So much for the Californian housing shortage

Let’s take a trip down memory lane. It’s early 2006 and the median house price in Los Angeles-Orange County, California has hit $582,000. Demographia has just released its latest International Housing Affordability Survey showing that Southern California has the most expensive housing market out of the six nations surveyed.

Property speculation is at fever pitched. Having watched others amass fortunes ‘flipping’ houses, first time ‘investors’ are entering the Californian real estate market en masse with the expectation of striking pay dirt. First time buyers, too, are rushing into the market before they are priced-out forever.

With some of the strictest land-use regulations in the United States, Californian housing supply is unable to keep up with the surging demand, creating claims of a chronic housing shortage that fuels expectations that prices will continue rising. Then, on 9 February 2006, the following article appears in a popular local newspaper:

The California Building Industry Association (CBIA) continues to express alarm over what it calls an ongoing housing crisis in Southern California.

Alan Nevin, the association’s chief economist, projected in a 2006 CBIA Housing Forecast that only 185,000 to 205,000 building permits will be granted this year, far short of the 240,000 new homes needed each year.

Southern California has been experiencing a massive population boom in recent years and it’s believed that 6 million new residents will be living in the region by 2020. The population increase, coupled with the housing shortage, has the CBIA worried that it will be increasingly difficult for first-time homebuyers to find a moderately priced unit.

“Los Angeles and Ventura counties are suffering from a housing crisis,” said Holly Schroeder, chief executive officer of the Building Industry Association Greater Los Angeles Ventura Chapter. “While we have seen increases in permitting, it still consistently falls far below the needs of our region. We have to find a way to take care of our own and provide housing to those that need it and want it”…

“In some cases, it can take nearly a decade to get new housing projects approved.That’s longer than it takes a pharmaceutical company to bring a drug to market,” Schroeder said. “The real question facing Southern California is how do we propose to help families realize the American dream and provide housing for the current and future generations living in California?”.

The 2006 forecast published by the California Association of Realtors paints a similar a picture to that of the CBIA… A 10 percent increase in the median price is predicted for a California home, the association said. Next year, the average home price in California is predicted to hit $573,000.

Officials are worried locally as well. “We are concerned that a lack of sufficient housing is causing prices to grow exponentially,” said Gary Wartik, economic development manager for the city of Thousand Oaks…

Back to reality:

The situation that I described above represents the prevailing mood in California in early 2006. The housing market was still buoyant and the mainstream view was that prices would continue rising on the back of the ‘chronic housing shortage’ that had developed following years of anemic new home construction.

How things change. Dr Housing Bubble last week published an article on the large increase in vacant homes in California following the recent housing crash.

In 2000 roughly 5.8 percent of all California housing units were listed as vacant. With the latest 2010 Census figures California is now listed as having 8 percent of all housing units vacant…

It might come as a surprise to many that California has 1.1 million vacant housing units. Back in 2000 California had 712,000 vacant units so over the decade we have increased the number of vacant units by 54 percent. At the same time. total housing units have increased by 11 percent…

Nationwide the median home price is approximately $160,000 while the nationwide household income is $50,000. Home prices nationally are 3.2 times the annual household income… In California prices are still out of balance with household incomes [see below chart]. The high leverage loans have been pulled from these markets allowing people to borrow 9 times their annual household income (or even higher in many cases)… [Although] Lower priced counties like San Bernardino [and Sacramento] are quickly approaching the pre-bubble price range…

How California’s shortage turned into surplus:

‘Underlying demand’ (or ‘pent-up’ demand) is the common methodology used in calculating whether there is a housing shortage. Put simply, underlying demand estimates what the demand for newly-built housing might be given the growth in population, trends in household size, demand for second (or holiday) homes, and economic conditions (e.g. employment, interest rates, etc). Underlying demand differs from ‘effective (actual) demand’, which is the quantity that owner-occupiers, investors and renters are actually able and willing to buy or rent in the housing market.

General economic conditions can dramatically affect the level of housing demanded. For instance, as economic conditions deteriorate, and unemployment rises, the number of people per dwelling will rise as they group together to reduce their housing costs. This most likely explains the current situation in California where, despite experiencing a chronic housing shortage (as measured by underlying demand) prior to the onset of the financial crisis, there is now a large oversupply of housing brought about by a deep recession.

Unresponsive supply cuts both ways:

The economic reality is that the demand for housing is changeable depending, largely, on the prevailing economic conditions. And when housing supply is unresponsive (‘inelastic’), these changes in demand feed directly into prices instead of new construction, making the housing market more volatile and prone to boom/bust cycles.

Nowhere is this more evident than in California, where strict land-use policies severely limits new home construction. In the lead up to the financial crisis, California’s unresponsive supply ensured that the extra demand caused by prolificate lending fed into higher prices instead of new construction. In turn, the price rises and perceived scarcity encouraged speculative demand and ‘panic buying’ from first-time buyers, which helped to drive prices up even further.

However, once the Californian economy began to deteriorate in 2007, demand evaporated causing prices to crash. The same supply dynamics that drove the market ever higher cut just as deeply on the way down.

Think about California the next time an ‘expert’ claims that Australia’s so-called housing shortage would prevent house prices from falling here.

Cheers Leith

[email protected]

Unconventional Economist


  1. Greed and prices are directly proportional to each other. These days folks don’t have to have a house for the price asked for. There was a time, especially in the 1980s, that some would pay more than the asking price.

    Humans can’t exist without greed. When greed takes over, prices rise.

  2. Dave From Pakenham

    Great post. The only thing peculiar to Australia (ok and Ireland) is our lack of income diversity…

  3. A real estate analyst I used to work with modelled exactly those factors (population growth, number of people per house etc.) to determine an estimated housing demand. Having played with the model you realise how sensitive it is to any changes in the inputs. If you return people per house to a historic norm (abnormally low levels today), for example, the under supply rapidly changes to an over supply. I’ve never listened to under/over supply arguments since.

  4. Our bubble is much bigger than theirs. I hope our housing crash is just as spectacular!

  5. Good post. But don’t forget Southern Cal’s ubiquitous “jingle” loans exacerbate the price crash as it makes it much easier for people to change their living arrangements (ie group together) and thereby more rapidly increases supply. My wife is from Seal Beach and she posted her keys back to the bank last year as it was the easiest route. Her decision would be starkly different under AU’s mortgage environment and therefore this will (in part) moderate the extent of the price crash.

    • If she was from Vegas, Miami or Detroit, could she walk away?


      Love your posts. Whatever you did for a living before being a ‘developer’ I hope you were good at it or have made enough adding a 100% premium for buyers that you are financially independant.

      • So by your first comment are you suggesting that non-recouse and full-recourse mortgage environments (all other things being equal) make no difference to the rate of supply in a negative equity climate (as in SoCal)?

        If so, then go live in SoCal for a while and see just how incorrect you are.

        If not, then I don’t follow what point you are making.

        And finally, not sure what you’re suggesting by your last comment but it seems largely irrelevant to me.

        • Yes I am. I’ve lived in the USA and I suggest you look at the glut of rubbish in Florida. All marketed as a shortage and the place the whole of North Am wanted to be (alongside SoCal, Arizona and Nevada).

          In a previous post you’ve admitted peddling 380K house and land packages. I countered with 200K tops.

          The games up. Pedal off into the sunset.

          • I see that the policy of this blog continues whereby attacking the man is fine as long as the man is a not a bear.
            I’m sure I read here that anyone attacking the man would be banned. Seems this place is fast becoming a bears only blog akin to bubblepedia, simplesustainable and creditcrunch.

          • Wow Sarah P your pretty quick to push the “attacking bulls” button. Most people would call it disagreeing rather then attacking. If LandDeveloper feels attacked he is free to contact the admins who would sort it out. LandDeveloper seems like he is more then capable of defending himself. For the record I tend to agree with LandDeveloper that the fact that we have full recourse will have an effect. To what level I’m not sure.

          • Hi 787 – there’s no doubt your posts are more entertaining than mine, and from time to time you seem to offer some credible views. The problem is you obscure your responses (to my posts at least) in emotion. I am aware my ilk are not all that popular here, but housing affordability is major concern on my agenda and I watch this blog to get a broader perspective. Unfortunately though, your comments on SoCal are wrong (and Florida is another story). And your comments on 380k dogboxes are also wrong. But I have thick enough skin to know that my posts here may not alwasy be what people want to hear. However I genuinely appreciate cogent responses and corrections because, unlike you, I actually don’t know everything and if I can learn from some very good economists (like UC et al) then I’ll happily stand corrected.

          • Watch the abuse 787, or I’ll get my friend Tinpusher from SS to ground you in the Mojave desert. Permanently.

      • Keep your comments above board 787 – this is not a place to denounce what someone does for a living or their personal choices.

        Would you say this sort of thing to someone at a bar/cafe over a drink?

        No – which is the level of discourse and discussion that is appropriate at MacroBusiness, not resorting to personal irrelevant comments, even if you are angry or frustrated about housing.

    • You make an good point. Problem is, you see it from a sellers perspective. The ensnarement of mortgagors by the system will just result in a more spectacular burst when the inevitable happens. Jingle mail acts as a relief valve, allowing banks to survive. When our market eventually blows, it will take the banks with it. Correction: it will take us with it, the banks of course will be bailed by the taxpayer.

      • I glad you mentioned the taxpayer “fix”.

        Nothing like Socialism, eh?

        Oh…i mean…a capitalistic democracy…or…hmmm…what do i mean?

    • I would argue that non-recourse loans are worse. While the crash in housing prices may be put off, people struggling will cease every other expenditure, bleeding the rest of the economy to keep paying their mortgages. Rather than being an early warning sign like in the “jingle mail” states, arrears will stay low until things are really dire, because by the time people can’t pay their mortgages they have nothing left. Hitting the wall and having no other assets leaves behind an utterly ruined economy (the five percent down loans I believe used to be known in the trade as “neutron loans” because they killed the people and left the houses).

      Even more importantly, growth in debt has been the engine of economic growth for many years. Loans are created by the banks, and spent by the people who take them out. This money goes to pay the wages of everyone involved in the housing trade, and adds to the real demand that would be present if debt levels were static. The USA amply demonstrates what happens when debt growth goes into reverse – paying back debt subtracts from the real economy, unemployment rockets, real incomes fall, the process becomes a vicious circle. We are nearing a point where debt growth cannot continue any further because borrowers are stretched to their limits. The machine of economic growth is broken, the recovery from the coming recession can’t happen by increasing total debt, and a radical departure from the prevailing economic system since the second world war.

      On an unrelated topic landDeveloper, the intellectual robustness of a forum depends on having differing views. Yours are expressed politely and intelligently, even if few here agree. Please ignore the trolls and continue to post.

    • LandDeveloper,

      Here’s a qn for you (actually to your wife)…

      Would she still send the keys back if had no other assets?

      I think the recourse loan thing only works if one has substantial assets (with equity) outside of their own home.

      A large number of people are loaded on debt on their homes, investment props and cars.

      If I owed $ on my home and car… and the prices fell by a significant amount, I’d walk away. I be broke anyway so what’s the bank gonna do… you can broke a broke person.

      Would love to hear your thoughts…


      • Reminds me of a charming story about the joys of non-recourse loans (I read it on a US blog so I don’t know if it’s true.) A woman in the early noughties buys a house with no deposit and a large mortgage. After a couple of years, the house has gone up in value so she withdraws some equity and buys herself a nice car, some jewellery and furniture. The housing market tanked, and although she could still comfortably afford her mortgage, she packed her furniture and jewellery into her nice car and drove off, mailing the keys to the bank. Then she bought a house at half the price in her sister’s name, and used the money she saved on mortgage repayments to buy season tickets to her favourite basketball team.

  6. The other thing that struck me about California is how the “surplus” is located in enclaves far away from where the jobs are… these days anyways.

    Affluent areas of CA have not seen “significant” price drops, yet. This is correlated to the unemployment rate of these areas — those with more education are more employable than those without. The story is far from over in California. The creep of lower housing prices will eventually start to affect the higher-priced areas. Right now, in more well-heeled circles and after a purported “paradigm switch” in how Americans view ownership, the concept of the “housing meltdown” is still widely viewed as happening to other people.

    • Jesse, I think the same can be said of the UK. The more affluent SE corner of the UK has not seen huge falls in value unlike the north, Wales and particularly Northern Ireland. Apparently, prices in the SE are creeping up again. Having said that, I think the low BoE interest rates are a significant factor.

      If rates do go up here (I think they won’t) then we will see huge falls of 40% or so……and fairly quickly.

  7. Come on everyone Australia is not California. Its different. LOL It wont be long till years down the road we are all reading the same thing about Australia. Laughing at all these spruikers, Ole Glenn, Julia etc…….

  8. Speaking of California – chances are the superhighway mindset is continuing to dominate planning decisions around here…

    Would like the know the odds of the ‘proposed’ rail being included against the 4-6 lane highway – you can only use that corridor once, make it count.

  9. There appears to be an almost universal theme that speculation using cheap money and debt is distorting markets in a way that damages the non-speculation economy, and often has quite negative effects on peoples lives.

    Houses are the obvious one, but oil and food commodities are there, as well as anything else you can name. Many assets that have normal utility (eg houses), where it’s actually hard to go short, look like a bubble waiting to happen when you introduce speculative money.

    I wouldn’t mind seeing some thoughts on what (if anything) economies can do to limit the speculation to hedging (or at least discourage non-hedging speculation) and prevent distortions that flow out of it.

    • The simple answer is much higher interest rates to discourage borrowing, but this goes against most conventional economic models.

      I’m in the camp of re-regulating capital from a taxation and legal point of view, based on holding time. e.g buy a share and don’t sell it for 10 years, you pay no capital gains tax. sell it within 12 months however, you pay 90%. sell it within 30 days you pay 99%. Same would apply with houses and land.

      Good question AJ.

      • Agree that tax does appear to be the most useful tool that economies have at their disposal to change economic outcomes and therefore behaviours. Not an easy tool to use politically however!

        I guess to get to this point it might require a theoretical acceptance of the view that markets – particularly when it comes to herd behaviour and speculation – do actually fail. I imagine there would be some pretty heavy opinion coming in against this… but as you point out perhaps markets are being distorted at the very core by the availabily of the cheap money.

      • I don’t like that idea at all for land. In my opinion where land is rezoned for housing, it should be built on and sold as soon as possible. I don’t want residential land held off the market for tax purposes.

        • How about just changing margin requirements? First home buyers to put down 30%. Investors to put down 40%, in cash, no “equity”. Loans for stock market speculation outlawed. Lending is to be aimed at productive enterprises (i.e. business loans). Obviously a recipe for massive deflation in a debt driven economy, I can’t see anything similar being done until after the debt implosion, when people are wondering how to prevent it from happening again.

    • Aj,

      I think the answer is to abolish the reserve bank… or at least remove the ability of the reserve bank to set interest rates.

      The reserve bank apart from distorting the price of money, also stabilises the price of money which also encourages speculation (e.g. Japan/Aust carry-trade).

      In a world without RBA, interest would be as volatile as any other market (e.g. Fx, stocks, bonds etc), which would naturally discourage over-investment. Banks would not lend you as much due to the volatility but more importantly we are home owners wouldn’t want to borrow as much as well. (e.g. how much would you borrow to invest in stocks vs currently in houses).

      The free market works beautifully if one let’s it work.

      P.S. Regulations are the problem not the solution.

  10. “Restrictive” land polices in southern California might carry some importance for the population.

    Last time I was there (OK, I admit it’s the only time I’ve ever been there) I asked a bus driver where they get all the fresh water to supply such a large number of people in what is obviously a dry, semi-desert climate. He replied that it comes from snowmelt further to the north, and that each year they needed to check the depth of the snowpack to make sure enough water would be available.

    Given that soCal is so heavily populated already, might it not make sense to place some restrictions on the amount of development? Did soCal only introduce tighter land use policies in around 2000 when the bubble started to take off, or have they been in place longer without having such an effect until the credit boom?

    If stricter lending criteria were had been enforced, the money necessary for a massive housing bubble would not have been available in the first place.

    • SoCal and San Francisco have had restrictive land-use policies in place for decades, hence the elevated median multiples and boom/bust cycles in these areas (see second chart). In fairness to California, however, it does also have physical barriers to supply to contend with such as the ocean and mountains (a bit like Sydney), so even with similar land-use policies to Texas and Georgia, land supply would likely still be less responsive than those states.

      I agree with you on the water issue / sustainability. However, concerns about population growth should be addressed directly rather than by forcing the price of housing up via restrictive land-use policies.

      I also agree with you on the need for tighter credit controls. To me, this is a no-brainer.

    • If government was concerned about a looming shortage of water the best solution might be a market-based one where the price of water rises to reflect the danger.
      This system would encourage existing residents to use less water and would send a signal that only frugal water users should move to the areas, and would possibly cause innovative new supply to come on line.
      By contrast your proposed scheme would restrict the number of houses, but not the number of water-guzzlers that may live in each house.
      Why restrict one thing when you really want to restrict another?

      Upon reading your post again I notice you actually want to restrict two things:
      1) restrict housing to save water
      2) restrict lending to stop your first restriction from causing price rises.

      • why not take water away from being an essentially welfare distributed (but you pay a fee) commodity to one where you actually pay for what you use. Can you imagine petrol being distributed in the same way?

        If we valued water to its cost and natural scarcity it would be fine. Clearly the existing mechanisms were designed to enable the community to transcend the natural high and low cycle of the environmental supply (as well as make water treatment more economic and control public health issues). However the community has relinquished (or lost) the sence of involvement and there is no sence of responsibility in water use.

        Combine this with a mindless bureaucracy that does lunatic things like ban trigger hoses while allowing free use of buckets (resulting in more water used) and the installation of a “don’t just suspect your neighbour, report them” mentality which harks back to the hitler youth and you have what we got in SEQld in 2005.