The home price rise is slowing in California’s largest cities. Prices increased slightly across most price tiers in August 2016 compared to the prior month, though some mid- and high-tier markets remained level. The statewide average for low-tier property prices was 9% higher than a year earlier. Average mid-tier prices were 6% higher and high-tier prices were 5% higher than a year earlier.

Anticipate prices to rise just slightly through the rest of 2016 due to the strengthening economy and jobs market. However, after mortgage rates rise due to action by the Federal Reserve — likely in 2017 — expect home sales volume to trend down and prices to follow within 9-12 months.

Updated November 2, 2016. Original copy posted September, 2009.

Charts are updated monthly. There is a two-month lag in reported data.

San Diego Home Prices

Chart update 11/02/16

Chart update 11/02/16

Aug 2016 Jul 2016 Aug 2015 Annual Change
Low Tier 266 264 245 8%
Mid Tier 231 230 217 6%

High Tier

211 212 203 4%

Los Angeles Home Prices

Chart update 11/02/16

Chart update 11/02/16

Aug 2016 Jul 2016 Aug 2015 Annual Change
Low Tier 280 278 255 10%
Mid Tier 257 256 241 7%

High Tier

241 240 230 5%

San Francisco Home Prices

Chart update 11/02/16

Chart update 11/02/16

Aug 2016 Jul 2016 Aug 2015 Annual Change
Low Tier 244 242 220 11%
Mid Tier 233 233 219 6%

High Tier

228 228 216 6%

California Home Prices – Tri-City Average

Chart update 11/02/16

Chart update 11/02/16

Aug 2016 Jul 2016 Aug 2015 Annual Change
Low Tier 263 261 240 9%
Mid Tier 240 240 226 6%

High Tier

227 226 216 5%

*The three pricing tier amounts listed in the Tri-City charts are averages of the tier constraints in Los Angeles, San Diego and San Francisco.

The above charts track sales price fluctuations of single family residence (SFR) resales in California’s three largest cities. Each city’s sales prices are organized by price tier, giving a clearer picture of price movement in each price range within the market.

To understand the “big picture” of the disparity between low-, middle-, and high-tier sales fluctuations, look to the Standard & Poor’s/Case-Shiller home price index as the authority. The index is an invaluable source of information and price comparisons for California’s three major cities and the state as a whole.

The above charts track changes in specific tiers according to the Case-Shiller home price index, displaying how different ranges of house prices in the market perform in comparison to one another. Portrayals of pricing in California take many forms. The index figure is particularly useful as it displays relative price movement rather than a misleading dollar amount which actually fits no single property.

Unlike many media sources, first tuesday shuns the simplistic median price approach. That approach tracks all home prices as a single tier by assigning them one average price. This one-price-fits-all dollar amount looks good on paper, but means nothing in the real world since it is a mathematical abstraction. Neither the actual nor adjusted median price represents the price of any single property. For the vast majority of properties sold or for sale, the median is a mathematical distortion.

Brokers seeking the actual value of a specific property would do well to remember that there is no such thing as a “median priced home” — you simply cannot find it. Median price is a statistical point which fails to work in the analysis of any price-tier analysis of properties, much less an individual property.

To determine how real estate will actually behave in the future, you cannot compare the price of a low-tier property with that of a high-tier property. Properties in different tiers move in price for very different reasons. Although the market tends to move in the same direction over time, the percentage of movement can vary greatly from tier to tier.

The best way to initially evaluate a property and set its price is to study comparable property values in the same demographic location (same house, same tract). Other ways to set the ceiling price include:

  • cost per square foot (replacement cost); and
  • income analysis methods.

Return to sanity

Now that the housing price bubble of the mid-2000s has burst, we need to know more than ever about the economic factors that cause real estate prices to move quickly or slowly. Also important is whether those factors affecting price can help us predict the speed at which different segments of the California real estate market will recover.

Price persistence and illiquidity are the two factors that Economist John Krainer uses to explain price movement:

Price persistence is the tendency of listed prices in owner-occupied real estate to resist change, staying high even when the market for resale homes has dropped, a condition more commonly called sticky pricesdownward price rigidity or the money illusion.

Related articles:

Federal Reserve Bank of San Francisco: Asset Price Declines and Real Estate Market Illiquidity

Home prices remain high today for two reasons:

  • the lingering price illusions left by the speculator frenzy of 2013-2014; and
  • the recent drop in mortgage rates which has increased buyer purchasing power.

However, the Federal Reserve (the Fed) announced the increase of the short-term interest rate (a benchmark for mortgage rates) at the end of 2015. This will affect mortgage interest rates later in 2016, once the bond market adjusts to the new regime of rising short-term interest rates. Once mortgage rates rise consistently, buyer purchasing power will decrease and prices will suffer.

Search frictions and debt overload hindrance

The reluctance of prices to adjust quickly to real financial conditions in the real estate market is due to two causes. The first cause is the difficulty of finding a property through a gatekeeper such as a broker, agent or builder, and then agreeing to an appropriate price, called search frictions.

In the hunt for a home, these search frictions make it far more difficult for properties to change hands and prices to be negotiated at current market rates. This prevents deals from being made when making a deal is what everyone has in mind. Thus, these frictions hinder the speedy resolution of a financial crisis, and work to the future detriment of the multiple listing service (MLS) environment.

Seller’s agents could be far more helpful by figuring out what it is they are selling, the due diligence rub that they so far are finding difficult to act on, then prepare a humble package about the conditions of the property improvements (TDS/NHD and reports), its title, its operating expenses, neighborhood statistics and the like for the buyer and the buyer’s agent to be able to make fast decisions.

The second cause of this lag is the crippling load of debt underlying many California homeowners which makes leaving a property (for those who must relocate) more difficult,  called debt overhang. Excess mortgage debt on a property forces buyers and sellers to ascribe distorted values to the real estate, part of the money illusion driven by property debt.

Restabilization of real estate market pricing and sales volume to meet the current economic reality, a prerequisite for the commencement of a recovery, will be difficult until the mortgage debt overhanging property owners can be matched by the property’s value (called asset inflation),or reduced to that value (called a loan cramdown modification).

Ultimately, negative equity homeowners are forced to become more financially rational. The good news is, these underwater homeowners are decreasing as rising prices boost them into positive equity.

Property caravans serve a useful purpose

When brokers can broadly agree upon an appropriate price, property values will reset constantly to their basic worth — cash values — without prices and sales volume rocketing to the artificial heights of a housing price bubble or the artificial lows at the bottom of the bubble’s collapse. Thus, the historical (long-term) trend line of property prices will be more closely maintained from year to year; boring, but better for the livelihood of all involved.

However, the combination of search frictions and mortgage debt overhang tends to make property owners reluctant, or simply unable, to sell for the property’s fundamental value (the “true cash value” of the property at any given time), especially in negative-equity, owner-occupied residential real estate.

Instead, sellers keep their homes on the market longer, hoping in many cases to avoid default, fishing for the rare buyer who might be willing to pay a higher price. Seller’s agents in high-end properties tend to pander to these instincts. This leads to price stagnation, in which the fall of prices is unnaturally prolonged: not a good thing, since it greatly extends the length of a market collapse, as it did in Japan in the 1990s and Mexico in the 1980s.

If only we could stick to a cash price

Japan’s financial crisis of 1990 included a collapse in both commercial and residential property values. Income property prices were especially volatile throughout the collapse, ultimately falling faster and deeper than owner-occupied residential prices, but bottoming sooner since investors are more rational. Owner-occupied residential real estate, which had a much higher variety of pricing and a greater burden of debt, also eventually fell catastrophically, but less dramatically.

The difference in price movement is because income producing real estate is more easily evaluated (by capitalization rates (cap rates), income flow, and replacement costs) and typically less burdened by high loan-to-value (LTV) debt ratios so equity remains to be worked with. These conditions of ownership make it easier for buyers and sellers to agree upon an appropriate price; thus, providing the owner with the ability to cash out — greater liquidity.

The relative ease of income property evaluation makes that part of the real estate market a more exciting and less predictable field, as cap rates can change dramatically, altering market values in a moment. Conversely, owner-occupied residential property moves slowly and steadily with sticky pricing, sellers not reacting to the recessionary market forces existing at the time. The historical reality of market implosion.

Readers should remember that real estate pricing often fails to correspond to objective reality. The discrepancy between the prices that homeowners set and the prices homes actually garner in the market is attributable to the human factor. Outrageous bubbles become more outrageous, and collapses become more devastating, due to a common set of irrational beliefs about market behavior. The most dramatic example of market fallibility took place in the very recent past — our Great Recession.