The housing recovery elevated prices across Coastal California, but left the Inland Empire behind. While prices rebounded off their 2012 lows, these fringe markets are still undervalued relative to what residents pay for rent on similar properties.
Homebuilders are most active where the commutes to major employment centers near the coast are shortest, and also where homes can be built and sold under the FHA loan limit. Markets just beyond the current activities of homebuilders are prime investment locations for developers and investors with longer holding times.
The old real estate adage says “you drive until you qualify.” Potential homebuyers must sacrifice their desires and substitute to far-flung suburbs (exurbs) because high house prices push them away from more desirable markets closer to employment centers. This phenomenon causes many California homeowners to endure brutal commutes. However, one notable difference between this recovery and previous recoveries has been the slow rate of home price appreciation in far-flung exurbs. This also creates opportunities for those with the data, foresight, and courage to act first.
A Deeper Dive into the Data
Market InSite utilizes rental parity analysis to establish useful valuation metrics across markets. The relationship between the monthly cost of home ownership and comparable rental rates represents the balance between the two alternative ways people occupy housing. When this relationship deviates from it’s normal and stable relationship, it signals a market is either overvalued or undervalued.
California inflated housing bubbles in the late 1980’s and in the early 2000’s. Lenders abandoned lending standards for debt-to-income and experimented with affordability products. The stable period from 1993-1999 represents a “normal” market when affordability products were not widespread, so Market InSite uses this period to establish a benchmark for valuation. Dodd-Frank banned unstable loans and put a stabilizing ceiling on affordability that’s become apparent since 2013.
The long-term price chart below demonstrates the bubbles and busts and the impact of Dodd-Frank’s affordability ceiling.
The exurb markets have always been more affordable than coastal markets, and these markets generally trade at a discount to rental parity. For example, in Corona homeowners typically pay 19.4% less to own a house than renters pay for a comparable property. Today, homeowners pay 19% less to own, so despite the discount, the Corona housing market is trading at fair value.
Most of Orange County and Los Angeles County is already trading at or near fair market value, and the adjacent cities in San Bernardino County and Riverside County show the same pattern. However, look a little farther out, and the cities become increasingly undervalued. Despite the rally in house prices since 2012, the remote suburbs still have not recovered from the housing bust.
In the chart below the column on the right shows how far under historic norms these cities are trading.
Tables are great for displaying raw data, but when these numbers are put on a map, the patterns become obvious. The following maps show the relationships between the key numbers in the tables above.
The map below shows the current relationship between the cost of ownership and the cost of renting. Remember, most of these markets historically trade at a discount.
To fully understand what’s going on, it’s critical to compare the current valuations to historic norms.
Not just are the remote suburbs trading at prices below rental parity, they are trading at significant discounts to their historic norms.
There are only two possible conclusions we can draw from this analysis: (1) Today’s valuations represent a new normal, or (2) these markets are undervalued and at some point, they will rebound. The latter conclusion seems more likely.
The above map clearly demonstrates that the high desert communities of Adelanto, Apple Valley, and Victorville are deeply undervalued as are the east desert communities of Palm Desert, Rancho Mirage, and surrounding areas.
High prices nearer employment centers hasn’t pushed homebuyers out to these communities yet, so homebuilding activity is muted; however, investors and developers should investigate these areas because typically the cycle would not end without recovery in these areas. When buyers seek more house for their money in these areas, home prices should bounce back to their historic norms – an increase of 25% or more.
The analysis above also shows why homebuilders are so interested in the commuter communities adjacent to Los Angeles County and San Diego County. The cities of Temecula, Murrieta, and Menifee are undervalued as is Chino, Ontario, and Rancho Cucamonga. These cities have room for further home price appreciation, and since they are a relatively easy commute to major employment centers, homebuilders assume they can sell with good volume.
Unfortunately, these markets face another constraint: the FHA loan limit. The map below shows how the median resale home price relates to home prices financeable using FHA loans. A completely different picture emerges.
While homebuilders will undoubtedly remain active in the commuter communities, absorption may not be as high as they would like. Potential homebuyers simply don’t have the down payments necessary to close the deal.
The lack of down payment equity will force two related trends caused when buyers substitute their preferences for what they can afford. First, homebuilders will provide attached and high-density detached products in markets unaccustomed to these products because increasing density is the only realistic method for producing houses salable at or below $370,000. Second, homebuilders will migrate further inland where traditional single-family homes can still be built and sold profitably for under $370,000.
This second trend will prompt homebuilders to take on projects in Menifee, Perris, Moreno Valley, and Redlands with a continuing push eastward. That being said, the push will be slow as Millennials so far resist the crushing commutes from the hinterlands. The commutable area where homebuilders can provide lower cost housing will be narrower than in past recoveries. Building a community 20 miles too far out will lead to slow sales.
Housing Market Reports
The data for this analysis comes from Market InSite’s Resale Market Value & Trends Report (Click Here). The report helps homebuilders and developers uncover where the best opportunities that fit within their unique investment parameters.
If you’re interested in learning more about these reports, contact me at 949-656-8011 or firstname.lastname@example.org. I would be delighted to meet with you and discuss how this report can help you meet your investment goals.
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