We get asked about a Los Angeles housing bubble a lot, specifically whether or not it is a good time to buy a house. It’s not a matter of whether there is a Los Angeles housing bubble, I say, it’s a matter of when that bubble is going to pop. First things first – why the hell is a Los Angeles air conditioning and heating company writing about real estate and the looming housing market bubble? Actually, we get asked about housing more than you might think – why we are knowledgable about the housing market is simple: inflated housing prices affect disposable income, and disposable income is what helps consumers decide whether or not they want to spend thousands of dollars to finally fix that noisy air conditioner. Truth is, those that are savvy in the construction industry follow the housing market religiously, especially with another potentially devastating Los Angeles housing bubble just over the horizon. It is possible to predict bubbles – when I was at UVA, one of my professors actually called the crippling housing bubble pop of 2007 before it even happened, and I’ve made it a point to watch the market ever since. The signs are there, and if you remove emotion from the situation, you can see it as clear as day. Those of you who read our articles regularly, know that we are a small, U.S. Veteran-Owned company in Southern California, and pride ourselves in giving people honest, straight answers to their questions. This will be no different. So, the question: is Los Angeles in another housing bubble? The answer is, without a doubt, 100% yes, we are in another Los Angeles housing bubble. It isn’t debatable, and anyone who tells you differently is either a real estate agent trying to keep you calm, or owns a house they might have paid a bit too much for. It is unfortunate because it’s not the fault of homeowners – they just wanted a nice house to live in – it’s the fault of the FED, amongst other factors we will discuss later on in this article. In this article, we will discuss how to tell if we are in another Los Angeles housing bubble, the reasons we got into this bubble, and what you can do to protect yourself.
A Disclaimer About Los Angeles Real Estate Agents
I want to say that we do a lot of business with real estate agents, I love real estate agents, my mother-in-law is a real estate agent, and what I am about to tell you is exactly what they tell me when a sale isn’t on the line. I have a lot of dear friends in real estate, so I want to make a disclaimer statement: real estate agents are just doing their jobs! It may sound like I’m hating on them throughout this article, but I’m not. It’s just how the system is and how it works. They are every bit as affected by it as you are, and there is nothing unethical about helping someone who wants to sell their house, or about helping a buyer find the house of their dreams. It’s YOUR job as the buyer or seller to be educated on how the market works, and that is exactly what this article aims to do. Selling and buying houses is their job – it’s what they get paid to do.
Another question: “But Tim, isn’t this article hurting the real estate agents?” No. All I am offering is the truth, and at the end of the day, Los Angeles real estate agents are smart – it doesn’t matter if they are selling a few ridiculously high priced houses or a bunch of more modestly priced houses. Real estate agents are paid on commission – they are going to make money regardless of what the market does as long as it doesn’t stagnate.
So the Real Estate Hate Begins (joking)!
I’m sure I’ll hear about this from my real estate buddies, but “always consider the source” – that’s what my father taught me. It’s true. “But Tim, my real estate agent said that it’s a fantastic time to buy a house!” Listen, asking a real estate agent if now is a good time to buy a house is kind of like asking a used car salesman whether now is a good time to buy that old Ford Pinto in the back lot. To real estate agents, it is ALWAYS a good time to buy a house, and it is ALWAYS a good time to sell a house. Real estate agents get paid a commission on each sold or bought property. I know I am going to anger some people, but look, all I’m offering is the truth. Besides, there is nothing unethical about helping people buy or sell a house.
We get emailed questions about the Los Angeles real estate market because Mike and I usually see more real estate in a day than many real estate agents do in a week. We are honest, and we gain nothing by telling you anything other than the truth. It isn’t for a lack of trying on the part of agents, it’s just that the HVAC business requires us to visit houses and commercial buildings all day, every day. Always consider the source – we don’t make money if you buy a house, or sell a house, but we have to be experts on the market because the market affects the air conditioning and heating business. We can make money either way, but it behooves us to know the market so we can adjust our business accordingly.
Los Angeles Housing Bubble – The 101 Course
Before we start, you need to understand a few basic principles regarding real estate and economics in general. The new Los Angeles housing bubble is a result of understanding these very basic economic principles, so please take a look before we get started:
Supply and Demand
Anyone who tells you that the real estate market is not affected by supply and demand…well, I’ll play nice – they are wrong. Supply and demand is the basic principle behind all market economies, and is an important concept in understanding the Los Angeles housing bubble. In its simplest form, as supply goes down, demand for a specific item goes up, and vice-versa.
Think about it this way: you want to buy a candy bar. You go to the store and they have fifty of them. You choose one and you buy it. This is known as equilibrium, meaning that there is a reasonable supply to match your demand for a candy bar. Now, hypothetically, cocoa beans all of a sudden stop growing (for whatever reason). Your favorite candy bar is made from chocolate, which is made from cocoa beans, and now they can’t make more than 100 candy bars a year. You go to the store and you can’t find the candy bar anywhere…your demand for a candy bar has now gone up due to a lack of supply. In fact, now the supply has gone down so low, that the few stores that actually have candy bars are now selling them for $50 each! This ridiculous mark-up is completely warranted by the market – no candy bars are available, you have a craving for a candy bar and it has now become a rare delicacy. Low supply; high demand.
Pop! Thank god, the cocoa beans have come back, chocolate is cheap, and we can all rest at ease. Candy bars have now returned to their equilibrium value of a $1.00 each. Only there’s a problem…that pop you heard was the candy bar bubble popping. And to make things worse, you, being desperate for candy bars and slightly inclined to invest in good opportunities, had just bought $1,000 worth of candy bars, and at $50 each, you ended up with 20 of them. Unfortunately, however, supply has gone up, demand has gone down, and you now own $20 worth of candy bars that you paid $1,000 for.
The Los Angeles housing bubble is the same way – replace candy bars with houses, and you will have a basic understanding of how supply and demand plays into Los Angeles housing prices. The mechanisms for supply and demand in regards to Los Angeles real estate are far more complex of course, but the principle remains the same. We will discuss these mechanisms a bit later.
For more information on supply and demand, read up on Investopedia: Supply and Demand.
Real Estate Bubble
Now that you have read the candy bar example above, the inflated prices that result from low supply and high demand are known as a bubble. If this principle is applied to real estate, then it is called a “real estate bubble,” or “housing bubble.” Simply put, prices will continue to increase beyond what they are truly worth until they become unsustainable, at which time the housing bubble “pops.” This pop is a market adjustment, meaning that the prices return to a more sustainable level. Simply put, when the Los Angeles real estate bubble pops, prices will return to what these houses are truly worth – somewhere in the low $300K range for the Valencia and Santa Clarita areas.
Is Los Angeles in Another Real Estate Bubble?
Yes. This part of the article is for the ten or fifteen people in Los Angeles who still haven’t caught on to the fact that we are experiencing yet another Los Angeles housing bubble. It isn’t really a matter of opinion, as many would have you believe. It is an economic fact, and it can be substantiated in a dozen different ways, but I’ll go over three:
Method 1: Determining a House’s Actual Value Using Market Rental Prices
Determining a house’s value – a lot of people like to say, “houses are worth what people are willing to pay for them.” This is incorrect. Housing prices are determined by what people are willing to pay, but what people pay is completely different from what the house is worth, or its value. For instance, if I buy a house for $500,000 then turn around and try to sell it for $2.2 million, is it actually worth $2.2 million? No. If someone actually decides to buy it at that price, does that change? No, it is still worth what I could reasonably rent it out for. Selling it for $2.2 million will certainly affect housing prices for the neighborhood, but that doesn’t change what the house is worth.
What the house is worth is, has been, and will always be determined based on what that house can be rented for. For instance, if you are paying a $4,000 mortgage but you can only rent the house for $2,000 month, then it is said that you bought the house for about twice what it is worth. This is pretty common practice in California – I mean, it’s understandable because California is so nice. Regardless, the economic formula for determining a house’s value is:
Annual Rent X 10 = House Value
Or, if you are talking in market terms:
Median Annual Rent X 10 = Median House Value
So, as an example, we will pick on our home area of Santa Clarita and Valencia, where a four bedroom house with 1,500 – 1,800 sq/ft typically rents for around $2,400/month. Let’s be generous and round that up to $2,500/month, just for argument’s sake (and because I don’t like math).
$2,500/month X 12 months in a year = $30,000 median annual rent
$30,000 X 10 = $300,000 median house value
Question: when was the last time you saw a Valencia house on the market for $300,000? You haven’t…not since the last time a Los Angeles housing bubble popped in 2007. What does that tell you? When a housing bubble crashes, houses typically return to their true values, or what the houses are actually worth…and wouldn’t you know it, when the last bubble popped, houses were being sold in the high $200’s to low $300’s. What a coincidence.
Method 2: Comparing Housing Market Value to Median Household Income
How is our median household income doing? Is it doing well? Have you gotten a raise lately? Probably not. Median household income for the country has gone down $5,000 since the last Los Angeles housing bubble burst, but yet housing prices in general keep going up, especially in Los Angeles where they have been growing by double digits over the last few years. This is a bad sign.
A picture is worth a thousand words – Los Angeles housing prices are nearing the same bubble proportions they were at during the 2007 housing market collapse, but yet, median income has decreased, and people keep buying houses. If house prices were going up and median income was also going up, you could then at least make an argument that the prices are somewhat justified. However, income is going down, businesses are leaving California in record numbers to avoid extremely high taxes, and housing prices keep going up. Bubble. Is the economy doing well in your opinion? Or is everyone buying cars and houses because of low interest rates? More on this later, but study the graphs and tell me how they look…
Method 3: Because Harvard Says So
Housing builder confidence is at a ten-year high…the last time it was this high was in 2005 – right before the last housing crashed (Read: Housing Builder Confidence High). If you are still in doubt, where on the sine-curve do you think we are? Take a look at this article from Harvard:
Why There is a Los Angeles Housing Bubble:
There are a multitude of reasons for the Los Angeles housing bubble, but many of them lie outside the scope of this article and I’m not in the mood to write ten thousand words anyway – besides, are you actually still reading this? I’m just an air conditioning guy, remember? This part of the article serves to help show you some of the major contributing factors to the new bubble, and what you can to do protect yourself.
1. The FED
I’m sure that everyone has heard about the “FED,” or the Federal Reserve – the US’s central banking agency. What the FED does is control interest rates. We will keep this simple and not go into the specific rates that they control, but they regulate these rates as a means of controlling the economy.
Why control interest rates? If the economy is growing too quickly, this can cause inflation (the candy bar costs $2.00 now because money is worth less). So, the FED would then raise interest rates to make borrowing money more expensive, slowing everything down. Conversely, if the economy is in trouble, they decrease interest rates in order to get people to buy a bunch of stuff, which stimulates the economy and helps it grow. Simply put:
- The FED controls how much you have to pay in order to borrow money, such as to buy a house or a car.
- The FED controls how much banks pay each other to borrow money from one another.
The FED has kept interest rates at zero or near zero for the last seven years…SEVEN YEARS!!! To give you a base of reference, the last time the FED did this was…never. Never, in the history of the FED, has it kept interest rates so low for so long. Why are they doing this if the economy is supposedly doing so well? The unfortunate fact is that much of the “economic recovery” we have been seeing is a result of these record low interest rates…just something to keep in mind.
How the FED Influences the Los Angles Housing Bubble
Since prices are so low, and money is so cheap, there are a lot of people who want to buy houses that otherwise wouldn’t be able to afford them. Could they afford them if interest rates went up as they will in the near future? No. The reason for this is simple – many people think it’s because the interest rates themselves make it hard for people to make payments on a more expensive mortgage. While this is true to some extent, an arguably bigger factor would have to do with the banks themselves. Remember number two in my list up above – the banks have to borrow money from each other to help cover their mortgages and other investments. But, as the interest rates go up, banks want to borrow and transfer less money between one another because it now costs them more to do this. That means mortgages too…so instead of throwing out a hundred mortgages to anyone who applies, as interest rates increase, banks will now have to be more selective because they are paying more money each time that they do it. So, as interest rates go up, many people not only can’t afford the new mortgage payments, but they won’t even qualify for a mortgage in the first place.
You may have read that the FED will be increasing interest rates soon (December 2015? March 2016?). As they do this, demand for houses will go down because people won’t be able to buy them anymore, and certainly not for the hefty $500K – $600K people are asking in Valencia and Santa Clarita.
2. Real Estate Agents Keep Prices High
Real estate prices are determined by the “comps” (i.e. comparable). The comp is a list of houses like yours that have recently sold on the open market (remember this…key words being “open market”). So, for instance, you want a nice 2,000 sq/ft home in Valencia, and you come across one you like. They are asking $500,000 for it. However, the comps say that two houses down the street, that are almost identical to the one you want, sold within the last few weeks for $325,000. You now know that this house is priced WAY too high.
Real estate agents know this, and it’s their business to know this. But when prices are inflated such as they are during this Los Angeles housing bubble, what keeps someone from listing their house at a fair price (say, $300,000 instead of $500,000) because they want to sell it quickly? In some, less savvy real estate markets, this person might actually get to sell their house for $300,000 instead of $500,000 and bring down the comps – effectively decreasing housing values in that neighborhood for a while. If others do it too, housing prices will fall.
However, large metropolitan areas are competitive and have the best, most savvy real estate agencies. Here’s the trick – what these companies do when a house gets listed so low (like $300,000), is they buy the house themselves BEFORE it hits the open market, and then turn around and list the house for a higher market value (like $500,000), thus keeping market prices high. These houses never make it into the comps because they never hit the open market – you never even had a chance to buy them.
This tactic works great if it is used to keep that weird guy, who just wants to sell his house quickly and cheaply, from crashing the housing market values. But if it is done too often, it actually will keep housing prices inflated when they should naturally be decreasing due to decreased demand. This feeds the Los Angeles real estate bubble.
Eventually, the real estate companies will run out of disposable money and lose their ability to buy these cheap houses as they hit the market. As such, the cheaper houses will start getting listed on the market. Supply will then go up, demand for expensive houses will go down, and you will start to see those lower valued houses selling. This is an early sign that the bubble is going to pop. Be careful.
3. The Economy
Everyone keeps saying that the economy is “booming” and we are well into the recovery. But is this true? Does anyone actually believe this? Some people have been unemployed so long that they stopped looking for a job or stopped being eligible for unemployment. Median household income has decreased by $5,000 since the last housing crash in 2007, according to the Wall Street Journal, and we have twice the National Debt, which is quickly approaching $19,000,000,000,000.
Regardless, all real estate is local, even when predicting a Los Angeles housing bubble – we need to look at the source – California. How is California doing? Have a read…my favorite part was how California, with all of our natural beauty, resources and attributes, is still number 46 in the U.S. for jobs. Another way to put this, is that we are the 46th best state to find a job in…what kind of a medal do you get for that? California Economy in Crisis.
Ask yourself a few common sense questions: is the world in a good place these days? No. Look at Russia, China, etc. Is the world doing well financially? No, China’s economy is slowing down rapidly, and hundreds of thousands of refugees from Syria are flowing into the European Union. Who will employ these people? Who will feed them? This money comes from somewhere…
4. Foreclosures From the Last Bubble
Here’s the truth about how it works: when someone fails to make their mortgage payments and defaults on their mortgage, the bank has a couple of options. First, they can foreclose on the people and evict them, putting the house on the market to cover some of their losses. Or, they keep the family there and don’t charge them rent.
Since the last Los Angeles housing bubble burst, there are still thousands of houses that have not been foreclosed on yet. Why? Because as long as the bank keeps the current people in the house, they don’t have to pay taxes on it. Once they evict the people and put it on the market, they have to pay the taxes on it. As such, the banks are holding off on most of their foreclosures while they still recover from the last collapse of 2007. They can’t do this forever though, and as soon as these houses hit the market, the Los Angeles housing market will be flooded with thousands of cheap houses that the banks are just begging to get rid of. You read the part on supply and demand…what will that do to the housing market? Pop!
5. Investors Drive Los Angeles into a Housing Bubble
An estimated 30% of Los Angeles houses are owned by investors. Investors are in the market to make money for themselves, but they also drive the market up by decreasing supply that would otherwise be available to people who might actually buy the house and live in it. Furthermore, investors don’t really care what they buy a house for like you do (the family that would actually use the house for what it is meant for). All they care about is that the market goes up, making them money. They also realize that by purchasing these expensive houses, they, by themselves, help run the market up further. But the smart ones are already getting out – remember, this is about money. They need to sell these houses to make the profit.
Unfortunately, investors add a level of unpredictability and volatility to the L.A. housing market…again, be careful.
6. Because People Want the Market to Go Up
Part of the reason the Los Angeles housing market is in bubble proportions again is because of very low supply. Aside from the reasons already mentioned, one reason is that many people were caught in the last housing bubble in 2007. They had just paid $650,000 for their house and then the market collapsed. These people are reluctant to put their house on the market until it at least recovers to the point they bought in at – so instead of selling the house and moving up to something better, these people are sitting and waiting – killing the normal supply of houses.
Plus, those that do want to sell, are asking higher and higher prices in hopes that some poor fool from Iowa will come along and buy it, not knowing any better (not picking on Iowa!). Think about it, you got caught in the market when it collapsed, but you have to get out of California. Are you going to list your house at a reasonable price or list it high in hopes it will sell and help you recover your losses?
It’s not dishonest either – it’s actually a well known psychological principle called primacy. In its simplest form, primacy states that the first way you experience something is the most powerful. Applied to real estate, it sounds like this: if you bought your house for $200,000, you will look at people who bought their houses for $500,000 like they are out of their minds…why are they paying that much for a $200,000 house? Likewise, those that bought their houses for $600,000 before the last Los Angeles housing bubble popped are thinking: why won’t anyone buy my house for $550,000?!? That’s cheap! It’s worth $600,000!
Who’s right? I’m not a referee.
If you need more examples, there are plenty of reasons that it is a horrible time to buy an expensive house in L.A. I truly feel that the Los Angeles housing bubble is best summed up in this post – warning; it’s a long one, but good: Ten reasons it’s a terrible time to buy an expensive house.
When Will the Los Angeles Housing Bubble Burst?
Here’s the hard part…predicting when. If I had to guess, sometime between late 2016 and 2020. If I were a betting man, I’d say before the end of 2017. It depends on a lot, but just look at the market…six months ago people were actually getting into bidding wars over houses and Los Angeles houses were growing in price by double digits. How long did you think this would hold up?
Now there are houses in Santa Clarita and Valencia that have been on the market for 60 days at $480,000 without selling. I truly think it is only a matter of time, but it could be up to five years. Mark my words though…the Los Angeles real estate bubble is about to pop again, and since this bubble is coincident with a stagnated economic recovery based on low interest rates, it’s going to hurt big time.
How to Use the New Los Angeles Housing Bubble to Your Advantage
My advice is simple – real estate agents are masters of making money regardless of what the market is doing. You can do the same thing:
If you are trying to buy a house in Los Angeles, specifically Santa Clarita, Saugus or Valencia – wait a few years until the Los Angeles housing bubble pops and the market comes back down. Even if there were a miracle, the economy magically recovered over the next two years, our national debt disappeared into thin air, the FED didn’t raise interest rates…you could still buy a house. It won’t be the end of the world. The best part is, prices are so high right now that they aren’t going to move up that fast even if they do move up. Don’t give in to the hype. Prices will be coming back down…wait two or three years for the bubble to pop, then buy your house for half price.
If you are thinking about selling your house – put it on the market now. Right now. You want to get the house out there and sold before the market is saturated with everyone else trying to do the exact same thing! It’s just like the stock market – sell high. But if you wait too long; if you get greedy, you run the risk of missing the peak all together and catching the devastating down-turn. It isn’t worth it to possibly squeeze out another $10-20K from your house. You are better off selling now before everyone else catches on. If you try to nail the absolute peak, you run the risk of everyone else listing at the exact same time. Your house won’t sell, and as housing prices fall, this will lead to a massive wave of houses flooding the market. Demand will then go down, and prices will soon follow. Then you will be stuck in your house for another 7-10 years while you wait for the market to recover…again.
Like I said, we have no horse in this race – all we are telling you is the truth. Do with it what you want.
Final Thoughts on the Los Angeles Housing Bubble
Look, I’d like to tell you that the laws of economics don’t support what I’m saying about the Los Angeles housing bubble, but unfortunately they do. As with anything else, it depends on what you are trying to do. It doesn’t matter whether you are a real estate agent, an entrepreneur or an air conditioning company. The principles are the same. This isn’t the end of the world though. If you are trying to buy a house, I’d say you should wait a couple years and buy it when it goes on sale. If you are planning on selling your house and getting out of California, I’d say you should sell now rather than later. But if you plan on staying in California for a while, it really does’t matter. The bubble will pop, like it always does, but it will come back eventually. The market rises and falls. In the end, the Los Angeles housing market is a house of cards. Sure, it’s nice to live in California, but it just doesn’t justify the current prices from an economic standpoint. Do your research, and you’ll see that what I’m telling you is not only true, but it’s been true all along. For those of you who would like to email us about what we usually write about – air conditioning – please take a look at our ASM Air Conditioning Blog for information on topics such as Ceiling Fans vs AC, Why is My Air Conditioner Freezing Up?, etc. For everyone who keeps asking about real estate, I hope this has helped answer your questions, because I’m back to air conditioning for now. Oh, and if there is anyone out there who still doesn’t think that Los Angeles is in a new housing bubble, I actually have a bridge for sale in Manhattan up by Washington Heights…I can sell it to you for $15,000…those are friend prices.