Real Estate Market Report
Are we at a peak?! In many areas of California, residential SFR’s sure feel like they are hitting a peak. This doesn’t necessarily mean price will drop though. More than likely, we will probably see price increases stop, and a plateau of pricing hit soon, if not, already in some areas. (real estate is always local)
Housing affordability is a great leading indicator of housing prices. A great and simple indicator of affordability is taking a family’s gross income and multiplying it by three to get how much house a family can afford. For example, if a family makes 100,000 a year, usually a well priced house for that particular family will be around 300k. (California frequently does not fit this mold, however). Another way to think about it is the total monthly payment of a house shouldn’t be more that 3X the gross monthly income. There are other leading indicators as well, such as oil prices, lumber prices, and price of labor, just to name a few, but the relationship is a little more complex. The “Case-Shiller Index” is another great tool to study.
Multifamily cap rates are extremely compresses in California as well. My belief is that foreign investment, coupled with low cost of capital has pushed cap rates to all time lows. For example, some markets and assets are selling for 5% capitalization rate or below. It is very hard to sustain this long term, as the cost of capital (interest rates) has only one way to go, and that’s up. Artificially low interest rates have persisted for many years now, and it’s only a matter of time before those rates start to climb, as we have seen recently.
While an there is an inverse relationship between real estate prices, both residential and commercial, and interest rates, it usually isn’t that cut and dry. There are many other factors such as locale, asset class, and perceived future benefits that play a part as well. But we can probably safely predict that as interest rates rise, affordability goes down. In addition, as cost of capital goes up, hurdle rates, or rates of return required by firms, goes up as well.
All in all, many areas will start to see a plateau in pricing if they haven’t already. This doesn’t mean price decreases, but the best time to buy has long passed. Buyers will likely turn to sellers in the near future in many areas as well, especially for multifamily properties in A markets like Santa Monica, parts of Los Angeles, etc…