California Market Inventory: Is the Lower End Running out of Steam? 5 Key Factors Impacting California Inventory. Borrowers Don’t Have Bubble Purchasing Power.

How many homes are currently for sale in California?  This rather simple question seems to be missed in many mainstream articles and is rather important to the question of the overall health of the California housing market.  In many cases it is assumed that having less than six months of inventory reflects a healthy and vibrant housing market.  If that is the case, California must be in excellent shape with only 3.9 months of inventory.  I think this number is rather deceptive and I will get into that later in the article.  Let us first look at the overall market data:

The reason the inventory has dropped so quickly are the sales occurring at the lower end of the market.  So if we take the current 3.9 months of inventory and the last month sales number for the state:

45,079 x 3.9 = 175,808

Now this number sounds about right.  Yet the trend is now slowly abating for a couple of important reasons.  Let me go through them one by one.

1 – Low Priced Inventory Running on Fumes

It is interesting to note that at the peak of the selling in California some 58.8 percent of all homes sold were foreclosure resales.  That number has now fallen to 43.7 percent on a statewide basis.  If we look at Southern California that recently published August data, sales fell by 10.8 percent on a month to month basis.  What happened here?  The lower end of the market is starting to see a bigger drop in sales:

We are looking at a couple of counties in Southern California that are bustling with investors and first time home buyers.  Yet the steam may be running out as indicated by the latest numbers.  In fact, if we look at FHA sales, these are to owner occupied buyers the number is now up to 37 percent.  What this means is investors may be pulling back.

2 – Tax Credit Steam

The recent $8,000 tax credit has been a major incentive for many buyers.  Couple this with the hot selling season and you give the impression that all is well.  Yet this is like adding gasoline to a blazing fire.  The tax credit cannot go on forever.  It is simply too expensive.  Yet the market has now started to rely on this.  This is tantamount to having interest only and option ARM loans in the market and suddenly, these loans are removed.  This takes away the perceived buying power away from borrowers.  If you look at buying power it exploded even though incomes went sideways:

This chart is the story of the bubble.  Exotic mortgages provide maximum leverage even though incomes went nowhere.  These items are removed from the market.

3 – Income

California is really in a difficult position.  With 11.9 percent unemployment and the trend moving higher, it is hard to see how this is going to help the housing market.  And you need to remember many recent buyers were cash flow investors, not necessarily flippers.  Yet in many of the lower priced communities where unemployment is even higher, rental rates are dwindling.  Many are using rental rates of a healthy economy in an otherwise deep recession.  That is why the West rental vacancy rate is so high:

So many of these investors unless they came in with big down payment might not be cash flow positive.  Aside from the principal and interest, you need to pay taxes, insurance, maintenance and other costs associated with being a landlord.  In Southern California the number has been high recently.  For July nearly 20 percent of all purchased homes were by investors.

4 – Longer Term Trend

Housing is reverting to the mean.  Even with the current fall in prices, in many areas in California prices are still much too high.  Take a look at the OC/LA region:

This lull is temporary.  You have a 3 front attack making the Case Shiller data move sideways.  You have the tax credit luring in some buyers.  You have investors jumping back in.  And then you have the seasonality of spring and summer sales.  These will be losing steam in the next six months.  Couple this with the Alt-A and option ARMs hitting in full force in 2010 and you have many more reasons to believe California’s housing is going to have longer term problems.  The overall trend signifies lower prices.

5 – Housing Perception

A large part of the mania was fueled by psychology and I believe that capitulation was never allowed to take full force.  We have backstopped the market with all these patchwork programs yet the market still has massive amounts of foreclosures.  Last month alone California had 92,000 foreclosure filings.  Many of these are not part of the inventory and are in the process of defaulting.  That comes out to 3,000 foreclosure filings a day.  Go back to the early days of the mania and California had about 5,000 REOs for the month.  The current rate of problems is still very high.

People also are not in a buying mood in a deep recession.  Although it might be the case that the nation is technically out of a recession, California is clearly not.  So take these things into consideration as we enter the fall and winter.

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