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Inventory, Inventory, Inventory. The return of housing to better days has mainly been attributed to lower interest rates, fewer defaults and a gradually healing economy. But what has brought the biggest smile to the face of analysts and homeowners alike is steady appreciation in home values as part of this new cycle. Since the end of 2011, home values have risen over 5% nationally, and are forecast to rise at least 6% over the next five years. The increases have been much higher in many major cities. It all has to do with supply, or the lack thereof, that’s driving home values north. While everyone is encouraged to see the return of equity of home values, a protracted period of tight inventories could have a negative impact on the current cycle. Simply put, if buyers can’t afford to buy, the process stalls.
Attaining the right balance of all the ingredients that have led to the current recovery phase can be tricky. The combined result of fewer foreclosures and mortgage delinquencies combined with brisk all-cash investor activity is effectively containing the specter of a looming shadow inventory of distressed homes that had once been seen as one of the major headwinds preventing a full housing recovery. The downside of this is, of course, an overall reduction in available, affordable homes on the market.
Fortunately, those developers and investors wise enough to understand the nature of the real estate cycle foresaw the scarcity in inventory and the resulting opportunity as they brought more units online. Investors in new multifamily housing flourished in 2011 with units becoming available now, and overall construction in housing for both apartments and single family dwellings actually helped to boost the economy out of recession. We have been involved in a number of new projects in Southern California aimed at bringing affordable units to the market. Case in point: we served as a major capital partner for a 156 unit condo development in the Ventura County area that broke ground in the 3rd quarter of 2011, and the developer is currently in the second phase of development to meet demand with most of these units already pre-sold. Another project we’re involved in is a 10 unit townhome subdivision in the Tujunga community that will be bringing 10 new homeowners into that market shortly. We are also online and committed to begin a residential gated development and a Thousand Oaks home development in the area.
What’s often ignored in the inventory equation is the participation of the “move-up” buyer and having available product to meet demand. For a fully functioning housing cycle to occur there has to be an upward migration of current homeowners to larger homes to allow first-time home buyers and growing family households an opportunity to purchase at affordable prices. Of course, as the last period saw home values depreciate, the cycle stalled as homeowners found themselves held hostage by falling equity and the inability to leverage it toward a larger purchase. Today paints a different picture, as homeowners are starting to test the waters with rising home values and multiple offers on listings. Inventory now becomes a welcome problem to have at the affluent end of the housing scale. In March, homes sales over of $800,000 are up over 33% from last year in Southern California. The current housing cycle requires adequate supply for move-up buyers to continue its progress. We have positions in the affluent market as well as the primary partner in a 20 acre, 15-estate equestrian development project in the Sunland community.
Home values for entry level as well as larger homes are skyrocketing, to the delight of homeowners, potential sellers, real estate professionals affirming that for the long term, real estate is and always has been, a sound investment choice. Additional housing units coming to market to balance the supply/demand equation won’t dampen appreciating values, but should modulate increasing values just enough to allow more new buyers into the market and persuade more owners that they can locate replacement properties if they list their current home.
What a difference one year makes in virtually changing the course of real estate. The specter of the shadow inventory and its predicted drag on the industry has been dispatched in a flurry of workout solutions, bulk REO to Rental strategies employed by GSEs, and the influence of all-cash investors snapping up bargains at a rapid pace. When combined with cautiously optimistic reports on the economy’s performance and improved consumer sentiment, the average American homeowner is enjoying the return of rising equity. What has not seen improvement at the same pace is the availability of affordable housing for rank and file consumers.
In today’s market, affordability is an elusive target due to the number of factors that define it. What homeowners applaud as “increasing equity” as the price of homes in their neighborhoods rise, potential buyers perceive as homes pricing themselves out of reach requiring a larger mortgage. The 30-year fixed rate mortgage benchmark is inching its way north of 3.5% as the economy improves, becoming another barrier to affordability for potential homeowners. Affordability is equally a concern for rank-and-file renters who face the never-ending cycle of rising rents, as demonstrated by the greater Los Angeles market where rents have increased by nearly 30% since 1993 while renter incomes have decreased by 6% over the same time period.
The real culprit here is not affordability, but available inventory, or rather, the lack thereof. One of the consequences of the last cycle was a contraction in single-family and multifamily construction as developers felt the crunch of a debilitating housing downturn. Moreover, the growing numbers of foreclosures and REO created the new “shadow” inventory class that gave the perception of surplus housing units available to the market. But that same downturn created opportunities for cash investors to snap up those distressed bargains in bulk from lenders and government entities. Additionally, foreclosure prevention activity initiated on both the state and government level capped the flow of new distressed assets into the available inventory. Now with a perceived end to the housing crisis and a return to stability, the industry finds there are simply not enough housing units at reasonable prices for renters and entry-level homeowners to comfortably afford. We are currently partnering in an affordable housing condo project in Oxnard, California and can attest to the overwhelming demand we have experienced from qualified buyers unable to find any housing.
If affordability is tied to available inventory, investor participation is absolutely critical to restore equilibrium. During the darkest moments of the housing crisis, multifamily property activity was the one bright spot in a lackluster housing market providing housing for those displaced as a result of foreclosure or other relevant lifestyle shocks. Developers in the single-family sector have already begun to seize the moment of a post housing crisis with new projects. New projects require fresh sources of capital. While the “thawing” of traditional capital channels via commercial lenders is continuing, lenders should bring more to the table in terms of flexible credit conditions to support more development in both multifamily and single-family arena.
Bringing more new units to market overall should also coax more existing single-family units into the housing supply. Many potential sellers are still waiting on the sidelines waiting for prices to appreciate even further before listing their property with an agent. As prices stabilize with new inventory, sellers should be motivated to put their property on the market before values begin to level off. The principles of supply / demand economics should modulate appreciating home values in such a way to allow more buyers into the market with more homes for sale.
This market is on the verge of a breakout year, but only if more buyers gain access to the market with available inventory to meet demand. The market must create favorable conditions not only for sellers with fair home values, but also for buyers whose purchase power can afford the homes on the market.
