Explaining Southern California's economy

Why housing prices are up in Southern California and what it means to you

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A "for sale" sign stands outside a home in Pasadena. Prices have been steadily rising in Southern California and throughout the state. But will they continue rising?

The January Case-Shiller Home Price index was released Tuesday. Nationally, prices in the 10- and 20-city composites that the index tracks haven't seen such substantial year-over-year gains since mid-2006.

Prices in Los Angeles rose by 12.1 percent compared with January 2012, according to Case-Shiller data, which lags the market by several months but is considered a gold standard by real estate experts because it only counts sales that have been fully executed.

"There's a bit of a buyer's panic," said Jeffrey Gundlach, founder and CEO of DoubleLine Capital, an L.A.-based investment firm.

"People are fighting with other people," he noted, engaging in bidding wars in which houses go on the market and immediately receive dozens of offers.

"It's almost the same type of environment I remember from the late 1980s," said Gundlach, a longtime Southern California resident. "People would be writing out offers on the roofs of their cars – and there would always be several cars lined up."

But there isn't really a new housing bubble now. Although plenty of buyers probably feel like there is.

A number of factors have collided to create abundant froth in the present-day market – one that has made it exceptionally difficult for everyday buyers with conventional mortgages to beat out well-capitalized investors and all-cash purchasers.

First, interest rates are at historic lows: Still less than 4 percent on a 30-year fixed-rate mortgage – the bedrock of the U.S. housing market. But those aren't the only interest rates that matter.

The Federal Reserve, in an effort to bolster the housing market and stimulate the economy, is keeping short-term interest rates near zero. That enables investors to borrow cheaply and look for under priced homes in highly desirable markets, like L.A. and San Diego, buying up foreclosures and under priced properties in bulk.

Meanwhile, banks have tightened lending standards and are requiring higher down payments, creating one of the current market's biggest ironies: even if you're ready to buy a house, you can't always get a mortgage – and if you can get a mortgage, in parts of L.A. and for homes under $1 million, you're likely to get outbid by 20-30 percent.

Second, we didn't build any new homes for four years after the downturn.

"Housing starts are still very low," Gundlach said. "They're back to levels that used to be considered bad."

That, in combination with banks' reluctance to flood the market with foreclosures, has led to a supply crunch. And that has led to price spikes.

Third, the Federal Reserve has also been buying up mortgage backed securities – the bonds that mortgages get bundled into and sold to investors – as part of an ongoing process of "quantitative easing" designed to juice the economy and keep the housing market from stumbling.

"The Fed is supporting housing tremendously," Gundlach said.

And he doesn't see prices heading lower any time soon. He thinks we're about halfway to some sort of correction, but he does envision what he called a "a couple of moves in the chess game" that could push prices down.

"People are talking loudly about these price gains, but they're not that high," Gundlach said. He said the broader 20-city Case-Shiller composite index, which was set at 100 in 2000, topped out at 200 in 2007 and is now at 148.

"It's rather easy to predict home prices going higher," he said. 

For Selma Hepp, Senior Economist at the California Association of Realtors, this adds up to a market that's "a bit nutty, a bit scary."

Like Gundlach, she sees prices continuing to rise in Southern California, but she doesn't expect another year of double-digit year-over-year monthly gains. For 2013, she thinks five percent will be more like it.

"I'm not surprised to see what we're seeing now," she said, adding that California is very restricted in terms of permitting for new home starts.

This has created another irregularity beyond what Gundlach has observed on the supply-demand front: the state is creating more jobs than it is building new homes. 

"That's creating a sense of bubbling up, if not a bubble," she said.

Ultimately, as the Southern California market regains some sense of normalcy, Hepp sees investors coming out with the best deals.

"They will end up selling when prices are higher," she said, indicating that many investors have already already "exited markets they've cleaned out, like L.A."

But continued low interest rates, which Hepp doesn't expect to rise any time soon, could come to the rescue of prospective buyers who aren't sitting on piles of cash.

"The rates themselves are what could make the deal for some people," she said. "They may get a $350,000 mortgage rather than a $250,000 one, based on lower rates, so in essence they're getting a good deal."

So there is hope in a market that Hepp calls "anything but normal." 

But it's going to cost you.

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