Lead Story… “When Orange County catches a cold, the Inland Empire gets the flu.” If you’ve spent any time in the real estate industry in Southern California, you’ve probably heard some variation of this truism. The relationship has held up over the years because the two regions are closely linked in terms of geography and economy: OC has white collar jobs and executive housing, whereas the IE traditionally has more blue collar jobs and more plentiful affordable housing. In a typical cycle, OC home prices rise first, followed by IE prices. When the cycle turns, the IE pricing and volume typically falls off first when entry level financing disappears and blue-collar employment falls off. The price movements in the Inland Empire are typically greater in percentage terms (although substantially less in nominal dollar terms) to both the upside and the downside since values there are lower. This cycle, that historical relationship has broken down, as I detailed in a blog post titled Mind the Gap back in May. Last week, JBREC’s Rick Palacios JR posted a research piece about the disjointed nature of the recovery across housing markets in the US, summed up neatly in the chart below:
The first thing that I noted on the chart is that, aside from Houston, every market on here is still on the positive side of the slope. Larry Roberts at OC Housing News wrote a follow-up post that helps put the above chart in context about how Dodd Frank’s crackdown on so-called affordability products will dampen volatility in future housing cycles.
The second thing that I noticed is more local and that is that JBREC classifies both OC and LA as late Phase 2 to early Phase 3 while the Inland Empire has barely made it out of Phase 1 and is plagued by relatively low levels of housing construction. Orange County prices exceed the prior cycle peak while Inland Empire prices are still 20% – 30% below. IMO, there are several reasons for this:
- While development impact fees are very high in both Orange County and the Inland Empire, they are far higher as a percentage of new home price in the Inland Empire. Housing prices crashed in the late aughts but impact fees didn’t, making it very difficult to build homes profitably in further out locations that haven’t experienced the coastal recovery.
- The Inland Empire is a less diverse economy than Orange County and is more reliant on real estate development to power it’s economy, which has struggled in light of the low number of housing starts the region is experiencing from what we would typically see at this point of the cycle.
- There was a far higher level of distress in the Inland Empire markets during the housing crash which took longer to work off than it did in Orange County.
- Perhaps most importantly, the Inland Empire is an affordability-driven market. Orange County is not. Riverside and San Bernardino Counties are both highly reliant on FHA financing that allows for much lower down-payments than conventional financing options. San Bernardino and Riverside Counties are constrained by the FHA limit of $356,500 which is absurd given the massive geography of these two counties – if they were their own state it would be the 11th largest in the US by land mass. At or below this loan amount a borrower can put up a down-payment as low as 3%. That down-payment goes up substantially for loan amounts above $356,500. That is a huge problem for builders in the IE since they are essentially sandwiched between rising impact fees / regulatory costs and an FHA price ceiling. If a builder wants to sell homes priced at or below FHA, he has to find cheap land and it’s still tough to make a profit. Price above it and his absorption dries up due to a lack of a buyer pool with substantial down payment capacity. Orange County has an FHA limit of $625,500. Even still, Orange County just isn’t that beholden to FHA limits because home prices are so high here. Perhaps the only silver lining is that it’s highly unlikely that the FHA will reduce loan limits for Riverside and San Bernardino Counties next year and increasingly likely that they will raise it a bit. Still, being constrained by a completely arbitrary government loan cap on a huge and diverse area is hardly a healthy situation, even if you can get some relief when that cap increases.
Perhaps I’m incorrect and the historical relationship will remain in tact when the market eventually turns. However, it seems unlikely given that the Inland Empire really hasn’t experienced much of a real estate recovery while Orange County has. It’s a lot more painful to fall off of a ladder than off of a curb.
Happy Losers: So much of what’s wrong with the US economy is summed up in this paragraph from the Washington Post:
Most of the blame for the struggle of male workers has been attributed to lingering weakness in the economy, particularly in male-dominated industries such as manufacturing. Yet in the new research, economists from Princeton, the University of Rochester and the University of Chicago say that an additional reason many young men are rejecting work is that they have a better alternative: living at home and enjoying video games. The decision may not even be completely conscious, but surveys suggest that young men are happier for it.
Quick to Jump Ship: Why decreasing employee tenure could be a positive sign for the economy.
Paycheck to Paycheck: Small businesses are now surviving but still not thriving. A new JP Morgan study found that the average small business has less than a month of cash operating reserves.
Movin’ Out: KB Homes is seeing more young people entering the first time home buyer market. Apparently, there are a few more vacancies in mom’s basement now.
Slim Pickin: Home sales fell in August as inventory fell over 10% from this time last year.
Super Sized Incentives: Builders are constructing super sized homes because they are highly economically incentivized to do so.
Acquisition Target: Suitors are beginning to line up to acquire beleaguered Twitter. Google and Salesforce are the among the latest rumored to be interested as is Disney. See Also: Why is Salesforce interested in Twitter? It’s all about the data.
Fashion Statement: Snapchat is entering the hardware business with a line of camera-equipped sunglasses. This is great news as is it will instantly ID people who deserve to get punched in the face.
Gross: Hampton Creek is a San Francisco startup that wanted to become “the first sustainable-food unicorn” in part by selling a vegan concoction called “Just Mayo.” The problem was that it apparently tasted like crap and the company was busted buying gallons of their own disgusting concoction from Whole Foods and other stores in an effort to boost it’s sales. (h/t Mike Deermount)
Chart of the Day
REITs get their own sector in major S&P 500 makeover
No Regrets: A 27 year old man from Boston attempted to create something he called a “scuba bong” by filling a scuba tank with marijuana smoke. He failed miserably and lost both of his testicles when the tank exploded. The gene pool has been chlorinated once again.
Stupid Is As Stupid Does: As many of you probably know, Apple got rid of headphone jacks on the iPhone 7 leading to angst among many loyal Apple users. A prankster posted a video purporting to show owners of the new phone how to “add” the headphone jack by drilling a hole in the phone. The video went viral and idiots are now breaking their phones by drilling them out. Imagine a person of average intelligence. Now consider that half of the world’s population is dumber than that person.
Florida Has Jumped the Shark: A tweaker on a 5-day methamphetamine binge cut off a certain part of his anatomy and fed it to an alligator because, Florida. A friend first sent me this story and I thought it was a fake. It appears to be legit. When it comes to Florida weirdos, reality is often stranger than fiction. (h/t Andrew Shugart)
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