California tiered home pricing

The home price rise is slowing in California’s largest cities. Still, prices increased across all price tiers in May 2016 compared to the prior month. The statewide average for low-tier property prices was 10% higher than a year earlier. Average mid-tier prices were 6% higher and high-tier prices were 6% 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 July 29, 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 07/29/16

Chart update 07/29/16

May 2016 Apr 2016 May 2015 Annual Change
Low Tier 261 260 239 9%
Mid Tier 226 224 215 5%

High Tier

210 208 199 6%

Los Angeles Home Prices

Chart update 07/29/16

Chart update 07/29/16

May 2016 Apr 2016 May 2015 Annual Change
Low Tier 275 272 252 9%
Mid Tier 253 251 238 7%

High Tier

237 235 228 4%

San Francisco Home Prices

Chart update 07/29/16

Chart update 07/29/16

May 2016 Apr 2016 May 2015 Annual Change
Low Tier 236 233 213 11%
Mid Tier 231 230 215 7%

High Tier

228 229 217 5%

California Home Prices – Tri-City Average

Chart update 07/29/16

Chart update 07/29/16

May 2016 Apr 2016 May 2015 Annual Change
Low Tier 257 255 235 10%
Mid Tier 237 235 222 6%

High Tier

225 224 215 6%

*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.

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22 Comments

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  5. Buffalo said:

    First Tuesday keeps trying to convince us that prices are in a bubble and won’t go up.

    But the reality is that prices just keep going UP—UP—UP!!!!

    In my opinion First tuesday has no ability to predict future prices and their opinion as to future prices are totally worthless!!!

    • Jason said:

      No, Buffalo, you’re screaming at the messenger, First Tuesday. All First Tuesday is doing is reporting what many sources rely upon (though we all may disagree): Robert Shiller and his home price index. First Tuesday was not predicting anything. They are merely reporting Shiller’s stuff.

      If you don’t like FT’s reporting you can write an intelligent one of your own. I’d like to see how you do.

  6. jt said:

    Southern California coastal cities continue to see rising prices. In 10 years, I expect they will double. And, they are already at all time highs.
    As far as the lower sales volume, that is being partially caused by the tax laws. Now a single owner can only take 250K from a sale tax free. A married couple is at 500K tax free. The rest of the gain is taxed. Add the 6% sales commission … the result is many Southern California beach homes have 7 figure gains and the owners are never selling. That is causing extremely low volumes at the beach. The only sellers are either forced sales, or estate sales. Move up buyers are not willing to pay the tax load for a trade up.
    Also, your bubble graph is very misleading. If the graph went started from 1900, the bubble would not look like a bubble.

    • Mike said:

      Excellent point. The tax impacts of selling real estate at these high prices does mean fewer listings, and continued price increases associated with this tax-driven scarcity.

  7. bode said:

    If you want adjusted for inflation go to calculated risk. Here’s his most recent “inflation adjusted” aka real prices for some major indices (oh and don’t forget to use seasonally adjusted numbers also unlike the msm):

    http://3.bp.blogspot.com/-4h2F2tquvME/VE-7qo3humI/AAAAAAAAhDs/5-JYDmXDEaE/s1600/HPIRealAug2014.PNG

    On a national basis adjusting for inflation we’re looking at 2002 “real housing prices.” I know everyone who doesn’t own a house would like it to be 1990 levels but it isn’t and isn’t going to be. That would be another 40% drop and why? With the lack of economic catastrophe, excellent underwriting since 2008 and near lack of homes with negative equity what will cause the crash? A mad rush of people who aren’t underwater selling their houses because they’ve got a job?

  8. Frank Zak said:

    I have been a broker 34 years in Los Angeles.

    This analysis is opinions on where price is going in the future,
    since you people have got it so wrong in the past, why not give
    up on forecasting. Be humble and admit you were wrong.
    Prices have gone up despite your constant harping we
    are in a bubble.

    • Alan L. said:

      If you were to look at the graphs, you would see that there is a certain pattern.

  9. S.Hall said:

    your article regarding the current and future market is well taken.
    We were experiencing many cash transactions which now seem to be slowing
    down. This could be due to the end of the year Real Estate activity.
    All I Can say is your article speaks nothing but the truth.

    Thank You

  10. Jody S. said:

    Do you have info on the East, South, and North bay tiered markets? San Francisco is not nearly equivalent to those locations and I would appreciate very much to know the tiers and movement on them.

  11. Ramesh Bhambhra said:

    This is good analysis of breaking down the real estate market into 3 tiers. Indeed as an agent … I have often used a similar analysis to help buyers and sellers in make their real estate investments appropriately. As a corollary to the 3 price tiers … I also use a similar analysis by properties distance from the employment hotbed. With the homes at the heart to be in tier 1…. say homes within 5 to 10 miles, 10 to 40 miles, and 40 to 75 miles.

  12. pops said:

    Great Articals. The next real estate top is projected about 2023, but until about 2017 real estate prices are going to be an up and down roller coaster ride, keep your powder dry, better prices are right around the corner, watch us baby boomers dump our over levered homes in order to get out from under the big payments to be able to afford to retireeeee.

  13. Frank Zak said:

    These top calls are getting funny. I have been a broker
    in L.A. 33 years. Listen to these people and you will
    waste a great buying opportunity.

    Real estate runs a 17 to 18 year cycle.

    Next top 2023 to 2024.

    Watch as these people try to call a top for the next decade.

    They are all trying to make a name for themselves.

    Most ridiculous posts I have even seen. Baby boomers
    are cashing out lump sum 401k”s and pensions. Huge
    amounts of money are being dumped in the system.

    It gravitates to houses. These experts always leave out the biggest factor
    effecting the real estate market. It will cost you a fortune if you
    listen to them.

    • Jim Olson said:

      The next top is when statewide affordability reaches 17%.

  14. BigIrr said:

    Excellent graphs, but the “matching” could be the “HUMP” vs. “FLAT LINE” and thus this could show the weakness of the cheaper homes “owners & shoppers” vs. the more expensive properties. AKA the higher the price, the less the volatility or “beta”….

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  16. joe said:

    these are adjusted for inflation, unless you think the inflation rate was 0% from 1989 to 1999.

  17. David Roth said:

    I’d love to see these adjusted for inflation. Then the prices today would likely be somewhere below the 1990 peak.

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