Playing The Surge In California Real Estate
On its face, the real estate environment seems like it’s in good shape. Not only are prices back up to – and in many cases eclipsing – pre-crash levels, but the number of foreclosures and underwater homeowners has fallen dramatically, especially in some of the harder hit areas around the country. Beneath the surface, however, danger is lurking as prospective buyers nationwide are finding it more and more challenging to find affordable housing. Playing The Surge In California Real Estate.
Along the California coast, it’s not merely challenging to find reasonably priced real estate – it’s nearly impossible. From San Diego to Los Angeles to San Francisco, home values are rapidly rising and a confluence of factors will likely continue to drive the market even higher. Consider the following:
**Prop 13 – A voter initiative passed in 1978 amid an anti-tax revolt, it caps California real estate property tax rates at 1.25% and freezes assessed property values at the original purchase price. While no one likes higher taxes, the measure artificially constrains inventory and make prices soar because it offers older homeowners a remarkable disincentive to sell.
**Greater investment property ownership – Investors flooded the middle market after real estate hit bottom during the financial crisis, gobbling up foreclosures and short sales at bargain basement prices and converting them into rentals – further squeezing what little affordable inventory exists within these markets.
**Lack of available land – In the most desirable neighborhoods within San Diego, Los Angeles and San Francisco, land is scarce. And when there is development in such neighborhoods, it often involves tearing down a $1 million home and replacing it with one that is three times more expensive. While this is good for surrounding homeowners – who see the value of their properties go up – it makes the broader market more challenging for prospective buyers.
**Foreign buyers inflating prices – From locating a property to negotiating price to going through each exhaustive step of the mortgage process, buying a home often takes months. But for wealthy foreign buyers seeking the safe haven of US-based hard assets, and making all-cash offers to sweeten their deals, it only takes weeks. And by frequently going above market prices in their offers, foreign buyers have helped drive up the price for everyone else.
Without question, California real estate is an extreme case. Many markets around the country are subject to more rational price pressures. In Dallas and Atlanta, for example, it is still very possible to find affordable real estate in desirable neighborhoods.
Eventually, market forces should provide a remedy, but in the meantime, here are some potential opportunities for equity investors looking to capitalize on the current environment:
Zillow Z +1.4% – In many ways, Zillow is the first point of entry for potential home buyers as they begin their search, long ago establishing itself as the ‘Google GOOGL +0.75% of the real estate market.’ And in an age of constrained inventory, when real-time access to data and listing information concerning properties is more important than ever, it is poised to strengthen its grip within this niche space, where very few have built the size and scale to compete effectively. Importantly, Zillow recently announced that its platform will be now available to a select group of brokers working in China, which is ground zero for many of the foreign buyers that are now penetrating luxury, high-end markets with all-cash offers.
The Blackstone Group – While most know Blackstone as a premier private equity firm, fewer are aware that it is one of the country’s biggest owners of single family real estate. When the market hit bottom, Blackstone swooped in and acquired thousands of distressed properties in downtrodden areas such as Phoenix, Las Vegas and the Inland Empire (California). It now earns duel streams of revenue off those investments: rental income and by bundling the mortgages of such properties into securities and selling them investors. For those who want a piece of single family housing, Blackstone is the pure play.
PulteGroup PHM +1.21% Inc– With housing starts across the industry lower than expected through the first quarter, Pulte’s earnings lagged behind last year’s numbers and its stock has suffered. But as one of the nation’s leading luxury home builders, it will eventually benefit from rising prices in top tier markets and is well-positioned once building begins to pick back up. At its current price, Pulte could represent significant value for investors looking to capture upside opportunity in markets where values continue to escalate.
Essex Property Trust – As a contrarian play, with so little real estate inventory on the west coast. Apartment owners are able to raise rents without pushback. Since so few people can afford California real estate it creates more supply of people to rent. Essex owns 163 multi-unit properties on the west coast. They should benefit from the unaffordability and continued rise of real estate prices on the west coast. If you can’t own you must rent and rents are going up.
There is very little doubt that the real estate market is on much firmer ground that it was five years ago, when it nearly experienced an apocalyptic collapse. But much like the broader economic recovery, obstacles remain.
And while limited inventory and high prices are not good for otherwise qualified buyers looking for a home, shrewd investors can realize upside opportunity in a sector where others have mostly found frustration and disappointment.