Commercial real estate has been struggling in recent years, just as many other sectors of the economy have been struggling. However, one advantage that most commercial buyers have over residential buyers is that they’re more willing to take on debt because their living expenses are likely a lower percentage of their income. As a result, loan originations for commercial properties increased dramatically in the first quarter of 2022.
As can be expected, the effect is greatest in the areas either least affected or most in demand as a result of the 2020 recession. These include hotels, industrial, retail, and healthcare. Loan originations for hotels increased a whopping 359% from 2021. Mortgages for the industrial sector also increased over 100%, by 145%. Increases in retail and healthcare were also significant at 88% and 81% respectively. Lesser increases were noted for multi-family dwellings at 57% and offices at 30%, but these still increased, not decreased. However, one should note that the available data isn’t entirely up to date. Mortgage rates have increased significantly since Q1, so despite the fact that they’re starting to slip back down just now, there may have already been a downward trend in commercial loan originations that we haven’t noticed yet.
Primarily as a result of actions by the Federal Reserve, mortgage rates have been trending upward since January. The rates peaked in June, and have now begun their decline in July. ARM rates are currently more volatile than FRM rates, and may continue to flip-flop, but they are still lower than FRM rates.
The 30-year FRM rate peaked at around 5.7% in late June. It’s since dropped slightly to 5.3% as of the first week of July. The 15-year fixed rate followed a very similar trend line, albeit at a lower peak rate of just under 5%. This is normal; the 15-year rate has always trended lower than the 30-year rate. The ARM rate was 4.34% at its highest in June, and has now dipped below 4%.
When renters are faced with rental price increases, as they are now, it’s typical for them to look for a cheaper place to rent. They don’t always find one, of course. But with the current inventory, it’s riskier to even look for one than to simply accept renewing their lease at a higher rent value.
Between April 2021 and April 2022, the share of renters renting at market value who chose to renew their lease increased from 53% to 57%. This is despite an 11% increase in rent prices during the same period. The problem is that there simply isn’t anywhere more suitable to go, partly because of low construction rates. Without renter movement, the number and type of vacant units doesn’t change very much, which further stagnates the market because what few vacancies exist are already deemed to be undesirable.
The number of homes sold in the South Bay has declined from last month, and has declined from last year. The quantities are actually rather dramatic given that May is typically a time of increasing sales. The drops range from -7% to -17% lower than April sales of this year, and from -17% to -25% below May of last year.
With over half the year remaining, mortgage interest rates have doubled, currently sitting around 6%. The hike in interest rates has so far reduced the average buying power by about -25%. Coupled with home price increases estimated to have risen 38% since the start of the pandemic, the immediate future of real estate looks dismal.
Inflated consumer prices are also blocking potential home buyers as the Consumer Price Index (CPI) climbs toward a 10% annual hike. There’s little chance of saving for a down payment when the price of everything on the shopping list is going up..
Retirement accounts are often a source of down payment funds. As of this writing the major stock market indices are all down: Dow Jones Industrial Average, -16%; S&P 500, -22%; Nasdaq Composite, -31%. Forecasts are growing for a Fed-induced recession that may begin as soon as this fall. Some potential buyers may see borrowing from their retirement fund to purchase a property as a means to preserve the capital during a recession. Others may not be in a position to do that.
Median Price Sold
May prices delivered a mixed message. The Palos Verdes Peninsula, which had seen two months of decline from a temporarily high median price, headed back up again. The Beach cities continued a steady climb, and the Inland area showed a modest price increase after having dropped 1% in April.
However, the Harbor area, which is as large as the other three areas combined, took a -6% hit to prices. We anticipate the Harbor and Inland areas, which comprise the bulk of the traditional middle class family homes in South Bay, to be the first to react to the economic stress.
Typically, the recession cycle starts with a slowing of sales. As properties languish on the market, sellers begin to reduce prices. One after another, median sales prices will drop until the price reduction offsets the impact to buyers. At that point, buyers will begin to support the reduced purchase prices and we can see growth in the market.
Experts differ in their estimates of how long this cycle will take, and when we can expect the market bottom. There are some predicting a rapid fall based on the speed with which the Federal Reserve Bank (Fed) is reacting. The June meeting of the Fed ended with a .75% hike in the prime rate, and a promise to raise it at least another .75% before the end of the year. While that could slow the economy as early as the beginning of 2023, more conservative minds suggest the end of 2023 for a turn-around.
Area Sales Dollars
The total sales dollars tell the truest story. While sales are slowing and median prices are beginning to slow, the combination shows up here.
Everywhere except the Beach is showing reductions in total sales on a month to month basis, and on a year over year basis. The declines are small to date, with year over year ranging from -1% to -10% in May. Month to month changes ranged from +2% at the Beach to -19% in the Harbor area.
These early numbers follow the general pattern we’ve seen in recent recessions, whereby entry level homes are the first impacted and the last to recover. We anticipate the Harbor area to lead the charge down, followed by the Inland area. Recent years have shown the Beach to be the strongest growth area, so we expect the recession to hit there last, following declines on the Hill.
The nature of the impending recession is still uncertain. Some pundits are saying that at least initially we should expect “stagflation,” that odd environment we first encountered back in the 1990s when prices of everything continued to climb, along with job layoffs and massive unemployment. Other forecasters suggest that because the international economy is roiling with continuing high tariffs (courtesy of the last administration) and new monetary sanctions daily (courtesy of the current administration), this particular recession may last much longer than normal.
In Summary
As the table below shows, the majority of the negative impact for May happened in the quantity of housing units sold. With one exception, prices continued to escalate. We believe this is temporary and likely to change before the end of the year. The -6% drop in median price at the Harbor presages the direction of home pricing as inventory grows and listings stagnate.
Approximately 3 out of 4 listings coming across our desk recently have been either Price Reduction or Back On Market. That means property is staying on the market longer. The Average Days On Market (DOM) for May ranged from 10 days on the PV Hill to 14 days in the Harbor area. As recently as this winter we were still seeing multiple offers on the first day the property was available.
Another measure of the market condition is how far the average sales price declines in the first 30 days on market. We did a quick look for May and came up with these statistics. Thirty days after the original listing, the price had dropped from the original: at the Beach, -9%; the Harbor -6%; PV Hill -18%; Inland -5%. As of May, we’re also seeing property that has been on the market for several months, with several price reductions.
Notable Properties
The high and low sales for May were not terribly dramatic. A Manhattan Hill section home and a downtown Long Beach condominium. Thay are simply very big, and very small.
High Sale
Located at 812 5th St, this Manhattan Beach hill section home was originally listed at $10.5M and sold for $8,980,000 after 34 days active on the market. The home offers six bedrooms and seven full bathrooms in 5576 sq ft. Amenities included ocean view, pool, spa, custom waterfall & fire features, a full basement with recreation/media room, home theater, storage, a temperature-controlled wine cellar, and private guest quarters.
Low Sale
Measuring barely 381 sq ft, the studio condo at 819 E 4th St #25 sold for $215,000 in one day. Located in the vibrant East Village of Downtown Long Beach this tiny home offers a remodelled kitchen and bathroom. The unit sits on the second floor, overlooking the intersection of 4th and Alimitos and within walking distance of many downtown shops, clubs and eateries.
Commute times in California, and indeed across the country, have increased in recent years, as people have moved away from job centers. The theory was that this was mainly due to work-from-home options. For some, that may be true, but many of these people aren’t working from home, they’re just commuting longer to work. Surely long commutes aren’t desirable, so what are they getting in return?
The missing factor is lower housing costs. Job centers tend to be larger urban areas with higher prices. By moving to more out-of-the-way areas, workers have reduced their mortgage and property tax at the cost of longer commutes. With gas prices on the rise, it’s not entirely clear whether this is a good financial choice. But more importantly, the people who are making this choice are the ones who have the financial means for it to be a choice. Over three quarters of higher wage workers work somewhere they can afford to live, whether they live where they work or not. Lower-wage workers don’t have an option. Only 4% can afford to live where they work, so they’re forced into longer commutes to find affordable housing.
New constructions are always built to certain specifications, whether that’s tract uniformity or client’s wishes. In the latter case, the client is usually also going to be resident. That’s starting to change, as investors are noticing that renting is becoming a lot more common as prices rise. Investors are now getting new constructions built for the express purpose of renting them out.
Only 3% of new construction SFRs were build-to-rent in 2019. By the end of 2021, this number jumped to 26%. It’s not entirely clear if this will continue to increase or not. While increased inventory of rental properties does benefit renters, renting is rarely a desired state. Almost everyone would prefer to buy if they can afford it. But it’s not renters pushing the trend. It’s the investors, and they stand to benefit as long as renters must continue to rent, whether they want to or not.
Buyers rarely find exactly the perfect home for them. There’s always something that isn’t quite what they wanted. But how do they decide what they’re willing to give up? Well, it’s different for everyone, because different buyers have different needs, and their decision may not actually be the best they could make. What can be tracked is statistical likelihood of certain decisions.
The most frequent concessions are age or condition, size, and style. Location is typically extremely important and not something most buyers want to budge on. While many buyers don’t want complete fixers, they may settle for homes with natural wear and tear due to age. Larger homes are becoming more popular, but the main attraction is more rooms. For many buyers, the rooms don’t actually have to be very big, as long as they’re big enough to serve their purpose. Style of a home does have some importance, since some styles may be more popular and fetch a higher price when you eventually go to sell it. Since you won’t know what will be trending far into the future, though, style is ultimately cosmetic. Many buyers are perfectly content ditching their preferred style for something that better suits their practical needs.
Accessory Dwelling Units (ADUs) have been contentious for a while, but SB 9 has passed recently, ostensibly making them easier to construct in California. Unfortunately, this hasn’t panned out as well as expected, as local governments aren’t entirely on board. They’re trying to sidestep the requirements by introducing zoning ordinances that effectively, but not explicitly, ban ADUs. Zoning restrictions have always been the largest obstacle to ADUs.
What clearly isn’t much of an obstacle is popular support. Particularly in California, major cities are seeing support of over 70%, even up to 80% in San Jose. But California isn’t the only state. Nationwide support is at 69%, with the remaining 31% split between opposing and indifferent. It’s no surprise that more renters than homeowners support it, since they’re more likely to be searching for housing. But both groups show strong support — 76% of renters and 66% of homeowners.
In a normal year one would expect April to be the turning point for the LA real estate market. March is still cold and the children are still in school for another 10 weeks. April’s the month when the weather turns warm, the flower buds poke up, and the buyers come out to start the spring buying season. It hasn’t happened that way this year.
Prices had gone through the ceiling by the end of 2021, much of the activity stimulated by fear of escalating mortgage interest rates. Usher in 2022–January and February were typically slow and in March home sales bounced up like an indicator of business as usual. But, interest rates continued to climb and April ended with the total number of home sales down instead of up. Likewise, total sales dollars were down across the South Bay.
Number of Homes Sold
Judging from the charts, entry level homes in the Harbor area were clearly the center of activity for South Bay real estate. As interest rates pushed against the 5% mark, panic set in among first time buyers who had been outbid multiple times. Prices went up as high as buyers could afford, a number that shrinks amazingly fast with each tenth of a percent increase in the interest rate.
Across the South Bay, the number of homes sold in April dropped by -4% from March, which had been an increase of 59% over the prior month. As we see from the chart below, sales were uneven between the various areas.
On the entry level front, at the same time Harbor area home sales were dropping off, Inland homes gained sales. On the high end, sales on the Palos Verdes peninsula were also facing declining numbers, while Beach area sales increased.
So far declining sales counts have been modest, but a decline overall, coupled with a decline in half of the individual areas covered indicates that buyers are pulling back. Part of the resistance is a matter of simply being priced out of the market. Another important piece is the anticipation of price corrections in the near future. We have heard multiple buyers say they are watching and waiting for lower prices later this year.
At this point we’re well into the second quarter of the year and it looks as though those folks may be on track for some savings. even some of our most gung-ho pundits are beginning to see a market downturn on the horizon.
Median Price Sold
Interestingly, Harbor area prices went up at the same time the number of sales went down.The March to April price increase was a modest +6% compared to a +21% increase over April of last year. Similarly, the Beach cities had a month over month increase of +4%, while showing +19% year over year. While sales prices are still rising in those areas, the increase is a fraction of what it was last year.
Sold prices on the Hill continued to slide downwards. Because the February increase in the median price was created by the sale of new construction, and that building phase is now sold out, a downward turn in median price is expected. We anticipate that leveling off soon.
In the Inland area the median price for homes sold during April of 2022, was +12% greater than sales in April of 2021. By comparison, the median price of those sold in March of 2022 versus April of 2022 decreased by -1%. It’s a modest decrease that points to the direction of the South Bay real estate market for the balance of the year.
Area Sales Dollars
The total dollar value of home sales in the South Bay usually tracks right along with the number of units sold. The few times it differs are important times like these when the number of homes sold is dropping, and/or the sales prices are dropping. Today, of the four areas we track, PV Hill has a declining number of sales, both in comparison to last year and in comparison to last month. As we noted above, the area also is declining in total dollars compared to last year and last month.
As we discussed in last month’s issue, some of the reason for the drop is found in new construction homes that sold at a much higher price than the typical Palos Verdes resale home. The rest of it can be found in longer days on market waiting for a buyer, and in price reductions.
At the opposite end of the spectrum, the Beach cities showed gains last month for both number of units sold and for the total sales value of those homes. The only decline this month for the Beach was in number sold compared to April of last year. Sales this April were off by -21%.
The Harbor area still trended upward in dollar value, both month over month and year over year. But, the number of units sold was down for both time measurements. The price competition was very stiff in what is generally an entry level market. During the past couple years, bidding wars and over-asking sales prices have kept the dollars high. The April numbers show that changing rapidly.
Total dollar sales for the Inland community increased 15% month over month. That was the highest growth of all four areas. Scanning those individual transactions showed an odd pattern. Sales in the price range from about $325K up to about $750K were a familiar mix of some under asking price, some at asking and some above asking. The degree of variance was about what one would expect. Unexpectedly, for sales over $750K, nearly every property sold above asking price, and in many cases well above asking.
We found no clear explanation for why this phenomena occurred. There is a suspicion that buyers who were priced out of Beach properties may have shifted their bidding wars into the increasingly popular parts of west Torrance. This theory is supported by the distribution of sales among the various neighborhoods.
In Summary
In the table below are the core statistics comparing April to March of this year, and comparing April of this year to April of 2021. The prevalence of negative numbers is convincing evidence that high prices and high interest rates are pushing the South Bay real estate market into a recession.
Notable Properties
One of the more interesting properties sold in April is a four bedroom, five bathroom home located in west Torrance. The home was purchased by the seller as their family home in 1990 for just above $360K. The children grew up and the parents remodeled in 2022 and sold the house.
As would be expected in a good neighborhood with a contemporary remodel, the home sold for over the asking price of $2.7M. The final selling price was slightly over $3M. and just happened to be almost exactly $360K over the asking price.
In the 32 years that family owned the home it appreciated at an average rate in excess of $84K per year. It’s the classic “American Dream.”
You can find advice for prospective home buyers all over the internet — including, of course, in our articles. But who knows better than the buyers themselves what they’re having trouble with? For over half of survey respondents, 56% to be exact, the biggest problem is finding the right property. This is probably partially the current market, with very low inventory, and partially buyers not knowing what or where they can afford to buy.
This isn’t one of the categories buyers mention, though. For nearly a third of respondents, the most difficult part is understanding the process and paperwork involved. 20% cite primarily monetary issues, either with saving for a down payment or getting a loan. Comparatively few, only 7%, believe that COVID-19 was a significant complication. Meanwhile, 18% of respondents don’t think the process of buying a home is difficult at all.
The majority of homebuyers choose fixed-rate mortgages (FRMs) over adjustable-rate-mortgages (ARMs) in order to not have to deal with the uncertainty of changing interest rates. However, there’s very little uncertainty right now — interest rates are going up. This does include both FRMs and ARMs, but ARMs tend to have lower starting rates — a 5-year ARM was at 4.28% in mid-April. Buyers are predicting that even with an adjustable rate, their rate is not likely to surpass the 30-year fixed rate of 5.37% as of the end of April.
ARMs aren’t exactly popular, though. Even with their share doubling in the past three months, that’s still only 9% of mortgages. About as large a share of potential buyers are instead choosing to simply wait for a better time, with mortgage applications dropping by 8% and refinance applications dropping by 9%. Refinance applications are also drastically lower than the same time last year, having dropped a whopping 71%. New mortgage applications also dropped since last year, by a much more modest but still significant 17%.
The usual effect of rising interest rates is a decrease in demand, as buyers would rather wait to lock in a lower rate. Decreased demand should then translate to lower prices, since sellers want to encourage buyers. Not so in the San Francisco Bay Area right now. Prices are still going up, and demand didn’t really go down all that much.
The culprit? A couple of factors. Most significantly, inventory is extremely low in the Bay Area. Buyers are encouraged to take opportunities where they can, since they don’t come up often. That often means paying less-than-ideal prices. Secondly, the Bay Area is generally a high-income area and already has high prices. Even with rising prices, most people able to purchase there aren’t going to be suddenly priced out. Those looking for a median-income or lower household aren’t looking in that area to begin with.
We know that the wildly high post-lockdown demand was in large part driven by fear of missing out, or FOMO. People definitely took notice of the low interest rates and decided to take advantage of them. Interest rates are no longer low, and home purchasing demand has slowed. However, home renovations are still in high demand for just a bit longer. Renovating is not as expensive as buying, so homeowners with FOMO who could not afford to buy instead sought to remodel their current homes to better suit their needs.
In turn, though, home renovation costs have also increased rapidly in response to demand. By the last quarter of 2021, the year-over-year change in home remodeling costs had risen to 9.4%, about 2.5 times the expected 3.8% increase. Current projections have the Q3 2022 increase at an incredible 19.7%. But just like with rising home prices, increasing home remodeling costs will begin to price out even those affected by FOMO. Q3 is predicted to be the peak, with the prices starting to slow again by Q4 2022.
Over approximately the past decade, the average length of time homeowners have stayed in their home has steadily increased, from 10.1 years in 2012 to the peak of 13.5 years in 2020. Until last year. The figure actually dipped in 2021, decreasing to 13.2 years, even slightly below the 2019 average of 13.3 years.
Much of this can be attributed to the economic aftermath of the pandemic, as relocations increased dramatically in 2021 as a result of work-from-home opportunities and low mortgage rates. It’s unclear whether this is a temporary decline, or 2020 was the peak of homeowner tenure and it’s going to continue to decrease. Analyzing the reasons for the decrease and why it’s been increasing in the first place suggests it’s probably going to go back up. Work-from-home is still happening; however, mortgage rates are no longer low and are still going up. Meanwhile, the initial reasons for the increase over the past decade include increased propensity for aging in place and a desire to keep one’s property tax base low. Neither of these are changing much, even with the ability to transfer your property tax base in some cases.
You’ve heard of first-time homebuyers. You don’t hear as much about first-time homesellers, even though of course they must exist. But now there’s reason for them to make the news. It turns out a significant number of homeowners in the younger generations — Gen Z and Millennials — are already looking to sell, despite also being the predominant first-time homebuyer generations. This includes 44% of Gen Z homeowners and 35% of Millennial homeowners.
With both first-time homebuyers and first-time homesellers being mainly between the ages of 18 and 41, agents really need to focus their marketing efforts if they want to do business with them. That requires knowing what people in this age category are looking at in terms of marketing. 59% of Gen Zers and 65% of Millennials consider social media marketing to be important for a real estate agent. Fortunately, this isn’t likely to ostracize other cohorts, since 58% of Gen Xers and 60% of Baby Boomers are in agreement. Agents that don’t have social media presence and are struggling to find deals may want to rethink their strategy.
Many older people think of Millennials as being young kids who have no life experience and no financial know-how. The reality is Millennials are in the normal age range for first-time homebuyers, and some are even older. Their financial problems are not due to lack of knowledge. It’s due to a series of economic struggles that were completely out of their control.
Most Millennials came to age during the Great Recession, and so employment simply wasn’t available during the years when they were expected to find a job. That has made it more difficult to find one even after the Great Recession ended, as employers are expecting someone their age to have more experience. The 2020 recession, during a time when society expects their age group to be looking for a house, hit Millennials yet again.
In addition, inflation has far outpaced wage growth. Even those Millennials who have a job are not earning nearly as much adjusted for inflation as older generations were at the same age. Only about half of Millennials are employed full-time, and less than two-thirds are employed at all. Even though wages are increasing, they are still stagnant because of how quickly prices are increasing. Between 2012, when the market was finally recovering from the Great Recession, and 2020, when the most recent recession started, wage growth was at 24%. Home prices, however, went up over 3.5 times as much, by 86%.
After a period of low mortgage rates, they’re going back up quickly. That is the expected effect of current Fed policy, but we may hit 5% faster than expected, possibly as early as next month. As of the beginning of April, the average 30-year fixed rate was 4.59%. If they do hit 5%, it would be highest rate in the past decade, though they did get close in November of 2018 at 4.94%.
The increasing rates are definitely going to slow down the real estate market. That may be a good thing for the market, given how hot it’s been, but it’s definitely not good for buyers. Demand isn’t going to disappear completely, though. And the effect is probably mostly psychological. Historically speaking, 5% isn’t a particularly high rate. It’s just that rates have been trending downward for quite some time, so it isn’t going to be familiar territory for the new generations of buyers.
It’s true that some people have taken work-from-home as an opportunity to travel far and wide, but it could be that most buyers still want to be relatively near where they already are. They also aren’t looking for major changes in community type, whether urban, suburban, or rural. Nor are their motivations primarily financial, except in cases in which they changed jobs.
In a small survey of 514 respondents who were actively searching for a home, just over 40% of them were looking between 6 and 50 miles away, and over a quarter were searching between 2-5 miles away. However, it is important to note that of those looking more than 50 miles away, most were looking over 500 miles away. Between 63% and 77% of respondents wanted to stay in the same community type, and if they wanted a switchup, it would probably be to a suburban area. The primary reasons for moving were either lifestyle fit or major life events, not a growing wanderlust prompted by the possibility of a work-from-home model.
What buyers want and what they’re able to get isn’t always the same thing. Buyers nowadays are frequently settling, due to high prices. However, their search keywords are a decent indicator of what they want, even if it’s just wishful thinking. And what they want right now is outdoor living, except from the comfort of their home.
The number 1 most searched home feature is a swimming pool. In fact, buyers currently seem rather obsessed with water. If they can’t get a pool or hot tub, many are happy with a view of the water, and it doesn’t necessarily need to be an ocean view. The second most searched term is a view of rivers, and beaches, waterfronts, lakes, or really any kind of water is a popular view. Buyers are also looking for other types of outdoor amenities, such as horse facilities, boating facilities, golf, tennis, and basketball. And of course, they search for a large lot or outbuildings to accommodate all these features.
Realtor.com has released their Best Time to Sell Report for 2022, and the predictions land on April 10-16. Spring is usually a hot season for the real estate market, and this year is no different. Demand is going up, prices are still high, and inventory is still low. Homes are already selling quickly after listing.
It’s not going to last for too much longer, though, which is why the window is so small. Mortgage rates are increasing, which will reduce buyer demand or cause them to look for lower priced listings. Inventory is also starting to recover as construction is accelerating. Also, if you are planning to sell in order to buy a new home, keep in mind that the best time to sell is frequently not a good time to buy.
