By Oscar Wei, Senior Economist
CALIFORNIA ASSOCIATION OF REALTORS®
The U.S. economy ended last year with a lackluster performance of 1.4% annualized growth rate in the fourth quarter of 2015. While the annual increase in GDP in 2015 maintained the pace as that of 2014, it was a letdown for many economists who predicted a stronger outlook for the nation last year. The subpar performance of the year was due to multiple factors including: 1) the sharp decline in oil and commodity prices; 2) the economic slowdowns in China, Europe, and Canada; and, 3) a strong dollar that makes American goods relatively expensive and weakens demand overseas. Despite the hiccups in recent quarters, the labor market continued to improve, with nonfarm employment averaging a gain of more than 233,000 new jobs per month in the last 12 months. The unemployment rate in March 2016 also reached a near-full employment level of 5% that we have not seen since 2007.
Meanwhile, the economy of California continued to grow at a faster pace than that of the nation as technology and tourism pushed the state economic growth ahead of much of the country. The strong performance in the labor market is an illustration of how well the Golden State has been doing in recent years. The unemployment rate in California dropped to 5.5% in February, the lowest level observed since August 2007. Statewide job growth has been rising at or near 3% year-over-year since late 2012. While the unemployment rate in California remained above that of the U.S., the growth in the job market at the state level has been outpacing the nation since March 2012. Overall, the outlook for the economy remains positive with continued improvement in consumer, business, and state and local government spending in 2016.
California Housing Market Outlook
With the economic fundamentals remaining strong in California, the state housing market has had a solid performance since the beginning of this year. Through the first two months of 2016, sales of existing single-family detached homes have surpassed the sales level at the same point of 2015 by 7.6%. When compared to the previous year, sales in February increased in most price segments except for those properties priced under $200K, between $300K and $400K, and homes over $2,000,000. Homes priced between $1,000,000 and $2,000,000 experienced the strongest growth—rising by 10.8% over February 2015.
Much of the growth in Southern California in particular was driven by the Inland Empire as sales in Riverside and San Bernardino were 7.5% and 5.1% above last year. Orange County saw a 1.5% increase in sales last month. However, Los Angeles, San Diego and Ventura all experienced negative growth in February. In the Bay Area, only Solano and Sonoma saw an increase in home sales, suggesting that tight inventories are beginning to negatively impact activity.
As for the statewide median home price, growth rate cooled to a 3.8% annual pace in February 2015 as the statewide median price increased to $446,460. This marks the slowest rate of growth for home price in six months and likely reflects the shift of sales activity toward the Central Valley which has lower home prices on average. As tight inventory in the Bay Area and Southern California drive a larger share of activity in more affordable areas, price growth should continue to normalize in the remainder of 2016.
The statewide housing supply remains an issue as the demand for housing continues to outpace the growth in inventory. While it is a welcome sign to see steady improvement in housing demand, the lack of supply is definitely a concern. The imbalance between the two sides not only intensifies market competition and pushes home prices higher, but it also leads to housing affordability issues that will ultimately lower homeownership rates if the problem persists.
The supply constraint in the Bay Area is more pronounced and has led to fewer homes being sold in the high-cost region. On the other hand, demand in regions with more affordable housing continues to improve and more home sales will likely take place in the coming year. As such, a slow-down in home price appreciation at the state level is anticipated as the mix of sales changes in favor of lower-priced properties in 2016.
High Desert Regional Housing Market Outlook
Home sales activity continued to improve in the High Desert region at the beginning of 2016. The number of single-family detached homes sold in February 2016 increased 4.5% when compared to the same time last year. In fact, sales have been improving on a year-over-year basis for every month since March 2015. The year 2015 was also the first year since 2009 that the market experienced a year-over-year gain in sales. With the economy expected to improve in the upcoming year, sales in the regional housing market should continue to grow with a mid-single digit in 2016.
The median home price of the High Desert region remained on an upward trend in the most recent month. When compared to last year, the regional median price increased 8.5% to $203,600 in February. Over the last twelve months, the year-over-year gain in median price has an average of 9.6%, slightly higher than the statewide average of 6.0% for the same time frame. Home prices in the High Desert region have been improving since 2012, with its annual median price increasing 24.5% in 2013, 16.6% in 2014, and 9.2% in 2015. Despite the upward trend in price in recent years, the regional median price in February 2016 remained 39.6% below the cyclical peak reached in June 2006 but was up 90.9% from the recent cyclical bottom reached in April 2009. For the rest of 2016, increase in housing demand in the region should put upward momentum on home prices as the economy continues to improve. The regional median price could increase year over year by a mid-to high-single digit in 2016.
Economic and Housing Market Forecast
Looking ahead, the state economy should continue to grow through 2016, as the high-tech sector remains in the driver seat. New product development may disrupt industries across the globe, but it could also yield sizable revenue and have significant spillover effect in their respective local economies. The construction industry is an example that shows how the rapid expansion of technology firms throughout Silicon Valley has helped to drive the construction payrolls to increase by double-digits over the past year. Improvement in the construction industry is expected in the upcoming year and will help to push the economy forward. The statewide non-farm job growth will increase by 2.3% in 2016, and the unemployment rate in California will fall from 6.2% in 2015 to 5.5% in 2016.
Meanwhile, the California housing market is expected to have a decent performance in 2016. The Federal Reserve will most likely raise the federal funds rate two to three times in 2016. Modestly higher interest rates, however, should not present much of a direct challenge to the housing market. With the economy expected to grow, housing demand should continue its upward trend, with sales of existing single-family homes projected to increase 6.3% in 2016 to 432,570.
Inadequate supply in high-end areas such as the Bay Area will continue to exert upward pressure on prices, but home sales in those regions will simultaneously be constraint. The constraint in home sales in the Bay Area leads to a decline in the share of high-end homes sales to overall home sales, which could also lead to a slow-down in the appreciation in the statewide median price. As such, the statewide median price is expected to increase at a moderate pace of 3.2% in 2016 as more homes in the affordably-priced Central Valley and Inland Empire are being sold.
Risks that Could Tip the Scales
Although the outlook for both the economy and the housing market remains positive for 2016, there are uncertainties and wildcards in 2016 that could change the outcome and tip the scales the other way. Global economic issues, for example, could begin taking a toll on economic growth domestically in 2016. Slow economic growth in China and other European countries, coupled with stronger growth in the U.S., have paved the way for higher interest rates and led to a stronger dollar. As such, international trade will likely be a drag on growth with global economic slow-down and the stronger dollar cut demand for exports, while continued improvement in consumer spending will pull in more imports.
Robust increase in jobs in high-cost areas could be another downside risk to the housing market. Due to the spillover effect of growth in high-paying jobs, plenty of lower-paying jobs have been created, with many of these jobs being in the same geographic areas where the high paying jobs are being added. As such, income disparity in these areas could further complicate and deteriorate the housing affordability issue.
Policymakers continue to list the mortgage interest deduction (MID) as a potential target in any movement toward tax reform. If MID were to be eliminated, home buyers would not have the tax savings benefit of homeownership, thus reducing their incentive to purchase a house, lowering the demand for housing, and thus reducing affordable homeownership across the country and the State of California. The economic impact would stress the state’s already battered balance sheet and, if any of the proposed changes were to come to fruition, could amount to billions of dollars of economic output lost.
While the recent volatility of the stock market has been drawing attention in the news, it is more of a distraction rather than a disruption to the continual improvement in the housing market. The drop in values of equity in January reduces the overall wealth and may have a small negative effect on the economy in general. Its impact to the housing market, however, should be minor, as solid employment conditions, anticipated increase in household formations, and record-low interest rates continue to provide support to the fundamentals of the housing market.