already-existing homeowners, you would assume that they are able to come back with a 20% down. This is especially true after 2013 helped them out. Bruce said this is interesting to him and why he looks at this affordability number and goes back to look at the 32% number. To him this is a very healthy percentage since we usually head below 20% before we have the market really end. Usually when affordability goes down, volume of sales go up.
If you look at these two charts, Bruce said it is hard for him to look at how we lost 2.4 million households and yet the volume continues to grow. There seems to be a disconnect between affordability declining as volume of sales increase. It could possibly be people who are moving up constantly. The first-time buyer would certainly be mathematically eliminated first since they did not gain any equity. Bruce asked when people buy and move up home are they bringing most of the cash they net from the sale to their next purchase. The down payment would sometimes far exceed 20% at this point.
It is interesting that affordability sometimes looks negative when you figure it one way, but look at other charts and see that nothing negative usually happens at 32% affordability. They usually go down until there is a breaking point. Bruce believes the breaking point is when enough lenders simultaneously have to say no to people that really don’t qualify. At 32%, we are at 2001 range as well as 1987 and 1977. These were followed by really good years, and this was part of whenever Bruce looks at the affordability chart and comes to different conclusions than he normally hears from CAR. This is why Bruce asked about when you have a room full of economists and you are doing research, there has to be somebody who will say they do not think something means what someone else says it does. They always say if you have 100 economists in one room, you will have 100 different opinions. Bruce said this is part of the fascination of trying to figure out what is next in our market.
In the last segment they discussed migration. Bruce said he thinks one of the important things besides affordability is also how migration affects the employment in California. It seems like the one industry we really do not have clicking on all cylinders is construction. This is a big driver of immigration to California. This whole question around construction employment is very interesting because from what she hears from the builders, a lot of the trouble in getting skilled workers is that they actually went to work in the oil field. As a forecaster, this is one of the things they cannot predict.
When we lost in California, compared to the nation we had a much more significant loss in employment and have not gotten to the levels nearly where a lot of the nation is. A lot of this is due to lack of construction employment that has not come back. Bruce asked if the builders will construct more if they had skilled labor, to which Selma said it is a lot of things for them. There is the skilled labor as well as California’s regulatory environment. They understand that the buyer that has been entering in the market is not the type of buyer they are looking for. There are institutional buyers and investors and foreign buyers. This is not the market they are going after, so they are waiting for the traditional buyer to come back before they start ramping up their production.
What is interesting is that usually when you are about to ramp up production, before this they would have ramped up sub-division creation. In Riverside, for at least five years sub-division creation is down 95%. This means that whenever they decide to crank on the building they will go through their existing lots. Bruce thinks there will be several years where there is a big hole in what they need and what they have. When you look at the new housing permits, there was a drop after 2006/2007 and it has since been at that steady, very low level. Right now we are at about 8,000 units being built, and we have about 15,000 household formation in the state. We are definitely not building up to the demand. A lot of that that building is coming in the multi-family sector as well as apartments, but not in the single-family sector.
Regarding household formation, if you do research you see a shift in what comprises a household. The assumption is that it is 2.3 kids and a married couple. However, this is no longer true. The whole concept of household has changed. Selma said she read about why the Feds missed the downturn because they were looking at the wrong numbers. It may be that we are looking at the wrong numbers when talking about household formation. They have not seen such a significant shift in what household means and may be completely missing the boat here in terms of only looking at numbers. The numbers show a drop, particularly in California household formation. From 2008 to today they have formed some 600 fewer households than we would have created had we grown at the rate we were growing prior to the crisis. Selma does not know if the state finance department comes up with the numbers by doing multiplication somewhere else or if this is their projection using something else.
Bruce said a fair amount of people that are households now are single. You have one wager, and what you can qualify for has to be very different from the traditional household. This may be part of the reason why we are not seeing a ramp-up in single-family activity but rather multi-family construction. Another thing Selma heard is they are building apartments to cater to these young people who are finally getting jobs and moving out of their parents’ homes, but they cannot afford their own home and go into an apartment first. Five years down the road, hopefully their income situation and they will have savings. They can then switch the apartment units into condo units, but they will already be condo ready.
This generation has certainly been laggards when it comes to household formation, but Bruce still believes what it comes down to is they will want their own piece of land and a single-family house as opposed to a condo with a weight room twenty stories down. Selma said it is a hard call right now. She did a lot of surveys on this, particularly the renter surveys. They did telephone calls and online surveys, and naturally the population is going to be different on top of telephone versus online service. Here you will get younger people on the online surveys. They are more interested in density. Homeownership is still important to them, and they still strive to have something on their own. In urban planning discussions, they talk about how people may be single for longer. However, when they get to the point where they double-up in the household and have children, that is the breaking point at which they are moving away from the condo and into the single-family home.
For this generation, instead of happening in at 21 and 22, it is happening at 28 and 29. Therefore, it has been a while since they formed households. On the other side of the equation, you have the maturing of the baby boom generation. Bruce asked Selma what she typically looks for when someone goes from 65 to 75. He asked if they un-own their big house and look for something else. Selma said historically this is what they typically saw. Interestingly enough, it has not been happening this time around in the last few years. Bruce said this makes perfect sense to him since this generation has been catered to for their entire life. Would you really want to leave your big house to go to a little place with common walls?
Another question is why you would be selling in the downturn. If you have already paid off your house, maybe even downsizing, then why would you be selling right now. This is something she thinks about when asking why there is no inventory and why baby boomers are still sitting out in their original long-term property they have owned. Traditionally when you have a downturn and begin a comeback, usually the first-time buyer is about half of the volume. We are somewhere in the 30s as far as first-time buyer participation. Historically we are around 38%, although the last survey showed only 25%. This is a really significant drop, and she does not think since the census started tracking this number that we have seen much of a drop.
Bruce said this is a big hole in the market, and he thinks one of the things that will help is even though FHA has lowered their loan limits. They have gotten more aggressive with who they will qualify. There is a chart Bruce picked out from an FHA report that showed in 2008 between the FICO score 560 and 640 that 60% of FHA’s business fell within those FICO scores. Now it is 9%. Basically, they did away with half of their volume just by changing the FICO score, and now a recent email said they are back to 560. There might be a resurgence to who they say yes to as first-time buyers, which would be a big help.
Selma said the tax credit in 2009 pulled in a lot of demand. Whether it pulled forward and the people would have eventually bought later or it stimulated demand is something about which economists debate. Nevertheless, it shows how much $9,000 helps because in multiple surveys we have seen that the biggest problem for everyone is the down payment. They may have no problem affording the mortgage, but they cannot come up with the down payment. The time to save would take way too long. When you are trying to figure out policies, one of the things you used to be able to do was have a Nehemiah fund that would fund the down payment like a gift. It would not be relative, but they look at this and say a lot of our default came from that type of program. It is hard to get a policy-maker to look at this and say they will go back to where we can have gift funds that are not connected to a relative.
If you look at one of the most successful loan programs go back 50, it is the veteran 0 down. It does not have a down payment, but it has a better delinquency record than any loan that we have. A lot of it depends on who is borrowing the money as well as the loan process. Whatever they are doing makes the loan safer than a down payment. There are down payment assistance programs generally through the state and local economies that were looked at when there was a lot of discretion about QRM and 20% down. Part of the requirement is to do education classes and money management, and the government programs are usually organized around contributions. If Selma were to contribute $100 and you give her $1,000 for every $100, this does not take long and accelerates the process.
The default rates are minimum in comparison to all other products and would open the world up not just to sales, but also the economics for the family going forward. They have become a homeowner, and they have equity. Eventually they may have an equity line that allows them to participate in other investments. It is a very big deal and a big difference in how things end up for that family going forward. They also lock in their payment, so instead of their rent being adjustable and always going up they now have a fixed housing cost. This is a very big deal for homeownership too.
Regarding inventory, Bruce said he noticed from December to now inventory has gone up from three months to over four months. Bruce does a lot of speaking and sees how a lot of people are concerned about this. Bruce wondered if most of this increase is due to actual more listings there, or is it due to sales not being as brisk as they would be. You are talking about the unsold inventory index, which is basically a ratio of raw inventory to sales. Every time you have sales going down, the index itself goes up. This is what we saw in the latest index climb that went from around 3 to 4.3 months. We are not necessarily seeing that much more raw inventory, but fewer sales.
Selma thinks when we look at raw inventory numbers at the aggregate, we do have more inventory. We have about a 10% year-over-year increase in inventory. You are also comparing it to a year ago when we were at our absolute lowest, so 10% over that is not that much more. There is a small increase in inventory, but the index makes it look like it is more than it actually is. What is significant is that most of the sellers now are equity sellers. When they sell theirs, they make another. It is hard to see how the inventory level would be a significant down drag on price any time soon.
Thanks for listening. From this interview, I think we can say we are all looking forward to a healthy 2014.
For more information about The Norris Group’s California hard money loans or our California Trust Deed investments, visit the website or call our office at 951-780-5856 for more information. For upcoming California real estate investor training and events, visit The Norris Group website and our California investor calendar. You’ll also find our award-winning real estate radio show on KTIE 590am at 6pm on Saturdays or you can listen to over 170 podcasts in our free investor radio archive.