Housing
affordability is at record lows in parts of the Southland, and some
real estate experts say it could signal slower gains in sales and
prices.
By Don Lee
Times Staff Writer
March 7, 2004
Southern California's long-booming housing market is showing signs of
strain, with low affordability and riskier loans raising concerns about
the sector's ability to be a primary driver of the region's economic
comeback.
Consumers' ability to buy homes, which has been weakening for some
time as prices have shot up much faster than incomes, recently hit
record lows in some Southland counties. Such low levels could signal
peaks in home prices and sales, economists say.
In addition, more buyers are stretching their finances,
contributing to a sharp rise in the use of adjustable-rate mortgages.
Although that has allowed people to squeeze into the market with lower
initial mortgage payments, it could subject them to much higher
payments if interest rates rise as expected.
Less-expensive financing, however, isn't enough for many home seekers, especially young families.
First-time buyers — vital to the market's overall stability — made
up just 30.6% of home purchasers in California last year, the lowest
rate since the California Assn. of Realtors began tracking the data in
1981. First-time buyers provide the foundation for the rest of the
market, because their purchases make it easier for existing homeowners
to move up.
Together, these indicators suggest slower gains in sales and prices.
"We're piling on more and more layers of risk in the housing
market," said G.U. Krueger, director of economic research at
Institutional Housing Partners, a real estate venture capital firm in
Irvine. "The question is, how long can this go on, and what will happen
when interest rates rise?"
Most experts don't expect anything close to a downturn of the
magnitude seen in the first half of the 1990s, when massive aerospace
layoffs and overbuilding resulted in prices plunging 23% in Los Angeles
County.
Most economists predict that home prices in the region will
continue to grow at a healthy rate for the foreseeable future, although
at a slower pace than the double-digit percentage gains seen in each of
the last few years.
The region, experts say, is not threatened by the economic
imbalances that led to the housing market crash of the early '90s.
Instead of overbuilding, there is a shortage of homes. The regional
economy has become more diversified, with less dependence on any single
industry that could lead to severe job losses.
What's more, foreclosures and defaults remain under control. And
mortgage rates have actually declined in recent weeks to the lowest
levels since last summer.
"I don't see anything that frightens me or makes me very worried
at this point," said Lenny McNeill, a senior vice president at
Washington Mutual who oversees residential lending in California and
other Western states.
Economists, however, remain concerned about the weak growth in
jobs, particularly ones that pay well. If hiring picks up, that would
help lift incomes. But that also would spur the Federal Reserve to
nudge up interest rates, although no one expects a sharp rise in rates
anytime soon.
Either way, the outlook points to an emerging slowdown in sales
and building activity. Both have been major economic stimulants,
especially in Southern California, where the housing market has far
outpaced the rest of the nation.
Even as manufacturing and other industries have cut back in recent
years, construction and other sectors tied to real estate, such as
mortgage banking, lumberyards and home-improvement retailers, have
added tens of thousands of jobs. Many consumers, meanwhile, have tapped
their rising home equities for cash to support their hearty spending,
adding further fuel to the economy in the Southland and elsewhere in
the nation.
Anecdotal evidence suggests that the current frenzied pace can't be sustained.
Glenda Estrada, a 29-year-old schoolteacher in Downey, recently
bought her first home. After a three-month search that included several
fixer-uppers, she settled on a 900-square-foot home on a busy street in
Lakewood. The house cost her $295,000.
With her stellar credit, she got in with no money down. But even
with a low adjustable rate of 4.5% and a financing plan in which she is
paying only interest, Estrada's monthly payment soaks up half her
income.
"It just feels almost unfair that housing is this expensive," she said.
Yet Estrada counts herself as fortunate. Some of her fellow
teachers, she says, are commuting from as far away as Moreno Valley in
Riverside County, where homes are cheaper. Others are stuck paying
increasingly high rents.
Nationally, six out of 10 households can afford to buy a
median-priced home, based on incomes and mortgage rates, according to
the National Assn. of Realtors. But in Orange and San Diego counties,
the affordability rate has dropped to fewer than two in 10. It is
slightly higher in Los Angeles County. Affordability in all three
counties is lower than in Silicon Valley.
Both Orange and San Diego counties have seen six straight years of
double-digit gains in the median price of existing homes. In January,
the median resale price surpassed $500,000 in Orange County.
For all of California, the minimum household income needed to
afford a median-priced home was $94,020 in January, versus $39,090 for
the nation, according to the California Assn. of Realtors.
"Everybody's stretching to buy as much as they can, or to buy
anything," said Woody Harper, an agent at Prudential California Realty
in Orange who specializes in the first-time home-buying market.
Like other agents and brokers, Harper is trying hard to help his
clients find something they can afford. He said business was off to a
slower start this year, noting that there were very few homes available
for sale.
The difficulties facing first-time buyers worry economists.
Renters or new entrants don't have the equity gains that trade-up
buyers can plow into their new homes, so they're much more dependent on
their incomes. And overall, incomes haven't come close to keeping pace
with home appreciation rates.
The big mitigating factor in all this is cheap financing. After
ticking up in late summer and early fall, U.S. mortgage rates have
since headed back down to near a decade low, spurring more purchase
activity. The average 30-year fixed-rate mortgage is 5.59%, compared to
an average adjustable rate of 3.47% for a one-year ARM.
In an adjustable-rate mortgage, a loan stays at its initial rate
for a set period (typically one to seven years), then converts to a
variable rate that adjusts to market conditions.
Federal Reserve Chairman Alan Greenspan recently questioned the
wisdom of homeowners sticking with traditional fixed-rate mortgages. He
suggested that consumers might be better off if lenders offered more
alternatives.
But in Southern California, the question isn't whether there are
enough homeowners going with ARMs, but whether there are too many.
During the last 12 months, the share of home purchases from San
Diego to Ventura financed with ARMs has nearly doubled to 57.1% in
January, according to research firm DataQuick Information Systems.
That's almost double the percentage nationwide.
Although Southern Californians historically have been more
familiar and comfortable with alternative financing plans, the recent
increase has alarmed some analysts. The last time the percentage of
ARMs increased so sharply in the region was in 1994, but that was
triggered by a jump in long-term rates that significantly widened the
spread between average ARMs and fixed-rate mortgages. This time around,
the spread hasn't expanded.
Furthermore, the fact that many more buyers are using ARMs when
fixed-rate mortgages are so cheap means that buyers are stretching and
in some cases overextending themselves.
"The data does indicate that more buyers are skating toward thinner ice, absolutely," DataQuick analyst John Karevoll said.
Amy Crew Cutts, deputy chief economist at mortgage financing giant
Freddie Mac, doesn't view the shift to ARMs by itself as a danger sign.
In part, she and loan officers say, it reflects consumer belief that
many won't be in their home longer than seven years.
So, in effect, they're planning and betting that they'll move out
and pay off the loan before the adjustable rate turns into a higher
rate.
Many buyers, however, are going not with five- or seven-year ARMs,
but those that convert almost immediately into variable rates.
Tom Swanson, Wells Fargo Bank's regional sales manager for
residential lending in Los Angeles, says that although the five-year,
interest-only ARM is the most popular, others are electing one-month
and one-year ARMs.
With some banks, borrowers can choose to pay even less than
interest payments each month, which increases the amount of the
mortgage.
Such financing decisions, analysts say, have implications for homeowners and the overall market.
When rates rise, buyers can compensate by shifting to ARMs, economist Krueger said.
"The problem is that we have already done this and there might not
be much left to shift," he said. "What happens when interest rates rise
and people need to have that option? … I'm not concerned about
defaults, but I'm more concerned about what happens to transactions
when that happens."
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