What happens in California's substantial housing market traditionally has been a helpful indicator of where the housing market is headed nationally. The volume figures alone are sufficient to recognize the significance of this state, with more than 36 million residents and nearly 10 percent of all permits issued nationwide in 2005. Despite trailing Florida and Texas in permit issuance, data from the National Association of Realtors shows that California led the nation in resale activity in 2005, with nearly 600,000 total existing home sales. Many California markets have seen unprecedented price appreciation over the past several years, which has been supported primarily by low mortgage rates, homeowners leveraging existing equity to purchase more-expensive homes, and an increasing willingness of homeowners to spend a larger percentage of their net income on housing expenses. However, as price appreciation starts to moderate so will available equity, and as mortgage rates rise the cost of financing becomes a diminishing benefit. As a result, California faces some difficult obstacles in 2006 due to what could be described as a moderate affordability crisis. First-quarter numbers already indicate that sales have slowed, and price increases have ceased their upward climb and look to be coming down from what was a 2005 peak.
There is a potential for the least affordable California markets to run into some trouble if prices have too far outstripped the capability of consumers to purchase homes. Rising mortgage rates only make the equation more difficult. According to the most recent Census population figures, areas like San Diego County and San Francisco County saw actual declines in population between 2004 and 2005, declines that are in large part due to migration to surrounding counties where housing is more affordable. There is the potential for oversupply in these and similar areas if the new-home products offered are not designed to be reasonably affordable. Higher-density units, condo conversions, and infill are expected to be increasingly prominent in high-priced urban areas as a way to combat staggeringly low affordability rates. In addition, while in previous years extra inventory was eagerly gobbled up by investors, much of that money has now left the less-profitable real estate market in search of greener pastures elsewhere.
Not everything is a negative, of course. California continues to gain population overall and most areas enjoy reasonably strong economic performance. While neighboring states can provide a more affordable alternative to California, they often cannot offer as mild a climate or as dynamic a lifestyle. Look for California to continue drawing in residents who can't resist the ideal weather and coastal living, but don't expect the same pace of price appreciation until incomes have a chance to catch up to prices. Many builders are staking their California plans on more affordable markets such as Fresno, Bakersfield, and others in the central or eastern areas of the state. Growth should continue in these areas as prospective home buyers head inland in search of more affordable living.