Retraction: Before we get to today’s post, Leonardo DiCaprio’s rep announced that he doesn’t support the anti-density initiative that I spoke about on Friday, despite his name being all over it’s literature. Maybe he is a regular Landmark Links reader and didn’t like getting called out😉
Lead Story…. Since I began writing this blog last year, one of my main areas of focus has been how the historical relationship between primary and secondary markets has broken down in this cycle, especially in CA. In the past, the inland production markets would heat up when prices rose along the coast. This lead to a virtuous cycle where housing starts beget jobs which beget more employment, wage growth and ultimately more household creation and home buyers. This cycle has been different for several reasons:
- Difficulty of inland builders to develop affordable homes profitably due to low FHA caps and high impact fees
- Growth in preference for urban living among wealthier adults
- Declining home ownership percentage impacts the marginal entry level buyer more than the affluent one and historically, the marginal buyer is more likely to look inland for housing.
It’s become fairly common in our industry to look to increases in FHA limits as the salvation of the secondary markets. However, for that to occur in any substantial magnitude (all indicators point to a small increase next year), Congress would have to revise the statutory formulas that they set back in 2008 to govern FHA limits. As my colleague Larry Roberts wrote in OC Housing News, that is far easier said than done:
Through the lobbying efforts by the National Association of Homebuilders or the National Association of Realtors, Congress knows exactly how the conforming loan limit impacts home sales and new home development.I recently spoke with Scott Meyer and Michelle Hamecs of the NAHB. They provided me their NAHB Issues Update that detailed the FHA loan limit issue (click here for that document). It isn’t ignorance to the problems the prevents Congress from raising the limit.
The conforming loan limit demonstrates the tug-of-war between two conflicting desires of policymakers. On one side, advocates for the housing industry and advocates for expanded housing opportunities to all Americans want to push the loan limit higher. On the other side, the more fiscally conservative lawmakers want to lower the limit to restore the prior mandate of insuring loans only for lower- and middle-income Americans. Further, they want to reduce the potential liability for the US taxpayer, who would currently cover all the losses if the market crashes again.
If the conforming loan limit were reduced, it would decrease the potential liability for taxpayers and reduce the size of the GSE operations and make it easier to someday dismantle them; however, the last time the conforming limit was dropped, Irvine, CA witnessed an 84% decline in sales volume in the price range no longer financeable with GSE loans. Ouch!
There is no doubt that increasing FHA limits would help. There is nothing particularly healthy about having a market that is 100% reliant on government-backed loans to function but unfortunately that’s the hand that we have been dealt. Raising FHA limits attacks the problem from the bottom of the prospective home owner pool by allowing buyers at lower price points to purchase homes with much lower down payments than what’s available using a conventional mortgage. Today, I want to look at a different scenario that could play out in the next few years. It’s more from the upper end of the pool where coastal renters could find themselves once again looking inland if prices continue to rise. Today, I’m going to focus on Orange County and the Inland Empire but the demographic dynamics that I’m going to focus on could apply to many affluent coastal regions and their less-affluent inland neighbors.
On the surface, things look great in Orange County. Economic growth is strong as is employment and home prices are now above their prior peak. Development is humming along and occupancy levels are extremely high in commercial and multi-family projects. In addition, OC has diversified it’s economy quite a bit as finance and tech have taken a large role as the County has become less dependent on real estate. However, as the OC Register detailed last week, Orange County has a growing demographics problem and I think that the Inland Empire just might be the prime beneficiary. The problem isn’t that Orange County isn’t creating jobs. It is and we actually have the lowest unemployment rate in Southern California. It’s that the jobs being created often don’t come with wages that would allow someone to live here. Combine that with relatively few new housing units being built and the cost of existing units rising quicker than inflation and you have a recipe for what economists predict will be a declining population of prime workforce age population (25-64 year olds) from 2010 – 2060. From the OC Register (emphasis mine):
“They say demographics are destiny,” Wallace Walrod, the Orange County Business Council’s Chief Economist told the conference. “It is imperative that everyone in this room understand the consequences of pending demographic shifts.”
The national trend of aging baby boomers moving into retirement, he said, is “magnified and exacerbated” in Orange County, where the over-65 population is on track to nearly double by 2060 to “a staggering 26.2 percent.”
Unlike California as a whole, every age cohort other than seniors is shrinking in Orange County, where the median age has risen from 33 to 38 since 2000.
Most worrying, the prime working-age population – 25-to 64-year-olds – is expected to dip by 1 percent by 2060, even as overall population grows by 15 percent.
By contrast, working-age groups in Riverside and San Bernardino counties are on track to grow by 61 percent and 47 percent, respectively.
“We are losing not only our 25 to 34 year-old workforce – millennials – but also losing K-12 and the college-age cohort as well,” Walrod said.
The trend, he warned, “could devastate O.C.’s pool of workers, creating talent gaps as large swaths of the workforce retires, leaving open positions that will likely go unfilled.”
The Register went of to identify the the obvious culprit: housing. I frequently hear friends, neighbors and co-workers and neighbors who live in Orange County complain that the area is being over-developed. The stark reality of simple math shows that view couldn’t be more wrong. Again, from The OC Register (emphasis mine):
A severe housing shortage has turned Orange County into one of the most expensive markets in the nation, with median home prices exceeding $650,000 and average monthly rents at about $1,900. Higher-density developments that could alleviate the shortfall are often opposed by current homeowners.
Rising values are “good news for current homeowners, but bad news for those looking to afford to relocate to O.C. or to buy a house and stay here, especially millennials,” Walrod said.
As a result, he added, “domestic outmigration has been accelerating.”
The report projects that “new job creation will significantly outpace projected new housing units over the next two and half decades, resulting in a housing shortfall that will grow from a current reading of 50,000-62,000 units to a staggering 100,000 units by 2040.
“Many workers are being forced into neighboring counties to find more affordable housing, increasing their commute and complicating their work-life balance.”
According to the report, it takes an hourly wage of $32.15 to afford a two-bedroom apartment in Orange County, putting it out of reach for minimum-wage workers in the county’s fast-growing service sector, given the current California wage floor of $10 an hour.
The story goes into much more detail about a developing skill gap and low wage job boom. However, I want to keep the focus on housing for this post. Note the above projections about working age populations in Riverside and San Bernardino Counties (growth of 61% and 47% respectively from today until 2060). Those are massive numbers that will create a strong demand for housing and not all of it will be entry level. If you take the median income required to buy and rent a median-priced home in Orange County today, it is around $100k (assuming you can put down 20%) and $70k, respectively, so there are a lot of people with well-paying jobs that fall below that amount. Given the fierce opposition to density in the OC, it is likely that those numbers will only increase. Also, keep in mind that the averages above are for the entire county. The most desirable areas with the best school districts can easily be double those amounts which is incredible when you consider that median income to afford an apartment in the neighboring IE is around $55k. At some point, something has to give. My guess is that it’s a move towards more relatively affordable housing markets, in this case the Inland Empire.
I want to make an important caveat about what I wrote above: I haven’t a clue as to when this change will actually take place and more affluent workers will start to look inland to buy or rent. However, one thing that I’ve learned witnessing our current market is that things change incredibly quickly once they hit a critical mass. Just a few short years ago we were subject to an endless barrage of “renting is superior to buying” articles in the mainstream and business press. Just this week, Bloomberg ran a piece that argued that it’s almost always better to buy. Such an article would have never seen the light of day in 2011. Both types of articles are virtually assured to be wrong since they argue in absolutes. In reality it’s sometimes better to buy and sometimes better to rent but that level of nuance doesn’t lead to many page views.
My comment about how quickly things change goes for regional and local trends as well. For example, 15 years ago, pretty much no one with a college education wanted to live anywhere near downtown LA. Within the past 10 years that has changed rapidly and an area which was once in the grips of urban decay has become one of the most desirable locations for young, affluent home owners and renters in the US. Some of the same conditions that created the LA gentrification/urban renewal boom have caused the Inland Empire to lag: delayed household formation by Millennials, preference for urbanization among high earners and a downward trend in the percentage of Americans who own a home. However, I have serious doubts that these are permanent trends and there are other factors at play already that could begin to create more inland demand:
- Addition of urban elements and amenities to existing CBD and downtown regions. This is already happening in downtown Riverside as more density and foodie oriented retail are on their way. There are other urban areas out in the IE that could experience the same thing over time, downtown San Bernardino for example. It’s probably difficult to imagine right now but that’s ok. Downtown LA as it currently exists was didn’t seem feasible back in 2001 either and I doubt that many of us foresaw luxury condos and apartments going up next to Skid Row.
- Self driving cars could help to ease commute stress in markets without mass transit infrastructure. The technology is advancing rapidly and the Inland Empire will arguably be the region that will benefit the most in the US.
- Bank lenders are starting to compete with the FHA for low down-payment loans to entry level buyers. Bank of America has been so successful with their 3% down program that they are doubling it. These lending programs are still tiny by comparison but it wasn’t long ago that they didn’t exist at all.
- Millennials are getting older. Many of the oldest Millennials are now entering their mid to late 30s which are the prime household creation years. Once people start families, studies show that they are more likely to favor the stability of owning over the mobility of renting and the family-friendly single family home over an apartment.
The Inland Empire is down but I wouldn’t count it out over the long term. The current trends that have hurt the housing market there aren’t likely to last forever and the region is adjacent to too many incredibly expensive areas to not experience some spillover as even relatively high earning families eventually get priced out of the coastal regions. Conventional wisdom is that only an increase in the FHA loan limit can revitalize the IE housing market. In the short term, that may very well be the case but a sustainable recovery just might come from higher earners moving into the region.
The Walking Dead: How bankrupt oil companies that are continuing to pump could keep a lid on oil prices.
Stay In: It’s getting more expensive to eat out even as grocery prices are falling.
The Spigot: Pension funds have been steadily increasing commercial real estate allocations for the past few years and that isn’t likely to change in 2017 despite signs of a maturing market. See Also: REITS have become a more attractive target for activist investors.
High Times: A San Diego based medical marijuana landlord just filed for an IPO.
Further Afield: High prices and low yields near the coast have investors looking for rental homes in cheaper locations through management and investment services like Home Union, Investability and Roofstock. However, a lack of local knowledge can lead to out of area investors paying the dumb tax by thinking that they are getting a good deal when they aren’t.
Pull the Lever: How smart phones and app developers create digital addiction by mimicking slot machines.
Paradise: The Cubs paved the way for the Dodgers to come to LA by hosting their spring training on Catalina Island. See Also: For the Cubs oldest fans, this year could be their last chance. And: There are people trying to get 6 figure ticket prices for a single seat at World Series games at Wrigley Field.
Chart of the Day
Hard at Work: Meet the TV weatherman who got bored with his job after 23 years and decided to become a porn star.
Not a Detail Person: Russian oligarch has giant hideous boat built at a German port on the Baltic Sea. Ship draws too much to get out of the straits at the entrance to the Baltic. Epic FAIL ensues.
Lawsuit of the Year Nominee: A woman is suing KFC for $20MM because she felt that her bucket of chicken wasn’t full enough.
Landmark Links – A candid look at the economy, real estate, and other things sometimes related.
Visit us at Landmarkcapitaladvisors.com