Why California Real Estate Prices Won’t Decline At A Pace Relative To Interest Rates

By Chase Bonenfant

9/22/22

It’s been a difficult few years in the real estate market if you’ve been planning to buy a home in Southern California, as well as across the country and it doesn’t seem to be letting up anytime soon. All industries, including real estate, ground to a halt at the onset of the pandemic in March 2020. By May of 2020, existing home sales in Southern California dropped by more than 45% according to California Association of Realtors, with other areas in California seeing more significant decreases. This is also paired with record decreases in the number of housing starts, homes that were going to be built. In order to bring some buyers back to the market, the Federal Reserve needed to make borrowing money easier, so it lowered the Federal Funds Rate (simply put, the rate which banks pay to lend money) close to 0%.

This created an environment where money was very cheap for lenders to issue loans and was reflected by low mortgage rates in the 2’s in many markets. A large number of homeowners all over the country took advantage of this by refinancing their higher rate mortgages to lower their monthly payments. An analysis done by SmartAssets showed that in the San Diego area, almost 28% of homeowners refinanced their mortgages, the fourth highest rate for refinance activity in the nation, with other Southern California cities not far behind. Those who owned a home during this time also saw large increases in equity. According to the Federal Reserve of St. Louis who collects data on markets across the country, the average California home value saw an increase of 27% from the first quarter of 2020 up to second quarter of 2022. It has been great news for current homeowners across the nation but has aided in widening the gap by pricing out many would-be first time home buyers.

The scenario in the real estate market we are observing in no way resembles the market during the Great Recession. Those who refinanced or purchased during the past year or two were highly qualified buyers, who, for the most part, are now locked in at record low rates. The median credit score of a conventional conforming mortgage was 771 in 2020 and even higher for jumbo loan borrowers according to consumerfinance.gov. In April of 2020, JPMorgan- the largest bank in the US, raised its borrowing standards for potential buyers, although at the time due to the pandemic causing a darkened economic outlook.

Now, approaching the last quarter of 2022, the Fed continues to increase the FFR with the goal of curbing inflation, doubling mortgage rates to an average of 6.29%. There has been a pullback in the real estate market because of this, significantly slowing sales with the San Diego market declining 23.6% from the year before. In the second quarter of 2022, California housing affordability index hit a 15-year low with only 16% of Californias households able to afford the $883,370 median-priced home, down from 24% in the first quarter of 2022, according to CAR.

With this being said, as inflation continues to hinder the consumers’ disposable income, costing the average household $11,400 per year according to zero hedge, the near term still shows mortgage rates are expected to continue their surge. The reason that home prices won’t keep the pace of decline that mortgage rates are increasing is because there are too many homeowners out there with a killer mortgage rate who are happy and not enough potential sellers out there who are willing to roll the dice with finding another home. Unless there is another scenario such as widespread layoffs or a war, this will continue to be the case.

The Fed has indicated it will keep up with their aggressive tightening tactics to attempt to lower inflation over the coming months with a potential pause in increases sometime early 2023. That is considering that they will be successful, though, in lowering inflation. Looking at historical mortgage rates, going back to the early 1980’s (a time in which we now rival with current inflation) mortgage rates hit a high of 18.5%, a level we are inching closer to quickly. The 1981-82 recession was triggered by exactly what is happening now, tight monetary policy. There is a decent chance in the coming months we see similar mortgage rates in the market, but don’t expect house prices to keep up their rate of decline. House prices could decrease 20% or more, but affordability will be much much lower with triple or quadrupled mortgage rates.