The So Cal housing market is still vastly overpriced in the medium to high price ranges. The subprime blowout has caused lower end markets to drop closer to sustainable prices in areas like Riverside and Lancaster. However, medium to high range markets have remained stubborn in returning to affordable pricing. This is due to a number of factors.
For one thing, the medium to high priced housing market is supported by more financial cushion, as opposed to the subprime where people tend to live paycheck to paycheck with no buffer. When funds become short for low income families there is no extra money to keep them from slipping right into foreclosure and bankruptcy. For another thing, the reset dates for subprime loans have come and gone already and we have worked through that end of the “exotic loan” funded housing crisis. However, this is not so in the medium to high end Alt-A and prime lending markets. The exotic loans originated for this sector had much longer teaser rate periods before recasts would set in. There is a huge tsunami sized wave of Option-ARM loans just now beginning to recast. The medium to high range market will see vast numbers of foreclosures over the next two two five years. Areas where prices have held up relatively well so far are now going to fall in much the same way the subprime areas did.
When the higher end markets start to fall in price the low end will see further reduction due to the downward pressure. The further collapse of the housing market comes at a time when there is a huge level of unemployment. California has one of the highest unemployment rates in the country. We are also in the middle of a huge budget crisis with years of further revenue loss ahead, which means more unemployment. Former Mayor Richard Riordan predicts bankruptcy for Los Angeles by 2014. Mayor Anthony Viaraigosa is proposing massive cut backs. Banks are not lending and access to credit continues to dry up. Commercial real estate has begun to follow the collapse in suit.
How do we know when real estate is fairly priced at sustainable levels? One key indicator is to look at income to price ratios. Put roughly, the median household income in any given community should be able to support the median price of a home there. In this respect Los Angeles is still very overpriced.
I recently took a closer look at the situation in the city of Burbank, for example. The median annual household income is around $65K. The traditional formula for measuring the affordability of a house is that the price not exceed 2.5 to 3 times annual income. That would place the correct median house price in Burbank at $195,000. The Los Angeles area has historically run a little bit higher in that ratio, with prices running around 3-3.5 times median income. Even if house affordability is evaluated at four times annual income, the median home price in Burbank should not exceed $260,000. The current median home price in Burbank is over $500,000.
To comfortably afford a $500,000 house, household income would have to be $200,000 a year. Fewer than 5% of households in the whole nation make that kind of money. The average household income in LA County is around $55,000. The average household income in the city of Los Angeles is under $40,000. And these are numbers that may diminish as unemployment persists. Housing has a long way to fall in this neck of the woods. And it will.
Burbank median price:
Option ARM resets: