This article anticipates the amount of time until sufficient demand for single family residences (SFRs) returns to bring the housing market to an acceptable level of occupancy. For a review of current vacancy rates and their link to foreclosures, see the companion first tuesday article, Foreclosures push California vacancies.
The equilibrium rate
Where are vacancy rates headed, and how can we predict future vacancy levels? Fortunately, we have recent history to guide our forecasts for upcoming years. Foreclosure activity in 2016 and beyond, after the end of the Lesser Depression and the beginning of a new boom in home sales, is likely to parallel the rate of foreclosure sales activity seen in the late-1990s.
During that time, both rental properties (which include single family residences (SFRS), apartment units and condos) and non-rental SFRs dropped sharply over a three-year period before leveling out by 2000 at a non-rental SFR vacancy rate just over 1% and a rental vacancy rate just above 4%.
As we have previously reported, California’s equilibrium vacancy rate non-rental SFRs is roughly 1.2% of total housing units: a keystone figure to remember. The actual non-rental SFR vacancy rate for California was 2.2% in the first quarter of 2011 and 2.3% for the second quarter, as reported by the Census. This is up from 2010’s rate of 2.1%. [For more on historic vacancy rates, see the first tuesday Market Chart, Nobody’s home: California residential vacancy rates.]
In 2010, the Census reported that 154,775 vacant units were SFRs available for sale only to buyer-occupants. 34,288 were SFRs which had been sold but were not yet occupied by the buyer. An additional 302,815 vacant non-rental SFR units were for seasonal, recreational, or occasional use. A full 215,748 vacant units were uncategorized. As the economy strengthens and then weakens, the actual vacancies will run below the equilibrium (as in 2005) and above it (as in 2010).
Rental vacancies have historically declined more sharply than non-rental SFR vacancies, often taking approximately ten years to go from trough to peak (and ten more years to fall back). In the early 1990s, vacancies dropped from record highs of over 8% in 1995 to a low of just over 4% in 2001. In the same period, homeowner non-rental vacancies dropped by a mere 1%. [For more on the decision homeowners make between owning and renting, see the first tuesday Market Chart, Rentals: the future of real estate in California?]
Rental vacancies most likely reached their peak in 2009 and are forecast to return to ideal lows by the mid-2010s. Non-rental SFR vacancies, on the other hand, are more likely to follow the aborted checkmark recovery seen in the employment and home sales markets. [For more information addressing the shape of the economic recovery, see the November 2009 first tuesday article, Divining the future: a letters game.]
These generalizations, however, do not account for the nuances of California’s two separate regional economies:
- the coastal communities, which are more affluent, better educated, more inclined to rent, and more likely to quickly fill vacant rental units; and
- the inland valley bedroom communities, which are supported by farming, agriculture and some industry, and remain heavily dependent on SFRs.
At the moment, most of California’s coastal communities are below the equilibrium non-rental vacancy rate, while the inland valleys still struggle under a higher non-rental vacancy rate. For instance, the non-rental SFR vacancy rate for San Bernardino-Riverside-Ontario, in California’s Inland Empire, was a striking 3.4% in 2010, one of the highest in the nation. Meanwhile, non-rental SFR vacancies in coastal San Diego-Carlsbad-San Marcos were at a much more manageable 0.7%.
The Inland Empire and Central Valley have in many ways borne the brunt of the Lesser Depression, and remain plagued by its ongoing joblessness. While the relative wealth of coastal communities prevents many properties from sitting vacant and unmaintained for long periods of time, inland vacancies pose a more intractable abandonment problem. [For more on California’s regional economics, see the first tuesday Market Chart, The distribution of California’s human resources.]
Impediments to filling the vacancies
Census numbers indicate that between 300,000 and 400,000 California SFRs currently remain vacant and must be occupied before the housing market can return to its former state of health (154,775 vacant non-rental SFRs for sale, 34,288 owned but unoccupied, and an unknown percentage of the 215,748 vacant units which went uncategorized). For the purposes of this article, first tuesday hypothesizes that there are approximately 350,000 vacant homes in need of owner-occupants.
We can estimate the absorption rate of non-rental SFR properties by reviewing real estate owned property (REO) sales activity. REO sales remain by far the greatest force removing vacant property from the market, totaling approximately 170,000 annually in 2010 and 2011. REO sales numbers are expected to remain high for approximately four more years. Thus, at the current rate of sales, the entire existing REO inventory could be removed from the market in just under two years, provided no other homes were placed on the market. [For a more thorough analysis of REOs and their impact on vacancies, see the March 2012 first tuesday article, Syndicators, schemes and scams: the business of REO rentals.]
That, of course, is impossible, thanks to an assortment of other factors that will combine to keep prices low and homes vacant. The foremost of these factors is the shadow inventory of delinquent properties not yet foreclosed and listed for sale in the MLS. Estimates have suggested that for every two properties listed for sale, lenders hold one off the market so as not to damage their balance sheets.
1.6 million homes were held in the shadow inventory nationwide in October 2011, unreduced from 2009’s numbers, as reported by Corelogic. Of these, a full third (or 533,000) were located in three states: California, Florida, and Illinois. This trend of REOs flowing into the market continues unabated, and shows no sign of ending in the near future. [For more on the shadow inventory, see the January 2012 first tuesday article, Shadow inventory lurks within lender balance sheets.]
Other factors will also hinder the ability of homebuyers to clear vacant properties from the market:
- speculators and flippers who bought vacant SFRs will seek to rid themselves of their burdensome properties as it becomes apparent that a return to high prices is years in the future;
- positive equity owner-occupants who, like speculators, have held offselling their property in the expectation of increasing prices, but will not continue to wait forever;
- owners of second homes (which make up 302,815 vacant properties statewide) who, due to their deteriorating finances or simple impatience, will sell their unoccupied properties; and
- new units, which continue to be constructed all the time. 21,420 SFRs were constructed in 2011, and more will follow in upcoming years until we return to (and likely exceed) the 70,000 units constructed annually that is necessary to meet demand for housing in a healthy market. [For more on current and future statewide construction, see the first tuesday Market Chart, CA single- and multi-family housing starts.]
Who will occupy these properties? First, we should look to first-time homebuyers. Generation Y, those currently aged 25-34, will be the strongest force removing vacant property from the market. Their influence will begin to be strongly felt in 2016, and will grow through the end of this decade. [For more on the influence of Generation Y, see the first tuesday Market Chart, First time homebuyers and new housing.]
Moreover, immigration and birth rates mean that 430,000 residents are added to the state every year, filling approximately 150,000 vacant and new homes/rentals annually. While 50% (75,000) of these new residents will be life-long renters, the other half will at some point purchase an SFR.
New residents are crucial for reducing SFR vacancies, since current California homeowners will either:
- sell and vacate their current home to buy a different one (leading to no net decrease in the number of homes on the market); or
- be foreclosed on and become tenants elsewhere, reducing rental vacancy but adding to the vacant SFR inventory. [For more on birth rates and the supply of new homebuyers, see the first tuesday Market Chart, Golden state population trends.
While vacancies will always be with us, improved employment and increased population will reduce empty property to more manageable numbers as the decade progresses. With 1.1 million residences vacant today, first tuesday anticipates the excess vacant SFRs (including REOs) will be resold and occupied by 2016, finally returning us to a state of equilibrium.