Economists say: Next recession to have biggest impact in California

When will the next recession occur? How will it impact California’s massive housing market?

Just over half of the 100+ economists and real estate experts surveyed by Zillow in the third quarter (Q3) of 2017 say the next recession will arrive by the end of 2019. Three-quarters of the respondents say the next recession will arrive by the end of 2020.

The most likely scenario to cause the next recession is a geopolitical crisis, such as an unstable European Union or political instabilities in Asia — or even closer to home in the U.S.

Respondents cite the next most likely cause of a recession to be monetary policy, implemented by the Federal Reserve (the Fed).

While few can speak to the actual likelihood of a geopolitical crisis, the odds of a Fed-induced recession occurring in the next couple of years are high by anyone’s standard, as its mandates to cool off the economy are clear.

The Fed uses monetary policy to keep the economy in check. The Fed’s policies specifically involve:

the size of its portfolio of bonds and securities; and
its influence over interest rates and the employment market.

The Fed held its key, short-term interest rate near zero from 2009 through the end of 2015, when it began to bump it up in small increments. At the time of this writing, the target Federal Funds rate is 1.25%. For reference, this is certainly higher than zero, but much lower than the 5% Federal Funds rate held before the last recession.

The Fed acts to increase interest rates in an effort to make borrowing more expensive. This effectively cools down an overheated economy and decreases the likelihood of a bubble forming. When implemented correctly, this action typically avoids a catastrophic recession like the one that occurred in 2008.

These more typical Fed-engineered recessions are called business recessions, which create a slowdown in the market but not a huge loss of jobs (or a foreclosure or financial crisis like occurred in 2008).

Thus, the next recession — if it’s induced by the Fed’s actions to increase interest rates — will see a brief downturn in the market, but not a disaster. Think of a controlled release of pressure, versus a volatile explosion.

California’s coming recession

While the majority of economists and real estate experts surveyed indicated the next recession will likely have a low to moderate impact on the housing market, they forecast three of the six U.S. cities to be most affected will be in California. These are:

The survey respondents did not elaborate on why they expect these cities to feel the brunt of the next recession. But these cities have a few things in common, including their:

high housing costs;
restrictive zoning and permitting regulations which limit and slow new construction; and
low- and mid-tier housing shortages.

In these parts of the state, renters and homeowners regularly pay half or more of their salary on housing and have little savings set aside for emergencies. Thus, the residents of California’s major coastal cities are especially vulnerable to an economic downturn.

California’s legislature is attempting to alleviate the burden of high housing costs by smoothing the way for more construction to be built in the coming years, especially in the low and mid tier, where it’s needed most. But real estate professionals need to watch their local markets with caution in 2018 and 2019. Agents and brokers who do their best to produce more today will protect themselves from a future housing downturn in the coming years.

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