For additional information regarding the new real estate paradigm, read Part I of this article.

Part II of this article comments on the optimistic attitude held by California agents regarding the developing statewide real estate recovery, but warns against irrational optimism with an eye on the achievements necessary to drive an organic, sustainable real estate recovery.

Real estate in the anomalous market

The real estate market has begun to level out and will now experience slow but steady improvement. In February, the statewide price paid for the phantom median-priced new or existing home was up 11% from one year ago, indicating wealthier individuals are returning to buy mid- and upper-tier homes. Similarly, low-tier housing is replete with speculators who will support that tier’s sales volume for a considerable time.

However, it is important to note that the improvements experienced thus far have not been organic. The market corrections of the past 12 months have been artificially induced by the United States Treasury, the Federal Reserve Bank (the Fed) and California’s state government. This aid specifically targeted the real estate construction, sales and mortgage sectors, and took the form of:

  • massive government subsidies (tax credits) to homebuyers; and
  • Fed actions to keep mortgage interest rates unnaturally low by buying up large quantities of newly-issued mortgage-backed bonds (MBBs).

In California, $200 million from the state’s treasury has been applied to the housing market on two occasions – subsidies totaling close to $400 million. The state’s most recent 2010 subsidies will grant $100 million in tax credits (prepaid taxes or refunds) toward the purchase of existing homes (primarily real estate owned [REO] properties) and another $100 million to the purchase of homes in builder inventory. [For a critical analysis of the tax credit, see the April 2010 first tuesday article, California’s homebuyer tax credit: an erroneous diversion of state funds.]

The stimulative actions taken by the state and federal governments have temporarily propped up the real estate market.

These stimulative actions taken by the state and federal governments have temporarily propped up the real estate market as intended. However, the resulting sales do not signal a return to normalcy. The federal subsidy has already expired, and the state subsidies will not be extended indefinitely. First-time buyers of new or existing homes must close escrow by December 31, 2010. Purchasers of new homes, either first-time buyers or otherwise, must enter into an enforceable purchase agreement and file for the credit by December 31, 2010, but have until August 1, 2011 to close escrow (inducing builders to build yet more housing). Thus, this temporary sales condition appears to be a bridge to nowhere since insufficient numbers of buyers exist to carry on the volume of purchasing the stimulus created.

In March 2010, the Fed started to unwind its MBB purchase program, returning to private investors the open-market option of purchasing MBBs. Since March, the rate as expected has already begun to move incrementally up, if only slightly, as funds have headed into stocks (a temporary trend which, as of this writing, appears to be reversing for both rates and stocks). [For an additional study of the Fed’s MBB program, see the April 2010 first tuesday article, Mortgage rate spike has homebuyers in a frenzy.]

Thus, a majority of the improvements witnessed in the market have largely been wrought by external “bridging” factors (government intervention), not organic industry growth. As first tuesday predicted in November of 2009, the economic recovery will not take the shape of the oft-cited” V,” “L,” “W” or “U” recessionary trends. Instead, it will look more like an aborted checkmark following the “dead cat” bounce during the period of mid-2008 to mid-2009 following the near total failure of real estate sales in January 2008. [For more information addressing the shape of the economic recovery, see the November 2009 first tuesday article, Divining the future: a letters game.]

We are now trudging over the long plateau of the aborted checkmark; growth in the coming two to three years will likely be relatively modest, if not just plain flat. Though the volume of sales and leasing in the real estate market will be largely static in the near future, reasons exist to be optimistic about the present – and the future.

Reason for optimism – employment and demographic changes pave the way

From December of 2007 to January 2010, California lost over 1.6 million jobs – however, this tide has started to reverse itself.

Employment is now growing and around 2016 will likely reach numbers comparable to the employment peak experienced in 2007.  Part-time and temporary employment will have to become full-time employment before the growth in jobs will produce the 400,000 to 500,000 jobs annually needed to completely pull out of this hole.

The quantity of jobs in California directly impacts homeownership statewide. Without a paycheck, nobody can afford to rent an apartment or buy a house (unless they are subsidized by the government or independently wealthy). [For a further discussion on the relationship between employment and real estate, see the April 2010 first tuesday article, Jobs move real estate.]

The basis for a real estate owner or buyer’s ability to obtain mortgage financing is his paycheck, or self-employed earnings from a trade or business, or income from investments.

Thus, the good news: if you have a job, you can absolutely afford a home – no matter the amount of your paycheck.  Your payments will equal 31% of your gross income, setting the maximum loan available and hence setting the price of property you can buy and finance with a 3.5%, 10% or 20% down payment.

Editor’s note – As a practical matter, brokers should not concern themselves with unemployment figures – unemployed people can’t buy houses. Brokers should limit their focus to data addressing employed people, as these are the prospective clients who can be pre-approved and potentially close a transaction with the broker in the coming year.

Projecting further into the future, California’s now changing demographics provide a reason for future celebration.  The 25-34 age group will soon supply increasing numbers of homebuyers to naturally revive the market. The pool of these first-time homebuyers will eventually peak in 2017, likely pushing the housing market into another (mini-)boom cycle as builders compete with resale multiple listing service (MLS) agents for their business. Prices will rise just as if there had never been a Great Recession and financial crisis (though not to the same heights), or the pain caused by their repercussions.  [For an additional analysis of demographics and the volume of real estate licensees, see the March 2010 first tuesday article, The rise and fall of real estate agents and brokers.]