Note: The following comments are opinions only and may not be consistent with the views of The Realty Exchange agents, sub-agents or third party associates/suppliers.
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February 2006 Through 2006, we expect residential and commercial real estate will continue to appreciate in value in California. The rate of appreciation in Los Angeles County is expected to be in the range of 5% to 10%.
Over the recent past, we have been thinking of 2006 as likely the year of a major top in the long term upswing that began in 1994. At this point, we are more inclined to expect the top to occur in the summer of 2008. At that time, the average per square foot selling price is expected to be in the $440 - $470 range (as compared to $400 at this time).
We believe the long term positive and negative influences on real estate valuations may be summarized as follows:
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Long Term Positives:
- Over the past 30 years, real estate in California has appreciated at an average annual rate of 9 percent, (source: California Association of Realtors).
- According to the California Association of Realtors, the statewide median price increased by an average of 13.6% whenever their unsold inventory index fell below seven months. For the past seven years, the index has been below seven months and has been holding steady at 2 1/2 months - 3 1/2 months over the past three years. the current level is slightly over 3 months.
- The California Association of Realtors is forecasting average price appreciation in the range of 10% for California in 2006. The California Building Association expects new home prices to rise by 5% to 8%.
- The economy remains healthy while interest rates have remained remarkably steady over the past year. The 30-year mortgage rate ended 2005 at 6.22 percent, up from 5.81% at the end of 2004.
- While California adds typically 225,000 to 250,000 households each year, there were 212,000 new home permits (apartments, condominiums and single family) for 2004 and 2005. The result is a continued shortfall of housing supply relative to demand.
- Lending policies by mortgage companies and banks have remained relaxed, allowing more first time home buyers and investors buying second homes to buy real estate.
- There is a steady to increasing demand from foreign investors due to a relatively weak U.S. dollar.
- Long Term Negatives:
- Possible rapid rise in interest rates due to inflation pressures in an over-heated economy
- Acceleration in foreclosures due to the significant increase over the past several years in people buying real estate utilizing "creative financing" such as 100% Loan-To-Value loans, adjustable rate mortgages, interest only loans, low coupon interest loans, etc. (As of the last Q4, 2005, an estimated 35%+ of new home loans in the hottest real estate markets were interest-only loans.) The initial grace periods on these loan programs are typically three to five years. Thereafter, property owners can face significant increase in monthly interest payments that may not be affordable.
- California is expected to add 200,000 - 250,000 jobs in 2006. This is well below the 400,000+ new jobs added in 2005.
- The possibility of an unanticipated economic disruption.
In a speech to the National Association for Business Economics in Chicago in late 2005, Former Federal Chairman, Alan Greenspan, said "History cautions that extended periods of low concern about credit risk have invariably been followed by reversal, with an attendant fall in the prices of risky assets. . . . Such developments apparently reflect not only market dynamics but also the all-too-evident alternating and infectious bouts of human euphoria and distress and the instability they engender." He was referring in particular to real estate.
Residential real estate prices have risen substantially over the past decade (up almost 300% in California). The question is - do rapidly rising prices necessarily translate into a bubble soon to burst? We would say, "not necessarily". Based on the above summary, it would appear that the long term cycle top will not likely occur until 2007 or 2008. In the meantime, 2006 should be a good year for real estate. We believe the window of 2008 - 2011 will more likely see a pullback in the range of 10% - 20% in real estate prices.
As for commercial property, we expect a continued upward trend in valuations over the next several years. Commercial property valuations have a traditionally close correlation to long term trends in interest rates. The decline in mortgage rates in 2002 - 2004 to levels not seen since the mid-1960's has helped create something of a collapse in CAP rates along with a boom in commercial real estate valuations. If the trend in rates over the next few years carries an upward bias, it would be reasonable to expect a moderation in commercial property valuations. Further, such moderation could eventually lead to a significant decline.
The short term horizon (three months) is reasonably positive. While there has been an unusually large increase in the number of listings versus properties sold over the past month, this is not enough to turn the market negative. Spring time is traditionally the best time for price appreciation and a decline in days to sell. One of the main reasons for this pattern is the increased demand from people relocating between communities. The relocation "driver" is traditionally the strongest in the spring time. Therefore, we expect prices to creep higher in the early summer, with inventory levels rising at the same time.
