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A view of the California market.

A VIEW OF THE California Market

As we close the door on the year just past, it is time to plan and develop strategies for doing business in 1992. To do so, a realistic look at the housing market environment is essential. The new year will bring with it a modest turnaround in the California housing market following three years of declining sales activity. The California Association of Realtors (CAR) is forecasting a 4 percent increase statewide in existing home sales activity in 1992. This will mean that approximately 437,000 home sales will be recorded this year compared to a projected 420,000 in sales for 1991.

To put the current cycle in perspective, California home sales fell between 20 and 30 percent a year during the 1980 to 1982 period but dropped 4 percent, 17.1 percent, and 5.9 percent respectively for the three-year period between 1989 and 1991. However, while the market rebounded quite strongly from 234,000 sales in 1982 to 343,000 in 1983 - an increase of 46.5 percent - the turnaround projected for 1992 is considerably more modest.

The pace of transactions will vary from region to region and neighborhood to neighborhood. In general, the trend will reflect a continued rebound in home sales in California's coastal metropolitan regions, which experienced the most significant improvements in affordability in 1991. Sales in inland areas of the state will also improve. This includes regions such as Sacramento, other Central Valley areas and markets north of the San Francisco Bay area. Within each area, sales of more moderately priced homes will likely do better than highend homes. Condominium sales will also improve but at a slower pace than the detached home market.

Home price appreciation will also vary from area to area. For the state as a whole, the median sales price is expected to increase 4 percent this year with a statewide median of $206,000. This will reflect a greater proportion of sales in the more expensive coastal areas as compared with 1991. But with relatively slack demand and moderate-to-high levels of inventories of homes for sale, there will be little upward pressure on home prices in most of the coastal metropolitan regions.

The outlook for the California resale housing market is tied to prospects for the state and national economies. Expanding employment, rising incomes, rapid population gains and strong consumer confidence fueled an unparalleled housing boom in California during the 1980s. Resale housing transactions grew from a low of 234,000 in 1982 to 562,000 in 1988. New housing starts in the state exploded from 85,700 in 1982 to 314,600 in 1986 and 255,600 in 1988.

Job creation averaged 400,000 a year during this period, while the state gained an average of more than 600,000 new residents a year, twice the national rate. Sharply lower interest rates, coupled with the increasing availability of adjustable-rate mortgages, also fueled the demand for housing. Between 1984 and 1989, the median price of existing homes sold in California increased 70 percent compared to a national increase of 30 percent. As we look ahead to what to expect this year, the picture appears somewhat dimmer than in the past, at least over the short term. The reasons for this change lie in the persistently gloomy national and state economic picture and in a cyclical correction within the California housing market.

California: an economy in transition

The diversity and strength of the California economy - the world's eighth largest economy - has meant that the state has often been an engine of growth for the rest of the nation. You must go back 20 years, to 1971, to find the last episode when California lagged the economic performance of the country as a whole. At that time, defense cutbacks coincided with a general economic downturn, a situation that is repeating itself today.

In October, the unemployment rate in California was 7.8 percent compared to 6.8 percent nationally, an indication that California has been faring worse than the nation as a whole this time around. As California has slipped gradually into recession over the last 18 months, it has become increasingly clear that the California economy is not recession-proof. Specific areas of weakness include: * Defense/Aerospace - This sector is

undergoing a significant downsizing,

primarily centered in Southern

California. McDonnell Douglas, for

example, has eliminated close to

11,000 jobs in the last year as it

struggles to cope with reduced orders

and competitive pressures

from Boeing and Airbus. Aerospace

job cuts for the state as a whole now

total 36,000 for 1991, following a

drop of 25,300 the previous year.

Statewide manufacturing employment

is off by more than 130,000

jobs on a year-to-year basis in

September 1991, a 6.3 percent decline

from 1990. However, it is important

to note that the state's

dependence on aerospace/defense

has dropped from 15 percent to 8

percent in the last 20 years. * Construction - New housing permits

in California are expected to total

102,000 in 1991, a 38 percent drop

over 1990, when permits dropped

30.8 percent. The declines in housing

starts and commercial construction

have resulted in a loss of more

than 106,000 jobs in 1991, a drop in

excess of 16 percent. * Drought/freeze - California's six-year

drought has made water-intensive

businesses scramble for water

at higher costs while the 1990-91

freeze cost California farmers an estimated

$500 million to $1 billion in

foregone revenue. * State budget deficit - In approving a

budget for the current fiscal year

the state confronted a deficit of

$14.7 billion. It was eliminated by a

combination of tax increases and

spending cuts that appeared to get

the budget back on track but also

reduced much-needed fiscal stimulus

and disposable income. However,

with tax revenues currently

running 5.3 percent below last year,

a $4 billion revenue shortfall is predicted

unless the economy improves

substantially. * Retail sales - Consumer spending in

this area is running 1.5 percent

below year-earlier levels based on

data for the first nine months of

1991, as major purchases are delayed

or economized in light of

heavy debt loads and an uncertain

economy. * Service sector slowing - Consolidation

within the financial services

sector, including the merger of the

Bank of America and Security Pacific,

are indicative of some of the factors

that will dampen job growth in

the service sector during 1992. Jobs

in the finance, insurance and real

estate sectors are down almost .4

percent statewide, a loss of more

than 30,000. In total, more than

38,000 service jobs have disappeared

in the state, a 1 percent decline

from 1990.

The California housing market

A debate is currently raging over whether the current recession in California is an indication of significant and possibly permanent structural decline or a cyclical downturn similar to past recession/recovery cycles. While the state's economy has cooled over the past year in several key sectors, including housing, it is our view that the slower activity presages a return to a moderate level of activity sustainable over the long term. It does not, as others have indicated, signal that California is following the oil-patch states and New England into a full-fledged regional housing depression. But it does mean that the recovery in California will not only lag the national recovery, but will experience a slower growth than has been the norm in other postwar recoveries. As noted earlier, we are anticipating a moderate turn-around in activity in 1992 with resale activity increasing by 4 percent over 1991.

In the existing home market, 1991 has been a year of some surprises. Sales jumped 25 percent between the first and second quarters, from an annualized sales rate of 399,100 to 499,200, as the post-war surge in consumer confidence combined with improved housing affordability. The gain was so large that our initial forecast of 400,000 sales by year end had to be revised upward by some 20,000 transactions. The post-war boom also pushed the median home price up to an all-time high of $207,840 as buyers returned to California's coastal metropolitan markets where improvements in affordability had been greatest. Third-quarter closed-escrow sales dipped 17.5 percent to 411,800 units on an annualized basis from 499,200 units sold in the second quarter.

The May peak of 525,240 transactions on an annualized basis was not sustainable in the face of lackluster economic reports, hesitant consumers and an expanding inventory of homes for sale. The index of unsold inventory of existing homes for sale in the market reflected the seesaw in activity, falling sharply from a 15.4-month supply in the first quarter of 1991 to a 10.3-month supply in the second quarter, and rising again to 12.7 months in the third quarter.

A historical perspective

In order to put recent trends in the housing market in perspective and assess the future, it is important to look back a few years. First, the slowdown in the California resale market began in the first half of 1989 in response to constrained affordability, not with the arrival of the recession in July 1990.

The California housing boom was concentrated in the coastal, metropolitan areas of the state: Los Angeles, Orange County, Ventura and the San Francisco Bay area. Starting in the spring of 1988, fears of rising interest rates and relatively low inventories of properties for sale combined to create a rush of activity. In some areas, prices went up at rates of 2 to 3 percent a month. For example, in Ventura, the median home price increased from $159,000 in 1987 to $204,300 in 1988, a gain of 28 percent. In August 1988, the supply of homes on the market reached an all-time low of 3.8 months, while a 10- to 12-month supply is considered normal for most markets. The median time on the market dipped from 52 days in 1987 to 43 days in 1988.

Conversely, during this period activity and price behavior in the less expensive inland areas of California were moderate. The median home price in 1988 gained 11 percent in the Riverside/San Bernardino area, 9 percent in the very northern areas of the state and only 6 percent in the Central Valley.

By the first quarter of 1989, when statewide resale activity peaked at an annual rate of 615,000 sales, affordability had tumbled. CAR's Housing Affordability Index dropped from a high of 32 percent in 1987 to 19 percent in 1989. Regional indexes showed a drop from 27 percent to 16 percent in Los Angeles, and from 18 percent to 11 percent in the Bay Area, over the same period. In response to deteriorating affordability, prospective homebuyers continued their search for housing in a variety of ways. For example, the condominium market, which had been very sluggish in the first half of the 1980s, began to show increasing strength. In 1989 the median condo price in California was $139,300, or 78 percent of the $196,500 median for existing, single-family, detached homes. This translates into almost $15,000 less in annual income needed to qualify for a mortgage, a big difference for households seeking affordable housing.

During this period there was also a shift toward sales of smaller homes as buyers found themselves increasingly priced out of higher-end homes. This affordability-driven cycle also fueled a major rebalancing of home sales activity and population toward the inland areas of the state. Between 1989 and 1990, the market share of home sales in the inland areas of the state increased by 5 percent.

Second, as the recession took hold in the summer of 1990 and the Gulf crisis sent consumers scurrying to the sidelines, the housing market entered six months of slower activity. When the war ended, as noted earlier, sales accelerated dramatically, from a 351,000 annualized rate in January to 525,000 in May.

Future prospects

There is no doubt that California is undergoing a structural readjustment impacting job growth and housing. What are the longer-term prospects for housing in the state?

California has not constructed the tremendous oversupply of new housing that has been characteristic of the Texas and New England markets. For example, during 1985-88, New England was building almost two homes for each new resident. California, in contrast, has built less than one housing unit for every two people added to the population. The Real Estate Research Council of Southern California reports that between mid-1989 and year-end 1990 the total inventory of unsold new housing in the southern region increased by more than 200 percent to 20,900 units. However, during the first half of 1991, inventory dropped by almost 30 percent, as housing permits for new construction dropped to their lowest level in seven years.

The rapid population growth California has experienced during the past decade will slow in the 1990s, but will continue to be stronger than that of most other states. Approximately 6.3 million people are projected to be added to California's population by the end of this decade, bringing the total to 36 million by the turn of the century. This means that housing demand will continue to grow. Development will also continue to shift inland as lower costs and higher perceived quality of life continue to attract households and businesses. And despite the slower growth projected for the Los Angeles and San Francisco metropolitan centers, they will still exceed most U.S. urban centers.

According to American Demographics, of the 50 hottest county economies ranked by projected new jobs in the 1990s, 10 were located in California. Orange (1), Los Angeles (2), San Diego (5) and Santa Clara (7) counties were all in the top 10 with a combined new job projection of 2.05 million.

Furthermore, California is expected to expand its employment base and increase personal income growth faster than most other states. A recent issue of Fortune magazine lists the country's 100 fastest-growing companies and 33 are headquartered in California.

California's non-farm employment growth is forecasted to average 1.7 percent a year over the next decade compared to only 1.2 percent nationally. In the 1990s one-third of all new jobs created in the U.S. will be in three states: California, Florida and Texas. Also, personal income is expected to grow an average of 2.4 percent per year compared to 2 percent nationwide.

Given these longer-term strengths projected for the California economy, the prospects for housing appear relatively positive. In the short-run, however, improvements will be modest, at best. The turnaround in California's housing market will hinge on the national economic recovery and revival in consumer confidence. This recovery is projected by many economists to begin after the second quarter of this year. California will continue to lag the nation by several months but by the second half of the year, some growth in personal income and employment, combined with low interest rates and improved housing affordability should help boost housing market activity. Once the housing market gains some momentum, it will not take long for the inventory of unsold housing to be absorbed to more normal levels given the substantial declines in new home construction. Thus, the biggest challenge for the state will not be in surviving the cyclical economic downturn, even with some of the structural changes it is currently experiencing. The challenge will be, over the longer - term, in finding ways to house, educate, transport and preserve the environment and quality of life for an expanding populace.

Leslie Appleton-Young is an economist with the California Association of Realtors in Los Angeles.
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Title Annotation:housing market
Author:Young, Leslie Appleton
Publication:Mortgage Banking
Article Type:Cover Story
Date:Jan 1, 1992
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