Last year at this time I wrote that I expected the real estate market in Los Angeles to begin to cool, and hit a plateau after the huge increase in prices for the past 6 years, dating back to 2011. Boy, was that off base as the market continued on at its break neck pace across most neighborhoods in LA. The median home price for a house in Los Angeles hit a record, and many neighborhoods are above their pre-2008 Recession prices. Overall, Los Angeles averaged a 8% increase in prices in 2017 compared to 2016.
Despite the increase in prices over the past 6 years, I still don’t feel that we have reached a “bubble market”. Unlike the crash in 2008 that was largely caused by poor lending practices and characterized by high debt, today’s market is seeing higher downpayment amounts (many buyers putting more than 20% down), stringent lending requirements, and is still being fueled by historically low interest rates.
That being said, there are several factors affecting the market in 2018 that I believe are leading us to the plateau that I falsely predicted last year.
The first and most important factor for the market in 2018 is rising interest rates. Rates have gone up about a half a point in the past 6 months, and are expected to go up throughout 2018. This will be a gradual process, so don’t expect any spikes in rates, but I think it’s reasonable to see rates in the mid to high 4% range by the end of year, which is nearly a full point higher than 6 months ago. While these are still incredibly low rates, this increase, combined with high prices, is continuing to reduce affordability in LA and slightly lower demand.
One of the key driving factors for our market run up has been buyers’ readiness to pay slightly more for a property because their monthly payment would hardly change when amortized over the life of a loan. At some point, the increased cost of the home, due to higher prices and a higher interest rate will be too much for buyers. They won’t be able to push the envelope on price when submitting an offer and prices will begin to level off.
The second most important factor on the LA market in 2018 is the rental market. The rental market over the past 6 years has mirrored the home sale market – limited supply, high demand, and increasing prices. Seeking to take advantage of this market, developers have been attempting to build apartment buildings as fast as they can, and yet have still failed to produce enough inventory to level off rents. However, that should begin to change in 2018. There is a plethora of new apartment buildings being constructed as we speak – specifically in Downtown – that should add the needed supply to the market.
In addition, with the cost of rent increasing so much over the past few years, more and more tenants are looking to the suburbs to find more affordable rent, which is reducing demand in the heart of LA. With more supply and less demand, rental prices are predicted to level off in the coming years.
Thanks to low interest rates, one of the biggest driving factors for our high demand to buy homes in LA was the fact that the cost of renting compared to owning was nearly identical when you factor in the tax benefit of owning (more on that in a minute). If rental prices level off or drop, while interest rates and higher prices make it more expensive to buy, more Angelenos will opt for the cheaper option and rent, thus reducing the buyer demand.
Finally, the new tax regulations will have an impact on the Los Angeles market in a negative way. Without being able to deduct state property taxes, and with a reduced amount of mortgage interest deduction (from $1 million down to $750,000) the cost of homeownership will rise in LA. I personally don’t think it will have a huge effect on the market since the tax benefit of owning a home is not typically a driving factor for most buyers, but combined with higher rates and more affordable rent, demand in the market should begin to wane.
Of course all of this is relative to each neighborhood and price point in Los Angeles. In general, the entry level home or condo market is still in high demand and I don’t anticipate that changing in the near future. However, in the higher price points, typically $2.5 million or higher, I am seeing the market begin to slow down. Listings are sitting on the market the longest they have in the past 6 years, and buyers are becoming more price sensitive since they realize they are paying a premium for each property. The plateau seems to have already hit the higher price points, and eventually it will reach the starter home level as well.
I had the pleasure of attending a real estate economic forum in December hosted by my company and featuring a presentation by John Burns Real Estate Consulting. The presentation outlined the strength of the Los Angeles market based on our strong local economy, high level of job creation, high desirability, and consistent foreign investment in our real estate. All good news, and all factors that should persist in the long term for Los Angeles – making LA real estate a sound long term investment.
The presentation did outline some of the factors I listed above about where prices should go in the near term. They are predicting (see chart below) that prices should increase about 6% in 2018, 5% in 2019, and only 2% in 2020. This reflects the leveling off, or plateau that I expect to see in the market as well. I personally think it may happen a little faster than they expect, so only time will tell!
Overall, I see this slowing in the market as a good thing since prices cannot continue on at such a torrid pace. A more normal market with balanced levels of supply and demand are what the LA market needs, and should get started in 2018.
If you have any questions on this piece, or the market in general, please feel free to contact me.