2015 in review and a forecast for California’s housing market in 2016

Learn about the changes brought to California’s real estate market in 2015 and how they’ll impact real estate business in the coming year.

New real estate laws

Each year, federal and state governments pass new laws which affect California real estate transactions, homeowners and agents. In 2015, the biggest change took place in the world of mortgage origination disclosures.

The Consumer Financial Protection Bureau (CFPB) introduced new integrated disclosures to replace the old required consumer mortgage lender disclosures:

• The Loan Estimate replaced the Good Faith Estimate (GFE) and the initial Truth-in-Lending Statement [See RPI Form 204-5 and 221]; and
• The Closing Disclosure replaced the Settlement Statement (HUD-1) and the final Truth-in-Lending Statement. [See RPI Form 402]

There was lender concern that use of the new disclosures may delay closings and somehow hurt home sales after they took effect in October 2015, a time of the year when sales volume is greatly reduced as the norm. However, while closings slowed in November 2015, timely closings were restored by the end of the year.

One real estate-related law to look ahead to in 2016 is the newly required Office Management and Supervision (OMS) continuing education (CE) course mandatory for brokers and sales agents renewing their licenses in California. Beginning January 1, 2016, California Bureau of Real Estate (CalBRE)-licensed brokers and sales agents now need to complete an approved OMS course as part of their continuing education requirements. [Calif. Business and Professions Code § 10170.5]

Editor’s note — first tuesday was the first CE provider to include the required OMS course in every CalBRE continuing education course enrollment. View enrollment details here.

To catch up on the many other new real estate laws introduced in 2015 — most of which will take effect beginning in 2016 — see:

• New real estate laws; and
• Pending real estate laws.

Economic picture — here and abroad

The big news going into 2016 is the Fed’s decision to increase the Federal Funds rate which directly affects ARM rates. This hovered around 0% from 2009 to December 2015. At that point, the Fed increased the rate to fall within their target range of 0.25%-0.5%. Looking forward, the Fed indicates they will gradually increase this short-term rate nearly one percentage point in each of the coming three years and plans for the Federal Funds rate to rest around 3%-4% by 2018.

This rate increase is of immense importance to the real estate market, since rising mortgage rates makes borrowing dollars more expensive for homebuyers. In turn, buyer purchasing power is reduced as the mortgage amount for which a buyer is able to qualify decreases. Thus, home sales volume are likely to slip and prices will suffer. 2016 won’t likely experience a decrease in prices, but by 2017 sellers (and their agents) will have lost their sticky pricing illusions and prices will dip briefly before we head into the next expansion, on the tail of a swiftly recovering jobs market.

That’s here in California, and more broadly across the nation. But the global economy experienced several setbacks in 2015, from the stalled recovery in the Eurozone and Japan to China’s renminbi decline and Brazil’s, Russia’s and Turkey’s magically shrinking economies. How do these global forces influence our U.S. economy, and more specifically the real estate market?

First, the uncertainty of many global markets causes foreign investors to eye U.S. Treasury Notes as stable. Parking their money in 10-year T-Notes is a safe bet while their own nations deal with economic setbacks. Therefore, as long as investors place heavy value on a 2% return for 10-year T-Notes, fixed rate mortgage (FRM) rates will remain near their current low rates of 4% or below. As 2016 moves along, these investors will eventually withdraw from 10-year T-Notes as they find investment opportunities in their home countries, and FRM rates will increase.

14% of real estate agents surveyed by the California Association of Realtors assisted international clients in 2014, and reports from national sources indicate the share of foreign buyers continued to rise in 2015. The largest international investor presence in California is found in San Francisco and Los Angeles.

However, international interest in owning California’s real estate will subside when foreign economies begin to improve, likely by late 2016. Most foreign investors hail from China, and investors have begun to look to more stable sources of income following China’s economic shock late in 2015. More importantly, the relatively strong U.S. dollar now makes it difficult for Chinese investors — and investors from other global economies in poor shape — to purchase U.S. real estate in 2016. Therefore, expect to see the investor presence decline somewhat throughout 2016.

California’s housing market

California’s housing market experienced a modest boost in 2015 over the previous year. Home sales volume increased about 9% over 2014, with roughly 39,000 more homes sold in 2015. For historical perspective, 2015 is about level with 2013, a year when speculator buying greatly increased sales volume, and about 300,000 — or 40% — less than the number of homes sold in 2005 during the Millennium Boom’s peak.

Home prices also increased in 2015, ending the year 7%-10% higher than the same time at the end of 2014. Prices increased more quickly in low-tier homes and less so in high-tier homes, continuing the bumpy plateau sales volume experienced throughout this long recovery.

Construction across California continued to recover in 2015, but at a reduced pace. Single family residential (SFR) construction starts rose by 10% over the previous year. Multi-family construction rose by 20% over 2014.

This is an impressive recovery for multi-family starts, which experienced the best year since the multi-family boom of the 1980s. However, SFR construction starts still have much room for improvement, currently experiencing only one-quarter of the construction pace of the Millennium Boom.

Going forward, expect history to repeat itself. In the 1980s, the Baby Boomer generation produced high demand for multi-family rentals as they graduated and finally found jobs. This environment fueled the boom in multi-family construction. In the following decade, their desire to trade up for SFR housing fueled the late 1980’s and l990’s boom in SFR construction.

Now, the children of the Baby Boomer generation — Generation Y (Gen Y) — are finally coming of age, albeit belatedly in the aftermath of the Great Recession. As Gen Y moves out of dorms and parents’ basements and look for apartments to rent or buy at a reduced cost near urban employment centers, multi-family will continue to outpace SFR construction, swelling to a peak around 2020.The shift from apartments to SFRs for Gen Ys will then create vacancies in apartments, as occurred in the early 1990s.

Extended forecast for California’s real estate market

How will home sales volume and prices likely fare in 2016 and beyond?

Sales volume is likely to continue its rise through the first part of 2016 as job numbers continue to grow. But this growth will be short-lived, to fall back in the months following the inevitable FRM rate increase. The FRM rate rise is likely to occur after mid-2016, thus sales volume will likely slip in the second half of 2016.

Anticipate prices to continue to rise slightly throughout 2016. However, after home sales volume trends down due to the FRM rate increase, expect prices to follow within 9-12 months. Absent other extraneous factors (like rampant speculation, as occurred in 2012-2014), prices follow home sales volume movement axiomatically.

Strategic defaults and bankruptcies will rise slightly heading into 2018, as occurred during the mid-1980s and mid-1990s recoveries when the Fed raised rates for the first time in those recovery periods.

The good news for sellers — not buyers — is home prices won’t stay down for long, despite interest rate increases. The jobs recovery will give home sales a needed boost in 2018, which will cause prices to begin rising again around mid-2018, first led by returning speculator acquisitions, then end user occupants. Increased construction starts will fill user demand for more housing in coastal city centers.

Rents and prices will then rise dramatically with demand centered in urban areas close to the best-paid employment, but less so in inland regions. Smaller coastal cities will likely fail to lift zoning restrictions on much needed high-density, high-rise multi-family starts driving Gen Y to other communities. Members of Gen Y will enter the rental and homebuying market en masse; in a demand convergence, their Baby Boomer parents will continue to retire in increasing numbers, selling and buying rather than renting. Home inventory for sale will be tight without new zoning and construction, causing prices to rise.

As a result, new real estate licensees will flood the market, large broker firms adding sales agents to match the cyclically higher sales volume.

Flying into all this excess, the Fed is likely to induce the next business recession. The hope is the Fed won’t let the economy get too out of hand before acting to cool it off, and risk another Great Recession and zero-to-negative interest rates.

Factors to watch out for in 2016 and beyond:

• Keep an eye on foreign investors in your local real estate market. The global upheaval makes the U.S. a very attractive place to invest, but the strong dollar makes it difficult for foreign investors to enter the U.S. dollar-dominated asset market.
• Watch for interest rates increases. While the short-term rate began to increase in December 2015 and immediately affect ARM rates, first tuesday expects FRM rates to increase later, after mid-2016 due to investor movement. But no matter when FRM rates do rise, prepare for sales volume to decline and prices to follow, albeit briefly.
• Stay informed on movements in your local jobs market. While influenced by global and national economics, real estate is significantly a local phenomenon. Therefore, future housing market movement can be foreseen in improvements (or failures) in the quality and quantity of employment immediately available to the local population.