California real estate: 2022 in review and a forecast for 2023

This article provides a bird’s eye view of the legislative changes and economic shifts which impacted real estate professionals during 2022. We then look ahead to the property market in 2023, and beyond.

The aftermath of Pandemic Economics

After two years of volatile economic waves, California’s pandemic response officially ended in 2022. As the year closes, real estate professionals preparing for 2023’s housing market can start by retracing the Pandemic Economy’s path.

At the state level, the pandemic pushed legislators to enact eviction and foreclosure moratoriums and distribute individual stimulus checks in 2020-2021. Along with the pandemic-induced supply chain disruption, these actions resulted in rapidly escalating inflation — both consumer price inflation and asset price inflation.

Extra money in their wallets emboldened consumers to over-spend (and under-save) during 2021-2022, which also helped prop up the jobs market. Employers continue to hire going into 2023, with jobs surpassing the 2019 peak in October 2022.

For the housing market, perhaps the most influential impact of pandemic era policy was on mortgage interest rates.

Following the Federal Reserve’s (the Fed’s) actions to drop interest rates to historic lows in 2020-2021, the Fed ended its pandemic period monetary policy of funding and setting interest rates on home mortgages by exiting the mortgage-backed bond (MBB) market at the end of 2021.

On exiting, the funding and setting of fixed rate mortgage (FRM) rates returned to the bond market. This resulted in a jump in mortgage rates to match bond market MBB yields which, unlike Fed funding, are based on the 10-year Treasury Note rate plus a risk premium rate presently set at double historic norms in anticipation of a recessionary rise in defaults.

The result of all the pandemic-related fiscal and monetary stimulus caused consumer inflation to exceed the Fed’s target of 2%. To rein in and tamp down excess consumer inflation, the Fed bumped up their benchmark rate several times in 2022. This directly increased interest rates on adjustable rate mortgages (ARMs).

Further, interest rates on long-term debt obligations, such as the 30-year FRM, reflect bond market investor perceptions about the level of success the Fed will achieve in their current fight to lower consumer inflation. When the Fed is succeeding in its fight — as is beginning to appear heading into 2023 — bond market investors accept lower yields, and FRM rates follow.

While mortgage rates skyrocketed in the first three quarters of 2022, they were slashing mortgage borrowing and thus buyer purchasing power. This brought on a cascade of altered behaviors in the marketing of real estate services, to stretch on for the next two-to-three years as buyers now take the reins.

The casualty of rising mortgage rates on sellers of real estate

These toppled dominoes lead us to the year’s leading market fundamental: As buyer purchasing power declines, so goes support for home sales.

Homebuyers qualify for a maximum mortgage amount based on their incomes and shifting interest rates. Thus, any rise in mortgage rates instantly cuts the amount they can borrow, and the price they pay for a home is reduced. The only factor able to move in the triangle consisting of the homebuyer, lender and seller is the seller’s list price.

Following a pandemic-distorted year of high home sales volume in 2021, sales volume peaked early in 2022. While year-end reports are not yet in, sales volume is likely to dip below 2019 levels — the last “normal” year for sales volume — in 2022.

Thus, home prices have fully reversed course from their May 2022 peak, ranging from 6% below the peak in the low tier to a staggering loss of 9% in the mid and high tiers.

Still, average home prices remain a tenuous 5% higher than a year earlier for low-tier prices, 6% higher for mid-tier prices and 8% higher for high-tier prices as of September 2022. This year-over-year spread is narrowing rapidly, with reports expected to show the annual price change turning negative near the start of 2023.

As home values plunge, recent mortgaged homebuyers are falling underwater.

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Negative equity homeowners are unable to sell their home when unexpected circumstances require them to rid themselves of their asset. These include a job loss — as is common during a recession — a required relocation or household change. Their only solution is to:

• negotiate a short sale with the lender; or
• exercise their put option, forcing the lender to foreclose.

Savvy real estate agents and MLOs will be prepared to handle the coming wave of distressed sales and work with an evolving base of homebuyers and sellers to earn fees, even as the volume of traditional sales slows to a trickle.

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Pandemic Economics are also removing support in the commercial property market.

Industrial space vacancy rates increased during 2022, on their way to a return to pre-pandemic rates in 2023 — an occupancy level evincing a “fair deal” environment for both landlord and tenant.

This rise in the vacancy rate is a prelude to the elimination of the excessive demand on space brought on by the pandemic period which needs to take place before the industrial market can begin to stabilize.

However, there is some movement for unused commercial space. An increase in commercial-to-residential conversions is both helping to alleviate the housing shortage and giving a second life to unprofitable retail and office space.

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New laws to encourage construction

California continues to experience a statewide housing shortage, which has led to an ongoing population decline as former residents head for states with more reasonable housing costs.

To address the housing shortage, state lawmakers continue to pass new legislation to add to the housing inventory.

Commercial-to-residential conversions are becoming more common with the passage of Senate Bill (SB) 6 and Assembly Bill (AB) 2011, which permit:

• multi-family developers to submit projects for a streamlined ministerial review process, which are exempt from conditional use permits and environmental impact reports; and
• residential development within areas zoned for office, retail or parking uses when specific conditions are met, including requirements for:
  • density;
  • public notice;
  • comment;
  • hearing;
  • site location and size;
  • consistency with sustainable community strategy or alternative plans;
  • prevailing wages for builders; and
  • a skilled and trained workforce.

Both bills encourage builders to transform office and retail commercial spaces into housing units for low- and middle-income Californians. These housing bills require general plans for land development and the compliance to local zoning laws.

Accessory dwelling units (ADUs) are also having a moment, with the passage of  SB 897 and SB 2221, which prohibit:

• owner-occupant requirements for ADUs; and
• a local government from establishing front setback limits for ADUs, specifies detached ADUs may include an attached garage, and decreases ADU permitting times.

California’s infamously restrictive zoning regulations and high building costs mean new housing for low- and moderate-income households remains scarce. But recent pro-ADU legislation has more homeowners cashing in on the shortage and becoming landlords.

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Property management updates

For landlords, the expiration of pandemic-era eviction moratoriums means a full return to the Tenant Protection Act (TPA) of 2019, which:

• caps annual rent increases at 5% plus the rate of inflation for much of California multi-unit residential properties;
• requires “just cause” to evict tenants in place for 12 months or more.

The applicability of the TPA is comprehensive, covering most multi-unit residential real estate housing in California and those single family residential (SFR) units owned by a real estate investment trust (REIT), a corporation or a limited liability company (LLC) with a corporate member.

However, there are numerous, sizable exemptions for multi-family units and conditions for SFRs to be excluded, including:

• residential units which have been issued a certificate of occupancy within the previous 15 years;
• a duplex of which the owner occupied one of the units as their principal residence at the beginning of the tenancy and remains in occupancy;
• units restricted as affordable housing for households of very low, low, or moderate income, or subject to an agreement that provides subsidies for affordable housing for households of very low, low, or moderate income;
• dormitories constructed and maintained in connection with any higher education institution in California;
• units subject to rent or price control that restricts annual increases in the rental rate to an amount less than that set by the TPA;
• multi-unit transient occupancy housing like hotels and motels;
• accommodations in which the tenant shares kitchen or bathroom facilities with an SFR owner-occupant;
• SFR real estate that can be sold and conveyed separate from the title to any other dwelling unit, like in an SFR subdivision or condominium project, provided:
  • the owner is not one of the following:
    • a real estate investment trust (REIT);
    • a corporation; or
    • a limited liability company (LLC) in which at least one member is a corporation; and
  • the tenant has been given written notice stating the rental property is exempt from the rent increase caps under the TPA. [Calif. Civil Code §1947.12(d); CC §1946.2(e); See RPI Form 550, 551 and 550-3]

Even though the TPA took effect in 2020, the pandemic interruption has meant many landlords have yet to enact the TPA in practice. The California Office of the Attorney General (OAG) has begun cracking down on landlords committing unjust evictions.

Read more about the rules for just cause eviction under the TPA.

Other new laws for landlords enacted in 2022 include:

• AB 2559, which encourages and clarifies rules regarding reusable tenant screening reports; and
• SB 971, which requires landlords receiving low-income tax credits to allow pets.

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Shifting requirements for real estate professionals

California requires Department of Real Estate (DRE) licensees to render their services to the public with consistency and competence. This means staying on top of the constantly shifting landscape of laws which affect licensees’ practice and treatment of the public.

Passed in 2022, SB 1495 delays the implementation of the implicit bias and fair housing law components in the Real Estate Practice course required for licensing education until January 1, 2024. Meanwhile, two hours of implicit bias training is already required for renewing DRE licensees, implemented by a 2021 law.

SB 869 requires the Department of Housing and Community Development (HCD) to regulate individuals acting as managers or assistant managers of mobilehome parks and requires the completion of at least 18 hours of training on the rules and regulations for operating a mobilehome park.

For prospective brokers, AB 2745 requires non-licensees applying to the DRE for a broker’s license to show the required two years of general real estate experience accumulated within the five-year period prior to the exam application date.

Forecast for 2023 and beyond

The biggest development of 2022 has been the abrupt about-face in real estate dynamics. What was a seller’s market for the past decade has quickly become a buyer’s market.

The reason? California’s housing market is being dragged down by the economic encore to the short-lived 2020 recession. This time, offsetting government stimulus will be limited while the Fed’s rate increases eliminate excess consumer price inflation and Wall Street resumes the setting of FRM rates.

Real estate sales volume and prices will continue to fall in 2023-2024 as dictated by rising mortgage rates and capitalization (cap) rates.

Watch for a return of real estate speculators in 2024 to provide a “dead cat” bounce in real estate sales volume and pricing, falling back and bottoming in 2025. A sustainable recovery will take off in property sales with the return of end user property buyers — more reliable buyer occupants and long-term buy-to-let investors — around 2026-2027. Then, prices will gradually rise during the recovery from the 2023 recession.

How agents can survive and thrive during the 2023 recession

What can agents do to adjust to the downturn in 2023-2025?

Agents need to pivot from focusing on providing seller services to finding and working with buyer clients. This means refocusing expertise on the needs of buyers (and tenants), and advertising yourself as a buyer’s agent.

Become an expert in assisting clients with the types of sales common during a recession, including purchasing:

• homes at trustee’s sale — foreclosures;
• short sales; and
• real estate owned (REO) properties.

For agents with seller clients during a downturn, they can help along the sale by encouraging the seller to offer seller financing, also known as carryback financing.

For seller’s agents, carryback financing can make their property more marketable, enabling a higher sales price, while also allowing the seller to defer the tax bite on their profits.

Carryback financing generally offers the buyer:

• a moderate down payment;
• a competitive interest rate;
• less stringent terms for qualification and documentation than imposed by traditional lenders; and
• no origination costs or lender processing hassle. [See RPI ebook Creating Carryback Financing]

Finally, agents can take on side gigs available in a multitude of fee-based real estate services, including:

• obtaining a higher fee split by upgrading to a broker’s license;
• gaining new marketable skills like becoming a notary public;
• earning a mortgage loan originator (MLO) endorsement to assist homeowner clients obtaining a mortgage;
• rounding out your skillset by becoming a property manager— one of the few recession-proof real estate jobs;
• becoming a foreclosure and short sale specialist, as distressed sales inevitably rise when home values drop;
• assisting with the management and sale of real estate owned (REO) properties; and
• using the recession as a launchpad for investment by becoming an expert in forming real estate syndicates and 1031 exchanges.

Poised to profit off existing contacts in real estate-adjacent careers, these agents and brokers will survive and succeed even as the housing market continues to slip deeper into the recession.

Track California’s housing market in 2023 with firsttuesday — subscribe to Quilix for your Monthly Statistical Update and more real estate market analysis in your inbox every week.

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