Explaining Southern California's economy

Why it's risky to buy a house in Southern California right now

Foreclosure

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It might look terrible, but you can't afford it.

The California Association of Realtors has just released data for September pending home sales in the state. The report contains what should now be a familiar refrain to both potential home buyers and sellers in California's market: we just don't have enough houses for sale to meet buyer demand.

One of the real areas of stress is with foreclosed "real estate owned" (REO) properties. According to the CAR, there's barely a two-month supply of REOs in the entire state. Coupled with other inventory shortages — we haven't buily much new housing in California since the bubble burst four years ago — this is driving up prices, particularly at the lower, entry-level end of the market.

There's a whiff of consumer panic in the air. Constrained supply is leading to ferocious competition for sub-$500,000 houses. We're feeling the REO crunch in Southern California generally – and L.A. in particular – as supply has fallen substantially since this time last year. Historically low interest rates — dirt-cheap money — are colliding with surging demand to create a bit of a bubble. Prices look attractive, given how far they've fallen from their highs in the mid-2000s. 

But then those attractive prices get bid up. So the market fundamentals are dicey. And it is unreasonable to expect banks that are holding foreclosed properties to flood the market, because that means they can't write loans for as much. It could take a year or two before the foreclosure backlog is fully worked through.

All bubbles, even small ones, eventually burst. This one will, too, so consumers who are worried that if they don't overpay today, they'll be priced out tomorrow shouldn't panic. They'll get another chance to buy. And given the number of investors who have come into the market, snapping up distressed properties over the past few years, this entry-level asset-price bubble is a good indication that the smart money could be looking for a way out while the (sorry) dumb money looks for a way in.

Buy low, sell high. It sounds simple but it isn't always easy to live by that rule. And, with a distorted market, it's even more difficult. You might not want to buy too high, then see prices go lower before things normalize and regular price-appreciation driven by fundamentals can resume.

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