Happy New Year South Bay residents and to all of our loyal weekly readers!
I hope everyone’s 2020 is off to a great start and you are feeling as excited and inspired as ever. Just like every year, I am ready to make my annual “fearless predictions” for South Bay real estate and the greater Los Angeles area.
This is one of the trickiest years ever to make predictions, but if it was easy, then everyone would do it.
Before we jump into my predictions, however, I want to give a little background on where the market has been this past year.
Real Talk: The Market is Soft
The California state housing market is up. The L.A. County market is up. And, affordability is also up.
Why? Lower interest rates. They saved the day in 2019 throughout most markets.
The L.A. County market’s median price is higher and somehow affordability climbed from 22 in Q3 of 2018 to 25 in Q3 of 2019. That jump in affordability means that more people can afford home, and that is all thanks to low borrowing costs due to all-time low interest rates.
But, if you were paying attention to the South Bay data in 2018 and 2019, the South Bay market “tipped its hand” early when interest rates began rising in 2018 and peaked in the fall of 2018. Local agents began speaking about things feeling “slower” and the market being “different” during that time. Since 2018, sales have slowed, and prices have fallen throughout the South Bay…even with these lower rates.
In 2019, the rapidly appreciating “affordable” areas in the South Bay, like North Redondo Beach and Rancho Palos Verdes, suddenly declined in price for the first time in years.
What’s more, sales are a mixed bag over the past 12 months, but going back 24 months, sales are decidedly lower in all areas covered in this blog.
The results of median price movement are in for 2019 and it is disappointing…
- Manhattan Beach is down
- Hermosa Beach is down
- Redondo Beach is down
- P.V. Peninsula (90274) is down
- P.V. Peninsula (90275) is down
They are all down!
I will have more to report in my quarterly mailer with specific numbers.
Albeit the median price drops are not huge, but prices are dropping throughout the South Bay.
With record low rates, record low unemployment, and a surging stock market, it is hard to believe that South Bay real estate prices are not higher. And, with all the great economic news, why is The Fed injecting liquidity into the Repo markets?
Don’t say I did not warn you about lower prices because I did.
My 2018 and 2019 predictions stated that prices would drop late 2019 or 2020 depending on interest rates. That prediction seems to be coming true.
My 2020 Predictions
- Prices declines between five and 15% in 2020.
- Interest Rates, up or down, become a negative for the market.
- Small income properties or SFRs with ADU upside outperform.
- East Manhattan Beach new construction could get hammered.
- Long Term Bet: ADUs are key in solving California’s housing shortage.
Price Declines (Continue) to Come into 2020
Prediction: Prices will decline between five and 15 percent in late 2019 or 2020 depending on interest rates.
I said it two years ago and I continue to stick to this prediction. And, it looks like 2019 was the year that price drops have begun to form.
This prediction represents a healthy correction that the market really needs. It is not a doomsday call.
When you take median prices versus the median income needed to afford a home locally, you realize they are so out of whack that it is just not sustainable.
In December of 2018, I wrote a blog post titled, “South Bay Real Estate 2018 Data for Homeowners,” which statistically showed the average qualifying income needed in order to afford a house versus what the actual median income is in the area.
I will give you an example of what you can find in that last blog. According to the last census, the median income in Redondo Beach is $99,000, but the median income needed to afford the median priced home is $234,000. Come on…those numbers just do not make sense! Go read that post and look at the imbalances.
These numbers do not pencil and it assumes that buyers have saved a 20% down payment, which the majority of buyers have not done.
The South Bay market is starting to show weakness with the 2019 data and I think it will continue into 2020, even though not many people are talking about it.
Interest Rates
Prediction: Interest rates are best described as, “you’re damned if you do, damned if you don’t.”
I have been dead wrong on this topic over the last two years, so I am not making a prediction on where interest rates will go.
But, my beliefs this year do not need a prediction. The idiom above best describes my feelings towards interest rates and it goes like this:
- If rates go up significantly, that will crush affordability and the market will go down.
- If rates go even lower, The Fed is cutting rates and/or implementing QE, which means the economy is weak and real estate will get weak with it.
Rates need to hold right around where they are today to not impact the market negatively.
I truly believe that interest rates pose one of the biggest risks to the real estate market. We are at all-time high prices and generational lows in interest rates. These astonishing low rates support the incredible buying power we see today.
Even though a past blog post I wrote in March showed that interest rates and prices have zero correlation, the way I saw the market react to climbing interest rates in 2018 was the perfect example of how much present home pricing depends on cheap debt.
To read more on interest rate/price correlation in my March blog, click here.
Small Income Properties, SFRs with ADUs Outperform the Market
Prediction: Small income properties throughout Southern California, single-family homes with large lots (i.e. larger Palos Verdes real estate), and anywhere that allows you to add an ADU will outperform the market.
Time for some real estate optimism.
I think there is huge opportunity for active investors with the new California ADU legislation.
Specifically, for my readers, that opportunity will be found in small two to four unit income properties and single-family homes on large lots.
If you can find an income property that cash flows and has space to convert a large garage, carport, or a big backyard to a one or two bedroom ADU, then that is going to be a winner.
Improving a triplex to a fourplex with an additional two bedroom unit can add at least $250,000 in value in most South Bay areas. If you can install the ADU for less than that (and many will be able to), then you will win in the near term and kill it in the long-term.
Why just small income properties?
In theory, adding an ADU to a 15 unit building increases revenue by 7.5%, while adding an ADU to a triplex increases revenue by 33%. It’s a big deal for smaller properties.
The same goes for single-family buyers and current owners of large lots.
If you cannot afford a home in the area you like, can you convert a garage to an ADU to get the income you need to afford it?
Furthermore, look for a larger lot and add the biggest ADU you can in the back. You will reap huge benefits from a cash flow standpoint in the near term. And long-term, when the market figures out the value of an ADU, you will be rewarded with a larger resale price.
Income properties that earn a reasonable return in areas like Hawthorne, Torrance, Lomita, and Gardena to name a few, will outperform if you can find space for an ADU.
Anywhere in Palos Verdes with a larger lot and room for an ADU will outperform if you add a unit for the same reasons as the income property explanation above.
Essentially, the value of ADUs are going to be underappreciated for the next five to 10 years. Now is the perfect opportunity to acquire small income properties and larger lots while they sell for inefficient prices and build ADUs as soon as possible to enjoy additional cash flow from renters who are desperate to find affordable rentals.
East Manhattan Beach Riskiest New Construction Market in the South Bay
Prediction: East Manhattan Beach New Construction is one of the riskiest investments in the South Bay (but west of Sepulveda is relatively safe).
New construction price growth in East Manhattan Beach has been breathtaking over the past few years.
These prices make me very nervous and I have not been shy saying it.
A new construction record sale at 1755 8th Street for $4.465 million closed in July.
Contrast that with an existing sale at 1411 8th Street for $2.805 million that closed in May.
You could buy the nicely remodeled existing home for $2.8 million, tear it down, and build 1755 8th Street and be all-in for close to $4.465 million.
That spread does not make sense.
Of the 37 sales on 7,500 square foot lots in East Manhattan, 26 of them (or 70%) sold for less than $2.805 million, suggesting that 70% of the closings could essentially be a land sale.
This type of imbalance makes the highest new construction sales vulnerable.
If my five to 15% correction comes true, East Manhattan Beach new construction prices could get hammered.
That said, I think west of Sepulveda Blvd. will be much more resilient due to unique supply and demand imbalances, as well as demand from this new generation of wealthy buyers flocking to Manhattan Beach.
New construction in East Manhattan has just gotten way ahead of itself.
Long-Term Bet: ADUs Key to Solving CA Housing Affordability
Prediction: ADUs will play a massive role over the next decade in easing rents by increasing supply.
Rents are extremely high in California. Obviously.
Vancouver currently has ADUs on over a third of its single-family housing, and California’s new regulations mirror much of what the Canadians have implemented.
Some estimate that there are over 1.6 million detached housing units in the county of Los Angeles alone. Can you imagine if over 500,000 ADUs were added to the housing stock? It would have a massive beneficial effect on the supply side and help keep rents in check.
If the current regulations stay in place, I think over the next couple of decades ADUs will be the single biggest contributor to ease rising rents.
It also won’t be too bad on the pocketbooks of homeowners and landlords that look to add ADUs to their properties.
That to me is a win-win!