California home prices have begun to collapse following a peak at nearly twice the historic trendline level for value.

Everyone can tell you the price of a home today, but no one can tell you its value. To introduce you to the price-to-value pattern, home prices are currently priced at 192% of their long-term value, as of July 2022.

This comparison tells a story of how far prices have deviated from their historical norm — the value level to which prices will inevitably return in the years ahead.

In 2022, interest rates leapt upward from historic lows, removing all support for home prices. Thus, today’s price decline was easily anticipated. The fast and furious pandemic stimulus of 2020 to replenish lost incomes fueled a surge in consumer and asset inflation which forced the “Fed Put” for pricing to be withdrawn.

Watch for prices to continue to fall back in the months ahead, slumping below 2019 levels by 2024 and reaching a level consistent with long-term home values around 2025.

Chart update 10/12/22

Jul 2022
May 2022
Jul 2021
One-year earlier
Home-price-to-value ratio192%200%176%

*The blue price deviation from California’s historical home price trendline is calculated using the Case-Shiller home price index for California’s major metros (Los Angeles, San Diego and San Francisco).  The black mean price trendline is based on homebuyer annual income changes, which has over time averaged 3.5% in California.

**The gray bars in the chart represent economic recessions.

Video update 11/1/22

California’s housing cycles produce a trend

Boom-time markets, flush with cash to support rising real estate prices, become momentarily untethered from historical price trends. During these temporary virtuous cycles, sellers and seller’s agents dominate real estate transactions. Seller dominance during booms has always been the case in California’s real estate market, reasserted in the rebound from the Great Recession. This dynamic was further supercharged during the Pandemic Economy of 2020-2021.

The momentum and volatility of boom times appear strong on the balance sheets of property owners. But the gains are momentary and only for those who sold, a fleeting phenomenon which long-term investors know better than to rely on.

Eventually with booms, sales volume evaporates (as began in April 2022), and prices dip (which began for California in June 2022). The boom slips into a bust, a process known as the vicious cycle.

At some point in a recession, demographics and economic conditions level out, then drive buyer demand back up. Momentum builds and prices rise again and exceed the trendline — a return of the virtuous cycle.

Neither a boom nor a bust is sustainable over the long term. They are, by their nature, short-term divergences. As such, they’re an unfit measure of long-term stability. However, as the booms and busts create their peaks and valleys, a trend develops between them. This is the mean price trendline for real estate.

Timing the market in 2023

Tying California property prices to the mean price trendline produces an idea — the notion of a property’s long-term value.

In the long term, home prices rising beyond 3.5% annually will fall back to prices dictated by replacement costs (reflecting more closely the price of the land and improvements) and income (the ability of homebuyers to pay the price). Thus, the mean price trendline represents the long-term value of property at any point in time, adjusted for consumer inflation and the California premium in average wage increases.

Using this information, real estate investors can ascertain the best times to buy, sell or hold.

For investors to maximize their profit on a resale, they first need to buy near the bottom to midway through a market recovery half cycle — the Buy Phase. This phase occurs when property prices are closest to their long-term trendline value. Patience to wait is required, sufficient to overcome emotional effects of fear of missing out (FOMO) related market momentum activity.

With prices soaring above the mean price trendline in 2020-2022, these years were not the time to buy. Nor is it a good time to buy in 2022-2024, with prices falling back.

Rather, long-term investors who own property (likely acquired in the Buy Phase) will hold onto their property until a future Sell Phase develops when property prices once again rise above the mean price trendline.

The Buy Phase commences with the start of the recovery, expected to next arrive in California’s housing market around 2026.

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California’s overpriced homes — and when prices will return to normalcy

As of July 2022, California home prices are priced at 192% of their long-term value. They have a long way to go and it will be many months before they return to the trendline, when home prices bottom out near 100% of their long-term value.

Imagine for a moment that home prices are like gas prices, which fluctuate on a daily basis. People don’t often talk about the value of gas. But if they did, the value of a gallon of gas would be what it represents — how far it gets you. But the price of gas fluctuates on a regular basis, while on the other hand its value is quickly quantified. Thus, the price-per-gallon goes up and down, but a gallon’s value for what it achieves for you remains steady, say, 32 miles to the gallon.

In the same way, a property’s value represents what it provides for you — shelter or a long-term investment. Interim price fluctuations are meaningless to a property owner unless they plan to refinance or sell imminently.

In 2022, homes remain significantly overvalued, though the spread of price relative to long-term value is now narrowing quickly.

California’s housing market is being dragged down by the onset of the 2022 undeclared recession and the Federal Reserve fight to eliminate the excess consumer price inflation and wage demands, conditions which flowed from the fiscal and monetary stimulus necessitated by the Pandemic Economy.

Expect prices to fall like dead weight, not finding a bottom until around 2025. Then, prices will bounce along near the mean price trendline through 2026-2027, with the next big peak in prices arriving sometime after 2028.

Real estate professionals who want to survive the ongoing decline will pursue recession-proof or recession-driven services associated with their current careers. Income property management, income property sales, foreclosure related sales, property exchanges, and private-money mortgage financing are a few examples. No matter the current price of housing, people and businesses always need shelter and someone to arrange it.

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