California’s ability to respond to housing demand is severely limited, according to a recent report by Trulia.

Trulia measures this ability to adjust — called housing elasticity — by comparing the number of new units built in a metropolitan area compared with the rise in prices over the same period. This produces an index figure between zero and one. The higher the number, the more able the metro is to keep up with housing demand and respond to the needs of its growing populous. Alternatively, a lower figure indicates the metro’s ability to supply housing is held in check.

Nationally, this housing elasticity index number averages 0.17, just below the historical average of 0.2. The peak index number over the past 30 years was 0.29 in 1999.

However, in coastal California, housing elasticity is well below average, at:

  • 0.04 in Los Angeles;
  • 0.04 in San Francisco;
  • 0.07 in San Jose;
  • 0.08 in Oakland;
  • 0.08 in Orange County;
  • 0.10 in San Diego; and
  • 0.11 in Ventura.

Alternatively, inland California sees higher-than-average housing elasticity, since the building process is smoother here and there is more outlying space to grow, with the index at:

  • 0.21 in Riverside-San Bernardino;
  • 0.22 in Sacramento; and
  • 0.26 in Bakersfield.

To get a sense of the divergent markets that exist in the Golden State, compare the metros with the highest and lowest housing elasticity on the list.

In Los Angeles, home prices increased 211% from 1996-2006. During this time, the number of housing units only increased by 9%. This produces the low index number of 0.04.

In Bakersfield, home prices increased 128% from 1996-2006. Housing supply increased by 33%. This dynamic produces the higher index number of 0.26.

Trulia found that metros with the longest average wait-time to receive building approval intuitively had lower housing elasticity. In other words, the harder it is to build, the more restrained the housing supply relative to demand. This causes prices to rise exceptionally fast.

Returning to our example, it takes about eight-and-a-half months for building approval in Los Angeles. In contrast, it only takes 7 months for building approval in Bakersfield. This difference is even more pronounced in other California areas, like Ventura, where it takes almost 15 months for building approval.

More inventory is needed

Demand is ultimately what determines home prices. This is part of the reason behind the higher prices of the past few years. Other pieces of the puzzle include continuing low mortgage interest rates and a home resale inventory that was diluted by speculator over-activity in 2012-2014.

While prices have increased at an annual rate of 8%-10% since 2014 (a cooling off from the 20%+ annual increase experienced in 2012-2014), incomes have fallen quickly behind, having increased only 3%-4% annually in recent years. The result has been the inability of buyers to keep up. For many, the financial finish line keeps receding faster and faster into the horizon.

As a result of low housing elasticity, would-be homebuyers are forced to continue renting while they continue to save for down payments. In the meantime, the renter population continues to grow as young adults — members of Generation Y (Gen Y) — move out of the nest in the biggest generational shift since the Baby Boomers came of age. This is evidenced in today’s low homeownership rate. Nationwide, it’s at a 50-year low, below 63%. In California, it’s even lower at 53.4% as of mid-2016.

Despite the rising number of renters, multi-family construction has actually decelerated in 2016. The supply-demand imbalance has led to rapidly rising rents, which in some places are increasing even faster than home prices.

The job of builders is to respond to market demand. So why aren’t they responding to this demographic shift by building more multi-family rental properties?

Local governments need to open the gates for builders by making the permitting process easier. This includes loosening zoning restrictions and creating building incentives to break ground on new projects. More rental inventory will cool off the price of rents, allowing Gen Y to put more of their slowly growing paychecks toward saving up for home purchases, and eventually, become owners.