Building In California With Jordan Levine #607

Jordan Levine blog

On Friday, September 28, the Norris Group proudly presents its 11th annual award-winning black-tie event, I Survived Real Estate. An incredible lineup of industry experts will join Bruce Norris to discuss perplexing industry trends, head-scratching legislation, tech disruption, and opportunities emerging for real estate professionals. All proceeds from the event benefit Make A Wish and St. Jude Children’s Research Hospital. This event is not possible without the generous help of the following platinum partners: the San Diego Creative Real Estate Investors Association, InvestClub, Inland Empire Real Estate Investment Club, ThinkRealty, Wilson Investment Properties, Coach Fullerton, First Lending Solutions, PropertyRadar, the Apartment Owners Association, MVT Productions, and Realty411. Visit for event information, and see Amazon Prime or YouTube for past events.

Bruce Norris is joined this week by Jordan Levine. Jordan is the senior economist at the California Association of Realtors, a statewide trade organization of real estate professionals with more than 190,000 members. As senior economist at CAR, Jordan analyzes housing market conditions, macro-economic trends, and public policy issues through the use of external data from the public and private sector as well as survey research studies conducted by CAR. He contributes frequently to CAR’s market analysis articles: Housing Matters Blog and Market Snapshot. He has also written various topics including housing supply, distressed sales, housing tax policy, housing affordability, and many other subjects relevant to the real estate industry.

Episode Highlights

  • What is a big concern right now in regards to sales, and what is causing it?
  • Where is inventory in terms of months’ supply?
  • What are some various hoops and fees involved with permitting process and building?
  • What are people’s attitudes right now in regards to building, both realtors and buyers?
  • What can we do to take care of the turnover rate when it comes to new developments?
  • What has been the migration rate out of California over the last ten years?
  • What charts does he look at to determine whether or not a recession is imminent?

Episode Notes

A big concern right now is slowing sales. Bruce asked Jordan if he is concerned, what his take is on it, and if he thinks sales are down. Jordan said he is concerned and we want sales to be going in the opposite direction, especially if you think about it from a homeownership standpoint. In July, there was a decline of about 3.4% on a year-over-year basis. This was a little slower than what they saw in June when sales were down by more than 7%. It is becoming fairly consistent in terms of sales not being able to break through some of these other challenges we have going on in the market.

Bruce asked what is causing the slower sales, to which Jordan said he thinks it is a couple things. He thinks one is the deterioration in affordability. Unfortunately, when you look at prices, they are continuing to go up from anywhere from 7 ½-8 ½% over the last 3-4 months on an annual basis. Unfortunately, folks’ wages are just not keeping pace with that. On top of that, you have the 1-2 punch with both rising prices and interest rates starting to increase. They have stalled out in the last couple of weeks; but that rise from 4% to 4 ½%, or 50 basis points, takes a big bite out of what people are able to afford from a monthly mortgage payment standpoint. With both the higher prices and rates, affordability is really tough.

Number 2 is the lack of supply out there, which is the flip side of the affordability question. You have a lot of good jobs being created; and when you look at the economy over all, it is still fairly strong. In California, we are at a 42-year low from an unemployment standpoint. Lots of jobs are being created all across the spectrum of wages industries, and this translates into housing demand. Unfortunately, when you look at supply, which has come up a little recently, it is very low by historical standards. What this ends up doing is it pushes prices up at these above average levels seen this year.

Bruce asked what inventory is at now in terms of month’s supply. Jordan said it is about 3 ½ months old, although it depends on where you look across the state. It is 3 ½ months over all, which is higher than what has been seen over the course of the last couple years. There is only about 3.3 months of supply out there available for sale at the current pace of sales. This is up a little bit from 3 months in June and 3.2 months at the same point last year. We got down into the 2s before, so it is a modest improvement. From a long-rn standpoint, the average is about 6 or 7 months of supply, so we are right around half of “normal” levels of supply. Folks just don’t want to move, and in California we simply do not build enough new housing.

You would think if builders could build a home and sell it for a profit, they would be doing it. Bruce wondered where the disconnect is in the supply chain. Jordan said yes and that it is three-fold. He thinks we have a statewide regulatory environment that makes it hard for the builders who do want to get out there and build new homes. It takes a lot of time and hoops you have to jump through to get those projects underway and break ground. There is several years from the time you take control of the piece of property and get the permits you need. In addition, there are all the fees that go along with it.

The second leg of the stool at the local government level involves the permitting process and all the various hoops you have to jump through and fees. These fees include water and sewer connections as well as developer. This makes it very expensive to build, and this is why you don’t see a lot of those entry level or starter homes there. A lot of these fees are assessed on a per door basis. What ends up happening is they are building bigger and more expensive homes to try and spread the costs across the higher dollar unit that they are constructing. In addition, you have all the regulatory hoops and the time it takes to go through, which makes it daunt of a challenge to get the new housing units online.

The third thing that may be more important than the state and regulatory environment is the attitudes out there. Folks are barely resistant to new developments, and there is a broad consensus that California needs new housing. However, in the general public they don’t seem to want it near where they live. They need more housing, just don’t build in their neighborhood or town. Unfortunately, this is a prevalent mindset out there. Until we can figure this out this piece and connect the dots for folks on what this lack of supply does for affordability and competitiveness of the marketplace for available homes, we need to do a better job of connecting the dots for people. They need to know what is at stake in terms of affordability and homeownership as well as what it is costing from an economic standpoint.

Jordan said those in the real estate community care about this because they are on the front lines of this. Ultimately, this will become a bigger economic challenge where businesses will not be able to pay wages that are attractive. Unfortunately, California is not the only game in town, so we can really start to chip away at some of these affordability issue. Bruce said they built some houses in California and Florida, and in California it cost $140,000 to have a building permit and a lot in Riverside. In Florida, you can finish a whole home at that cost. When you have to spend upwards of $200,000 before sticking a shovel into the dirt, it really goes a long way towards explaining why we are not building $250-$300,000 homes. The guy builds a 3,000 square foot house because that is the only price range that makes sense.

Bruce said when he was a young man getting into the housing market, the typical tract was 1,300-1,400 square feet. That was the entry-level home where you could be a 22-year old guy and walk in and buy it. Bruce said the problem is he does not know how you would turn it around very quickly. Jordan mentioned the three big issues; but there is no realization that unless somebody changes the regulation, the builders will not change. In fact, they will probably consider moving somewhere else. This is why Jordan says getting the public on board is first and foremost. Until you have people saying they want their kids and grandkids to be able to live there and not have to fly to a lower cost market just to visit, it is a real challenge to get to those state and local policy makers to effectively be sticking their neck out without a lot of public support out there for what they are doing.

Unfortunately, what we see is we keep adding on more fees and resistance to new developments, which is really what we need to unlock the turnover rate. This would give folks the opportunity who want to get into those smaller, lower-rate affordable housing units since they are not being gobbled up by folks who want to be homeowners and have the money and wherewithal to do that. The policy and regulatory environment definitely has to change, but it is almost impossible to see how you get there without getting the public on board with this idea. This speaks to the issue of your kids not being able to live in the neighborhoods where they grew up, even if they make 6-figure incomes. In some cases, this is actually scary and not great for our economy. We need to get those business communities on board and evangelize on the recruiting aspect of it.

We need to take into account the fact that over the last ten years about 750,000 people have migrated out of California. We are not the only game in town for these skilled workers and folks who want to work in construction and high-tech industries. This used to be true back in the late 1990s. For example, if you wanted to work in tech, you had to be in California. This is not the case in 2018. Unfortantely, the thing a lot of these markets have going for them is the do not have $1-$1 ½ million home prices out there, so folks can afford a great quality of life since housing is so much more affordable.

The negative migration mentioned is within states. We lose domestic migration constantly now, which never used to be true. It has been up in the 6 figures now for the last three years running. In 2015 alone it was over 160,000 people and over 100,000 last year. Unfortunately, with the way affordability is going, which is measured every quarter with the release of the affordability index, we may not see this trend reversing. We will not be able to turn this around when home prices continue to go up much faster than income. One of the critiques he Jordan always hears when he is out there in the field is that California has always been less affordable than other parts of the nation. This is absolutely true, and there has always been a sunshine path on property in California. Over the last couple years, what we have seen in the last 3-5 years is that gap is actually growing. It is becoming harder and harder to stay in California and afford those housing units, which are sometimes in the 6-figure income categories.

Bruce said there is immigration that counters the negative domestic migration. We have very positive immigration, and people immigrating here somehow managed to make it. Bruce wondered why this was the case. Jordan said when you think about it from a lifestyle, cultural, and geographic climate standpoint, people still want to live in California. It’s still a great place to be and a place where people can come and take their vacations. This is why we have such a thriving tourist industry. When you have such a tight housing market, it goes to the people who can afford to be there. We are bringing in all of these higher skilled folks to work in the tech sector, and these are folks who are getting paid above average salaries and can stomach some of these high home prices. It is actually those in the middle class who are leaving in larger numbers. The vast majority of folks who leave California are those making less than $100,000 a year and are in that 35-55 prime working age category, so it is really a double whammy in terms of us losing both the skills and potential to grow the economy.

Bruce asked Jordan if, as an economist, he looks at the overall economy of the U.S. We have good GDP growth and we have had record low employment for four decades. We have a 2.85% ten-year T-Bill. This is interesting since those three numbers have never gone together in years prior. The interest rate issue is definitely tricky, and it shows how interconnected our economy is these days. The economy is definitely our biggest strength right now going forward. We have low levels of unemployment in almost every industry in California expect natural resources. Here, the oil sector is still on the rocks. Outside of that, every major industry is growing or seeing growth in different wage categories and job types. The economy is growing, so the people out there are buying things and businesses are starting to reinvest back into the economy.

The business piece was a bit later to the game, but you are finally starting to see new commercial projects come online from a construction standpoint. They are putting money back into equipment, software, and other things that expand the productive capacity. The rates issue is such a function of things beyond what the Federal Reserve is doing. The Federal Reserve is really only in control of that short end of the yield curve, the short-term rates. The longer-term yields are really driven by global capital flows. The U.S. overall is still seen as the kind of safe haven for foreign investment. There is a big gap between consumption and savings and a lot of these developing countries. A lot of wealth is being created, and the U.S. still seems like a good bet both in terms of our real estate and our stock market.

There’s also places you can put that money; and even if they don’t go up by big amounts in terms of returns, you are also hedging against your own foreign currency risk. This is to the extent that you think your own domestic economy is going to have ongoing challenges like China or Brazil where you are not sure if you will get those 7-8% growth rates. In the U.S., it makes sense to park a lot of your wealth there in terms of longer-term U.S. bonds. This is what keeps those longer-term rates fairly low despite the fact we have a pretty power house economy at this point in time.

Bruce asked what importance he attaches to an inversion of a bond yield curve and if he thinks this is coming soon. Jordan said the Fed continues to show signs that they will raise those short-term rates. They have the cover to do so. When you look at things like economic growth and low levels of unemployment, the fact that even if strip out the volatile food and energy crisis, core inflation is still around 2.3 or 2.4%. This gives them the cover to continue to raise short-term rates. This is a risk going forward, and they are paying attention to this. It is a tough sell to sell a 30-year bond when the 1-year bond will give you just as good a return. This really disrupts financial markets.

However, Jordan does not think we are here yet. He thinks the longer end of the yield curve will start to move. The forecast is that it will be near 5% by next year. This is not a huge move, but it is enough to stave off a huge part of the yield curve, at least short-term. Bruce wondered if Jordan meant the long-term bond, whether it is the 10 or 30-year, will be approaching 5. However, he was thinking more in terms of mortgage rates, and he thinks the ten will go back above 3 and potentially get into the 3 ½% range over the next 18 months. That will also help to stave off some things. We have inflation starting around 11, and investors are paying entry-level as well.

Bruce asked Jordan what charts he pays attention to in order to say that a recession is imminent. Jordan always looks at the average net worth per capita, which hasn’t tipped negative yet. This is one of the best indicators of the yield curve. We have not had a time yet when the yield curve has been inverted. Another thing Jordan is trying to look at as a forward-looking indicator are the financial markets. He tries to do a PE ratio for the nation as a whole. He looks at the value and the market cap of a Wilshire 5,000 Index, which is every publicly traded company in the valley of those companies. Then, he tries to divide it by corporate process to see how much that net worth is backed up by how much money they are making in the financial market. It actually seems fairly frothy at this particular point in time, even a little bit more with the housing market.

Recessions don’t just come out of nowhere. Something has to happen that has to precipitate the recession, like the yield curve inverting or folks dipping negative in terms of their net worth. He does not see this happening on the short run with home prices in the financial markets being so high. Financial markets themselves are worth a lot relative to the amount of corporate profits. These have gone up fairly nicely during course of the cycle. When you look at where the equity markets have gone on the back of those profits, a big gap has opened up there. It is not purely backed up by additional earnings.

In the housing market, most of the people who have gone into the housing market since 2010 and 2011 have had fixed-rate mortgages and some skin in the game, around 3-3 ½% in terms of a down payment. They have had to document their income, so they have not had a lot of those “ninja loans.” You also don’t have a lot of those 5/1 option arm products being used very heavily. You are starting to see some of those now, but through the vast majority of the cycle so far you have not had that. The housing market is not that kind of ticking time bomb element that it was back in 2005 and 2006. Even if home prices did not go down, you had a lot of folks who were staring at potentially significant increases in their monthly mortgage payments over night because they have the 5/1 option ARMs or negative amortization or other technical financial reasons.

Ultimately, what it meant was that even though they did not lose their job and the economy had not headed south yet, they just simply couldn’t afford those mortgage payments. We do not have that this time, which is why he does not expect the housing market to be the kind of ticking time bomb that taps everything off. With that being said, everything in California comes down to a supply challenge. The thing that could upset that is a ground swell of new supply, which he does not think is reasonable to expect over the very short run. If you take away that demand component because the frothy financial markets end up going for a correction or realizing the companies are not worth as much as they thought originally, the companies are then forced to lay off and take away some of that demand element. This could be a broader problem for the housing market and the economy overall. He is looking for something outside the market to be the thing that tips us over, like the financial markets or some bigger global, economic issue. This could take away a lot of the demand, and this would be a concern. The fact remains that we are almost ten years into this current business cycle and expansion. As far as expansion periods go, ten years is a fairly long time. However, it takes something to tip us, and this would be the things he is looking for.

Bruce said if and when the recession occurs, it has been typical that the Fed reduces interest rates in the short end of the bond yield curve by 4-5%. Bruce asked if you had a recession before they get to 3 ½%, what would they do? Jordan said this is one of the reasons they are in a hurry to “normalize interest rates.” This would put some more rounds back in the chamber to use to fire up the next inevitable downturn, whenever that may come. If they have not gotten to a normal level of interest rates, you will see more of those specialized interventions, such as when they directly intervene in the mortgage-backed securities market or financial sector by bailing out some of these banks or doing other ways of creative financing to keep those institutions alive.

Unfortunately, those things are highly unpopular. When you only have a Fed funds rate in the 2-2 ½% range, this makes it challenging since you have a limited amount of ammo from an interest rate standpoint to throw at the crisis.

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