Orange County Housing Report: Happy New Year – A 2017 Forecast

January 1, 2017

HAPPY NEW YEAR!!!  Now, what does that mean for Orange County real estate? 

First, let’s take a look back at what happened in 2016 in terms of the inventory, demand, expected market time, luxury properties, and distressed properties.

Active Inventory: Strong demand and the trend in homeowners not moving kept the inventory at very low levels all year.

The year started with an active inventory of 4,400 homes on the market and ended with a little over 4,200. A total of 44,000 homes came on the market in 2016, identical to 2015. That may seem like a lot; however, it’s 31% fewer than the number of homes that came on the market annually prior to the Great Recession. The 44,000 homes pales in comparison to 2005 when 64,000 homes were placed on the market. It’s no wonder buyers were tripping over themselves to find a home to purchase in 2016.

In 2016, there were 650 more closed sales, 2% more than 2015.

Other than starting the year off with fewer homes on the market, 2016 looked a lot like 2015 in terms of the inventory. The peak of 7,329 homes was reached in mid-July due to slightly stronger demand during the summer than what is typical. The Orange County yearly peaks tend to occur during August. The 2016 peak was still slightly higher than last year’s peak of 7,167.

Nonetheless, the active inventory has remained at anemically low levels since the start of 2012, and has been a seller’s market ever since. The long term active listing inventory average is 8,000 homes, and it has only reached that level for a few weeks in the summer of 2014.

In order for the market to start tilting in the buyer’s favor, the active inventory not only has to eclipse the 8,000 home mark; it needs to remain consistently above that threshold for a long period of time. Only when there is extra supply will appreciation slow. Until then, we can expect more of the same, slow methodical appreciation.

Homes are not appreciating as swiftly as they did in both 2012 and 2013. With low interest rates and very hot demand, the only reason the inventory grew at all this year was on the backs of overpriced sellers. Buyers were willing to stretch a tad in the hotter ranges, below $750,000 for detached homes and below $500,000 for condominiums. However, sellers who juiced their price to leave negotiating room, or were afraid to leave money on the table, or simply wanted to see if they could get more, learned a hard lesson in pricing and success. Success only comes by meticulously pricing a home according to its true Fair Market Value. Price above that value and homes sat on the market with no offers until the price was properly adjusted.

The inventory grew by 60% from January through July. And, as Orange County housing transitioned from the Summer Market to the Autumn and Holiday Markets, the inventory dropped by 42%. Over the past twelve years, only 2013 had fewer homes to start a New Year with 3,161. Home price appreciation has everything to do with supply and demand. With such a low supply, 2017 is definitely starting on the right foot.

Demand:  With record low interest rates in the mid 3’s, demand continued to sizzle in Orange County.

This year demand had a bit of a slower start due to a speed bump in the Chinese economy, a worldwide stock market correction, and a detrimental drop in the price of oil. This was accompanied by a flight to the safety of long term government bonds, especially United States treasuries. The rush to bonds helped fuel this year’s boom by ushering in mortgage rates in the mid 3’s. Despite higher prices in Orange County, the low interest rates helped improve home affordability and buyers took advantage.

For the first couple of months, demand was off by 5% compared to 2015, but by mid-March, the slower start was in the rearview mirror. Oil, China, and international stock markets were on stronger footing as well. The Orange County housing engine, along with the rest of the country, was vibrant and making up for lost time. The second half of the year experienced 10% stronger demand with interest rates remaining at historically low levels.

It was not until after the election that interest rates rose to the mid 4’s, too late to have any kind of an effect on the housing market.

With rates in the 3’s for most of 2016, it was no wonder buyers were lining up to purchase. For proper perspective, in 1990 the interest rate was at 10%. In 2000, it was 8%. And, just prior to the Great Recession, interest rates were at 6.4%. Higher rates cut into Orange County affordability dramatically due to its higher prices. For now, even at 4.5%, interest rates are facilitating affordability and propping up demand.

Luxury End:  More homes sold in the luxury end this year than ever before.

Orange County’s luxury home market has been pumping on all cylinders. Through December 29^th, more homes have closed above $1.25 million than ever before in the county. There were 3,229 closed luxury sales compared to 2,941 last year, up 10%. The highest level prior to the recession occurred in 2005 at 2,857.

So, demand was up for luxury homes. Yet, for many sellers in this higher tier, the market felt sluggish. Higher priced homes notoriously behave differently compared to the lower end of the market. The upper end always tends to contradict the hot housing market. Homes don’t fly off the market with multiple offers and the expected market time ranges from 5 months to even over a year depending upon the price. There are fewer potential buyers in the highest stratospheres of the market.

Overall, the market felt a bit slower because there were more homes on the market competing for a small pool of buyers. The higher demand helped, but there were a lot more luxury homes for sale.

Distressed Properties: Foreclosures and short sales are nothing more than an asterisk to the 2016 market.

In Orange County, homes have appreciated substantially since the beginning of 2012. With a five year run in housing, the number of underwater homes have declined to 1.6% of all homes with a mortgage. In 2016, distressed sales were nothing more than an asterisk to an overall healthy, nearly recovered housing market, almost not worth mentioning in reviewing 2016.

97.2% of all closed sales were good ol’ fashioned homeowners with equity.

Expected Market Time: Based upon the low inventory and hot demand, it was a seller’s market the entire year.

The expected market time (the length of time it would take to place a home into escrow based upon current supply and demand) remained below the 90-day mark all year, continuously tipping in the seller’s favor. It only dipped below 60 days, a HOT seller’s market where homes appreciate at a faster clip, in March and April. For the most part, this year’s market remained between 60 and 90 days, a slight seller’s market where homes don’t appreciate that fast, but the seller’s still get to control more of the terms of a sale during the negotiating process.

The expected market time for all of Orange County grew to 75 days in the past two weeks, but is still a great start to a New Year.

For homes priced below $1 million, the expected market time is at 53 days. For homes over $1 million, the expected market time rises to 196 days, or 6.5 months.

The 2017 Forecast: With higher interest rates, change is in the air.

With interest rates increasing by nearly a full percent since the election, change is afoot. The new presidential administration is poised to spend money on the U.S. infrastructure and lower taxes, a recipe for increased inflation. As a result, many experts are anticipating more Federal Reserve hikes in the short term rate, which will be accompanied by a rise in long term rates as well. Here’s the forecast:

• Interest Rates – in December of 2015 the Federal Reserve hiked interest rates and then hinted at four more in 2016. That did not happen for a variety of reasons. Initially, it was for economic reasons, but that shifted to not hiking during an election cycle. Yet, since the election, interest rates climbed on their own accord. Investors around the world pulled their money out of long term bonds and moved into stocks that would benefit under a new administration. Rates rose to as high as 4.5%, but have eased slightly recently. The Federal Reserve meets eight times per year and it will most likely pull the trigger on further increases three more times in 2017. By year’s end, expect interest rates to eclipse 4.75% and may even climb to 5%.
• Active Inventory – the year will begin with a very anemic inventory that will translate to a good start for housing. Yet, with the prospect of inflation, the Federal Reserve will be inclined to pull the trigger and raise rates, most likely two more times by mid-July. Long term rates will rise as well. Buyers will be less inclined to budge from paying more than the Fair Market Value for a home. Higher rates clamp down on affordability. As a result, the active inventory will climb beyond the 8,000 home mark for the first time since 2011 and appreciation will slow considerably. Expect the inventory to peak in August between 8,500 to 9,000 homes.
• Demand – initially, with an anemic inventory and buyers anxious to cash in on historically low rates before they rise further, demand will be strong during the Spring Market. Buyers will be willing to stretch slightly in price compared to the most recent sale; so, expect appreciation around 2% during the first 6-months of the year. As the Fed increases rates, buyers for the second half of the year will not want to overpay and will zero in on the Fair Market Value for a home. Demand will fall slowly and appreciation will be flat for the second half of the year.
• Housing Cycle – the housing market will follow a normal housing cycle. The strongest demand coupled with plenty of fresh inventory will occur during the Spring Market. This will be followed by less demand and a continued new supply of homes in the Summer Market. From there, demand will drop further along with fewer homes to enter the fray in the Autumn Market. Finally, all the distractions of the Holiday market will be punctuated with the lowest demand of the year and few homeowners opting to sell.
• Closed Sales – the number of successful, closed sales will be slightly fewer than 2016. There will be a similar number of “move-up” sellers, which will prove to be a wise decision as mortgage rates rise in the future and affordability starts to erode.
• Luxury Market – luxury sales will drop slightly from 2016’s record.
• Distressed Inventory – the distressed inventory will remain low with a very similar level of successful short sales and foreclosures, representing just a few percent of all sales by year’s end.

The bottom line, 2017 will feel a little slower than the past couple of years. At first buyers will be lining up to take advantage of the end to low rates, but as affordability erodes, so will the buyer’s appetite to pay much more than the Fair Market Value for a home. Orange County will be poised to move from a seller’s market to an equilibrium market, one that does not favor a buyer or seller.