November 2024
Here are some key takeaways from their conversation:
• Brian highlights that while low-interest rates previously boosted affordability, recent increases have made it difficult for buyers to afford homes, particularly as property prices have not decreased to offset these rates.
• Mikey explains that the supply shortage in California dates back to the 2008 financial crisis, which drastically reduced new developments. Ventura County alone now faces a 33,000-unit shortage.
• If interest rates decrease, more households would qualify to buy, increasing demand faster than any additional supply from homeowners who might then choose to sell.
• First-time buyers are often relying on co-signers or family gifts, while non-QM (Qualified Mortgage) loans and retirement account withdrawals are used as creative financing methods.
• For individual buyers, both Brian and Mikey suggest that purchasing a home now may make sense for long-term plans. For investors, they are buying multifamily properties despite challenges, leveraging current market conditions and California’s slow-building process to secure profitable assets over the long term.
Looking to watch more of the live sessions from our 2024 Investor Symposium? Stay tuned as we release more episodes like these in the coming weeks such as Replacing Income in Retirement, Liquidity: Blessing or Curse?, and New Trends in Investing.
Watch previous episodes here:
Ep. 110 How the Election Impacts Your Investments
Ep. 109 Boomers vs. Millennials: How Generations Shape Financial Choices
Hey. All right, everybody, how are we doing here? I'm excited to talk a little bit about the California housing market update.
My name is Chris Galeski. I'm one of the wealth advisors here at Morton Wealth. I'm very lucky to have Brian Farwell, a mortgage advisor. He's going to be tackling a little bit of the California housing crisis as it relates to interest rates and lending. And then we have Mikey Taylor, who's a California real estate investor, and a Thousand Oaks City Council member.
So I'm excited to have you guys. Thank you for joining us.
Thank you very much. Excited to be here.
So if you're an owner of real estate, especially in California, you're probably pretty happy, right now if you're looking to buy in California... you're probably not very happy. And so this topic really comes up in a lot of conversations with clients as it relates to themselves personally or their kids or future generations. And as Grant Williams mentioned earlier, how we got here was sort of a shortage of supply of homes here in California, extremely low interest rates for a very long period of time, and then more buyers than there was supply, which caused prices to go up.
And now interest rates are higher. So home affordability here in California is not very good. So I'm going to start with you, Brian, in terms of kind of what's going on. Like what are the biggest issues that you see with having interest rates low for a really long time?
Yeah, I mean, you actually use the two words, a lot of people define their year by a word. And I was thinking about the last four years and what words come to mind. And the two is we have an affordability issue and we have a supply issue. So you mentioned both of those and a lot of that, if we were to just take a small look back at the last few years, has to do with obviously we saw interest rates shoot down very quickly with everything that happened in 2020.
And then for about a year around 2022 is about 14 months. We saw the Fed boost up the fed rate, which in turn boosted up interest rates from 3% on average to 7%. So that happened in about a 14 month period. You can imagine what that did to the, the ability to borrow or even the comfortablity of a payment for someone.
So when I was talking to a lot of clients, you know, that just completely shocked them, because what didn't happen is home prices didn't come down because of that. Sometimes home prices coming down is what can offset that interest rate change. But we didn't see that because of what we'll dive into a little bit more, which is the supply issue is still rearing its head even today.
And Mikey, do you want to mention the supply issue and sort of you know, how we got here in California today?
Yeah. So I build multifamily. So I'm going to speak on the multifamily asset class. If you look at the numbers specifically in Ventura County from let's say, 2000 to 2007, so leading up to the financial crisis, we were adding a lot of units actually on the residential side leading up to that point. It ranged anywhere from about 3500 units per year all the way up to our biggest year, which I believe was 2006, which was about 5000 units.
And then if you look at the financial crisis, let's call it 2009 to 2017, we did a fraction of those first five years leading up to the crash. So, you know, for context, 2009-12, we were doing less than 500 units per year in Ventura County of new supply. 2017 was the first year where we kind of did okay.
And then we had a couple lull years and then 21, 22, we were kind of rocking again. Last year, from what we're seeing, a lot of development just went on a standstill. And we're also seeing that on the city level because, you know, not only am I a real estate investor for my actual business, I'm also a policymaker for the city to figure out how we address the affordable housing side.
So we want developers coming in, adding supply and a lot of projects that had gotten entitled that we were looking forward to becoming part of the community, stopped the interest rates, just halted it completely. So, you know, fast forward to today. We're about 33,000 units short in Ventura County. If you look at the state levels, they're saying we're anywhere from two and a half to 3 million units short.
And for context, the state over the last ten years has added 100,000 units per year for the last decade. So we are very, very far from where we need to be.
And there are a lot of homeowners that refinanced back in 2020, 2021, extremely low interest rates. Some people sub 3%. There's the feeling that they're holding on to their homes because of that cheap mortgage. Brian, do you think if rates were to come down we're going to see more supply and activity?
I mean, there's a lot of people that are hoping that's the case. I think this is an interesting question. And there's sort of, I won't give a bunch of numbers, but there are two, in my opinion, two main data points that sort of clash at this question. So the first is, you mentioned low interest rates. So the last I saw, 89% of homeowners have a rate below 6%, and 60% of homeowners have a rate below 4%.
Okay. So you look over the last about year and I'm obviously painting with broad brushstrokes here, but rates have been between 7 and 8%. So for those people to move off of a two and a half interest rate is very difficult for them to do. So the thought is, is that margin decreases, right? As rates come down into the sixes and hopefully high fives, they'll be more motivated, which would put more supply on the market.
Now here's the counter data point. As rates drop, every 1%, 5 million more households become qualified and eligible to buy their home. Okay. So lower rates are going to mean people can now qualify for more. So the question is which one is going to give. Right. And the thought would be, 5 million new households for every 1% of interest rate is probably going to outpace the supply that's going to come on the market.
And so the short answer is, do I think supply will increase? Yes. Do I think competition will increase? Yes. And so it won't become easier to buy. There just may be more options for the weakened.
Those numbers are staggering. So as it relates to kind of home affordability today, Brian, obviously home prices are at all time highs and it's very expensive to borrow money today. How are you helping people qualify and be creative to be able to make purchases?
So just for context sake, if it wasn't clear I specifically work with people buying residential real estate, right? I'm not in the commercial space, multifamily, anything like that. So, there's really two buckets of people or groups that I feel like are really struggling or can really struggle with where affordability is at. So the first, which may not apply to very many people in this room, but it may apply to the next generation of your kids and stuff, is first-time homebuyers.
The first time homebuyer, is the average age of 35 years old right now, and I was doing some math before I came in here, assuming they have no debt at all and they're buying, let's say, I know this is crazy, but $1 million home, which is almost a starter home in this area, they need to be making about $175,000 a year to qualify.
That's with no debt, no car payments, no credit cards, no student loans, nothing. That's a big number. That's a very big number. And so what we're seeing and I don't have a number for this, but anecdotally is I would say well over 50% of the first time homebuyers, I'm hoping right now either have a cosigner, usually a parent.
It doesn't have to be a parent that's basically going on the loan and saying, hey, I'll use my income and my debt, but I'll use my income to help them qualify or clients are getting, homebuyers are getting gifts from also usually parents, to help them with a larger down payment to bring that payment down on a month to month.
So that's really the first time homebuyers. The other group is going to be a lot of self-employed people who rightfully so, the way they structure their tax returns, they take advantage of all the wonderful tax codes where they don't have to show all the income that they take, which for you guys and Morton and is lovely for a lender.
We have to take what's being shown on the tax returns. If you want to fit into what I'm going to call the normal loans. But what is growing immensely right now are what we call non QM loans. These are loans that are maybe outside the typical Fannie Freddie and we'll look at self-employed borrowers and shockingly maybe use our brains a little bit and look at some bank statements of cash flow assets.
And we'll be able to actually qualify them based on those things rather than what you report on your, you know, 1040 tax returns.
And you also mentioned one strategy is for people that are retired and have assets, but not a lot of income is setting up, you know, a systematic withdrawal plan out of their IRA to show income coming in. So that way they can qualify and then you can turn that off after they closed.
Yeah. That's a huge trick with.... you don't have to be retired. This includes inherited IRAs and things of that nature where we work. And this is why, kind of the partnership we have with Morton to help service you guys is so great because we get to just talk to your advisors and make life a little easier for you.
But setting up draws from IRAs, from retirement accounts, whatever it may be, we can use that to qualify you, you know, we have to do some calculations, make sure you have enough in there. But it's a way to almost turn on some income to qualify for a better interest rate and then turn off the income once you buy the home.
Now, Mikey, you love California. There's a lot of people that maybe don't like California real estate. For whatever reasons, prices, interest rates, it's expensive. Why do you like California so much?
Well California's California, right? Like what do they always say? You'll never leave this weather unless, you know, we start running it so poorly. That would be the only reason to leave. I think it's true. For a real estate standpoint, I have a very contrarian way of looking at real estate. So it's not just me. My whole company has the same view that when everyone running from some area, we want to be running towards it.
We want to be going in the opposite direction. And in 2017, 2018, you started seeing this, this move out of investing in California, at least speaking from the investor base. And everyone started looking at the states that were very easy to invest in- Midwest, Sunbelt states. A lot of money going into, you know, Georgia and places like this.
And when everybody started leaving, what they were saying and the reasons why they were heading there, I agreed with, like, it is very difficult to invest in California. The regulation is very, very stiff. If you talk about rent control laws. The state definitely favors the tenant, not the owner. But when everybody started running to where, you know, money flows easily, I wanted to know what opportunity was created in the place that they were leaving.
And what I saw in California was kind of how we talked about the numbers. If California was entering in 2017, you know, the beginning stages of the worst housing crisis we have ever seen. Well, that means, you know, supply is significantly below demand. And then the reason why everyone's leaving here actually makes that challenge worse, not better. So now if I'm only talking from the investor, you know, standpoint, if we're 2.5 million units short and the state only puts 100,000 new units on, and all the policies they create make it harder to build, you can make the argument that the state is keeping the competition out for you.
And if this deficit remains, what happens to rents? Rents go up. What happens to cap rates? We see him continue to compress, which means even though the state I think makes policy with the tenant in mind, the unforeseen outcome on their end is they end up making investors more wealthy than I think we would be if they just created more of a free market with a deregulated approach.
So to summarize, if I got it right, the lack of supply and then the amount of demand that can become available if rates are to go down is just going to keep housing prices in California fairly stable or continue to go up.
Okay, so here's a perfect example. Everybody's putting money into the Midwest and the Sunbelt states multifamily, right? If you're seeing what's happening to rents out there, they're giving rent concessions. Rents are coming down. Cap rates are going up, which means the value of those properties are going down. They are in a world of hurt. For the projects that we own in California, we're not getting rent concessions. Rents are continuing to go up. So you've got to ask yourself if you got 25 people putting an application to rent one unit, what are you going to do? The rents, they're going to continue to climb. And so if you ask me, like, how are we going to solve the housing crisis, now moving over to maybe the city side, I would say you got to make it easier to build.
We have to make it easier to build. Now, personally, the powers that be that actually run the state, I don't know if they're actually going to open this place up in a way that needs to actually solve it. And so if that doesn't happen, yeah, I want to own here.
Brian, you first and then Mikey, is it a good time to buy or sell here in California?
Oh, man. Let me go first for this one.
Thank you.
Well, I don't want to go.
Here's what I would say to that question. I would say that it depends on your situation. And that's such a cop out response. So let me give a little bit of clarity, not just leave it with that one sentence. I think the problem that I'm seeing with a lot of clients that are current homeowners that I'm talking to who call me and say, I really want a bigger house, I want to move into a different school district.
I want to, whatever, is they feel handcuffed to their home because of the interest rate they have. So for some of those people, depending on what their home is, it may be worth it to wait a little bit, wait to see if that once again, that, difference between the rate they have and the rate they're going to get on their new purchase comes down.
But for people that are sitting waiting for it, and this goes back to the first question for man, I can't wait for a year. I just don't think that's going to happen when rates drop. A lot of people think that's going to happen and they're waiting.
I don't think that's going to happen. So is it a good time to buy it in, I guess, individual situations? I was having lunch with a group over here, and we actually were talking about this question, and I ended it with this. I said to me, someone would be insane to sell their home right now with a 2.5% interest rate, to go take a 7% interest rate on a new home.
I did that three months ago. Okay, so I did that three months ago because the home I was in was not the home that I saw myself, me and my wife with our four and six year old living long term, we had a long term plan. We're in our new home. We have a long outlook, ten plus years on it.
If you're looking to flip real estate right now, meaning single family, it's probably a pretty tough, tough time to make those numbers work. But if you have a long term outlook, I just wasn't going to allow, you know, the term is I wasn't going to allow the tail to wag the dog in terms of the interest rate control, the home I move into.
So that was my personal experience on answering that question.
Mikey, you got to go after that.
I was going to hate the music that came on was such an epic, kind of, yeah, this is like what you put on TikTok after you make your edits. Okay. So is it a good time to buy? I think for single family, what my outlook on single family has always been I treat my house as my house. I never tried to treat my house as an investment, that got me in trouble the first time I did it. So if I'm looking at my home as a home, considering I can afford it, buy it whenever I don't think there is a bad time to buy, considering that's what you're here to do.
If you're flipping single family. Different story. My friends at flip right now, they're having a hard time selling it on the back end. As you get into different asset classes, this answer becomes different for multifamily, buying existing product right now. So, you know, your stabilized multifamily... kind of tough, right? We're seeing a lot of people do it in cash and they're looking at, you know, potentially backfilling it with debt when you know the interest rates maybe normalize for us.
Yes, we are buying we're buying more properties today than we've bought maybe as a firm in the last 20 years. We are buying right now. Why we're buying is twofold. One, we've seen cap rates move almost twice as much as they did in 2009. So that basically means, the value has dropped even more on multifamily in 2023 than it did in 2009.
So our our asset class has corrected. Now, the caveat is rents have also increased. Right. So you got to consider that. But right now we're in a window where a lot of the big players aren't buying. And the mom and pops can't qualify for their lending or people that we're building in 2021/22 aren't qualifying for their refinance and are trying to keep their assets to survive.
That's a great buying opportunity for us, so it feels like we are not competing right now. The second part to it is if we're building projects today and they're coming online this year, next year and the following year, the second that everything opens up, like what Brian said, when rates normalize and everybody comes back into play this game, that doesn't mean their apartment is built.
They still have to go through two years of entitlements, one year of permits, two years to build it. You're talking about a five year outlook until an apartment is actually realized. I love the idea that while we're in a housing crisis, we are going to constantly have product coming online that's going to be rented out. So we are in buy mode right now.
But that does not mean it's easy, right? We have to put almost twice as much equity down right now. So it's a heavier lift. But it goes back to the contrarian thing.
What was it you said California is for the big leagues?
Yeah. So I'm, I do a lot of stuff on social media, so the reason why I'm saying this, I have a few million followers on all the platforms. It's a different audience on social media than when you're talking to investors. Right. So a lot of my audience is people wanting to get into real estate.
They want to do something in single family. They want a house hack, a quad plex. It's more of a DIY audience. For them, 85% think myself and my company is absolutely nuts for investing in California. They think we're crazy, right? Because it's so difficult and the barrier to entry is so high. So what I told Brian and Chris the other day, look, California is not for everyone.
Like this is where the big players are. This is the big leagues, right? The minors, the Brewers that may be there. What was the... Idaho or something? I don't know.
I think you said Nashville.
Yeah, I've had a lot of friends move to Idaho. Apparently. I'm still bitter at that. But anyway, look it's not easy to do real estate here. It's not right. It's difficult. The barrier to entry is very high. I look at that as a strategic advantage. If the barrier to entry is high, your competition isn't where you are. Which means it's harder for your asset class to become saturated.
If it becomes saturated, that's when you start having to bring rents down. That's when numbers don't pencil out. So yes, I'm buying and maybe I'm going to close it with this. 2008 was the first correction I went through and I was making some money. I had some investments. And, you know, fast forward to 2011, 2012. I was like, dang, can we go back to that?
Like there was such a big buying opportunity that ever since then, I told myself, the next time we enter this, I want to give it everything I have. So once the next correction's over, I feel like we went after it. And so, you know, we're head down right now. We are trying to get everything we can in this moment because it turns quick.
And when it turns, there's a lot of money that comes in, which means a lot more competition.
Guys, thank you so much. I know we're out of time, and this is a topic that I think most people would like us to spend a couple hours on. I mean, the main themes are here in California, we have a huge shortage of supply. And yes, it's expensive, but if rates come down by 1%, there's potentially 5 million more people that are qualified to be able to purchase a home.
We just don't have a lot of supply. So if you own a personal residence, it's likely to be fairly resilient, during this time. So thank you so much.
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