California Coastal Housing Unaffordable Again

One of the earliest phenomenon that occurred during the housing bubble was the ascension of home prices that led to housing becoming unaffordable relative to incomes. This was especially acute in California coastal cities and spurred outflows to Riverside and Sacramento, which then in turn became overdeveloped epicenters of the housing bubble and subsequent burst.

The cascade of markets across the nation from affordable to unaffordable was a key signal that prompted us to warn of the coming housing downturn. It now appears that this first symptom has cropped up once again, as almost all of California's coastal cities are now reading as unaffordable according to our calculations.

Home prices along the California coast have rebounded spectacularly from their trough, with all the major coastal cities seeing gains of at least 21 percent, and San Jose, Orange County, Oakland, and LA seeing gains of at least 30 percent. Despite that robust growth, prices are still well below their all-time peaks, with L.A., Oakland, and San Diego home prices still more than 20 percent below their highs.

Despite the discount in prices, affordability proved temporary for the Golden State, as the lack of income growth and rising mortgage rates has made home prices unaffordable once again at these levels. Only San Diego measures out as affordable and that is by a very slim margin.

The lack of wage recovery during the economic recovery has been a persistent feature, owing to high unemployment, and every major California coastal metro saw median family income lower at the end of 2012 than in 2007 when it peaked.

Even San Francisco and San Jose, the epicenters of the social media and tech boom that has occurred, have seen incomes fall 3.3 percent and 2.1 percent, respectively, from their 2007 peak. San Diego has seen incomes fall 7 percent, and L.A./Orange County has seen incomes fall 4.3 percent from their peak.

In addition to a lack of wage growth, mortgage rates have risen significantly over the last several months. Conventional 30 year fixed mortgage rates hit a low of 3.49 percent at the end of 2012, and have been climbing since, measuring 4.59 percent most recently in October.

The rise in rates by more than a full percentage point has been rapid, and coupled with strict underwriting standards already in place, has made buying a home increasingly difficult for many. Though mortgage rates remain below their pre-recession level, it is not enough to offset the lost income from the recession.

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While it is possible for unaffordability to remain in place for some time, especially in destination markets such as San Francisco and L.A., we believe something will have to give to normalize the market. Last time we saw this phenomenon, it resulted in people fleeing the coast for more affordable inland markets, prompting development that eventually got ahead of itself. We do not expect this to reoccur given how many people were just burned by it and the fleeting liquidity that exists in the housing market due to the preponderance of institutional buyers. However, the status quo is unsustainable for a long period of time.

Currently, our up-to-the-minute auction data shows home prices easing in the state, and this should be reflected in home price data that comes out over the next several months. Traditional pricing metrics have a several-month-lag owing to the long closing and reporting times of traditional home sales. The easing in prices should help dissuade concerns about affordability temporarily.

The healthiest resolution, though, would be for the economy to kick it up a gear, reducing the slack in the labor market and generating a rise in incomes. This would likely signal a shift into economic expansion and perhaps mean the whole episode is finally behind us.

The other solution would be for mortgage rates to fall, but a significant downshift seems improbable. Interest rates are already low and the next Fed action, whether it comes sooner or later, is going to be a de facto tightening of policy, which should bring rates higher.

As we mentioned, it is possible for markets to remain unaffordable for a period of time, but it is very hard to imagine significant, sustained home price appreciation in the California coastal markets until incomes begin to rise--something that has proved elusive throughout this economic cycle.

_Peter Muoio, Ph.D., is the chief economist for ""Auction.com Research"":http://www.auction.com/market-research/ and a regular lecturer at the New York University Real Estate Institute._