Southern California has seen a substantial increase and subsequent drop in home values, commonly referred to as a real estate bubble. Both the rise as well as the subsequent fall likely have had substantial economic implications for local stakeholders. The increase in housing prices during the upswing afforded home owners the possibility of increased consumption through borrowing against their perceived new wealth. During the downturn, this development has been reversed, often leaving those who had borrowed against their houses during the upswing with no or negative equity in their homes after the market crashed. Additionally, neighborhoods with high housing turnover have generally become less desirable causing further price drops there. Property tax revenues first rose and then fell, and the banks have had to absorb an increasing mountain of mortgages in default.
These events, however, did not affect all locations in Southern California with equal force. The following analysis and tools provide some insight in the spatial distribution of these effects. We expect three groups of stakeholders to be especially interested in this analysis: (1) businesses, including banks and construction companies (especially small ones) that operate or sell locally. They may wonder how quickly their local customer base has been or might be changing, how large the increase and subsequent drop in home equity has been that their customers were able to tap into before, and they may also wonder where the customers with the largest credit default risk are located. (2) Politicians and public administrators may worry about local tax income and neighborhood stability. Finally, (3) current homeowners may worry about how risky their neighborhood really is and how this may affect their home-value. Prospective homeowners may ask how this information could guide them in terms of where to move within the area.
We will provide information on these issues with the following six indicators per square-mile. All of these are calculated based on single family home transactions only:
- Price development
- Housing unit turnover
- Equity at time of purchase
- Consumption possibilities out of housing wealth
- Property tax income as determined at the time of purchase
- Mortgage default risk
Each stakeholder can use the maps and animations, find their location and obtain a picture of how her or his individual neighborhood has fared so far. Home-owners will likely be interested in information provided in sections 1, 2 and 6, politicians in 2, 5, and 6, banks in 1, 2, 3,4 and 6, and other small businesses in 1, 2, 4 and 6.
The analysis in this section covers Southern California, including the California Inland Empire, here for simplicity defined as San Bernardino and Riverside County. In a separate section, we present more detailed information about the Inland Empire. The measures used for the two areas differ slightly from each other, but the overall pictures that emerge are similar, yet somewhat more dramatic for the Inland Empire.
Price Development in Southern California
Southern California has experienced a dramatic development of house prices (see animation below: price development in SoCal).
Real house prices more than doubled on average, but certain neighborhoods, namely in the California Inland Empire and in Ventura county saw home-prices more than triple. While all neighborhoods encountered substantial increases in real home prices in the upswing, this development was by no means uniform: some neighborhoods substantially rose more than others. Preliminary analysis suggests that home prices in neighborhoods that were more desirable at the outset both rose and fell less (so far) than those which were less desirable. One might ask whether we are back to where we started. The answer is no: while adjacent neighborhoods have generally experienced similar changes during the rise and fall of home prices, closer inspection shows that there has still been a substantial redistribution of housing wealth taking place.
Housing Unit Turnover
We proxy housing turnover with the number of transactions from 1998 to 2008 relative to the number of housing units in the year 2000. While this measure does not gauge turnover perfectly, since some housing units have changed hands several times during that time period, it nevertheless is a good proxy for neighborhood stability. Data for the Inland Empire indicates that in some neighborhoods the number of transactions during the analyzed decade has been more than 50% of the number of units, while others saw only minimal turnover.
Equity at Time of Purchase
The down-payment new homeowners offer at the time of purchase determines how much buffer the banks have in case of mortgage default. As long as home prices rise, this is not much of an issue, since housing equity (= market value of the house – total mortgage amount on the property) increases in such a situation. Banks can then expect to sell homes whose owners default on their mortgage for a price that covers the outstanding mortgage balance, and likely also their administrative costs incurred in the foreclosure process. Once home prices fall, this is no longer the case and banks may suffer losses if down-payments are lower than the market value loss on the property in default. During the bubble, down-payments have been surprisingly low in Southern California, with negative average equity for many neighborhoods at the time of purchase in many areas, especially the Inland Empire for those purchases that were reported to have been financed with at least one mortgage.
In the above animation, red squares indicate negative equity shares (= equity as a percentage of sale price) at the time of purchase, green squares positive equity shares. After the bubble started bursting, banks required higher down-payments. However, data from the first quarter of 2009 rather indicates a reversal of this trend: While the total number of transactions was small, those financed exhibited very low equity shares. Two features stand out: negative equity shares are concentrated in those areas that exhibited the strongest growth and later decline in house prices (namely the Inland Empire), and average equity shares during the early downturn were lower in most areas than the decline in home prices. This indicates that more pain for the banks, especially in those areas with low equity shares, lies ahead.
Consumption Possibilities out of Housing Wealth
Increasing housing wealth implies larger consumption possibilities, decreasing housing wealth reduces consumption possibilities. There is an ongoing debate on how much consumers actually spend out of increased housing wealth, but it is commonly agreed that they at least spend some of it. Decreases in house prices consequently reduce consumption possibilities, and likely reduce consumption directly through a negative wealth effect. It may also induce consumers to save more in order to provide for emergencies or retirement goals, and thus further reduce consumption out of income. If increased housing wealth was used to buy long-term consumer goods, consumers do not need to replace those as quickly during a downturn. While this suggests that positive wealth effects may have a smaller effect on consumption than negative wealth effects, this may not necessarily be the case, since consumers may not be willing to adjust consumption downward if they can still afford their level of consumption. Moreover, locally foreclosures may drive cash strapped consumers out of a neighborhood and replace them with more affluent ones. Nevertheless, the possibility of reduced consumption rises with a fall in house prices.
Wealth effects were hugely positive during the bubble upswing. Anyone who purchased a house even with negative equity saw the red ink eroded and replaced with continued perceived wealth increases. All of Southern California benefitted tremendously from this effect.
The animation above shows the dramatic increase in equity based on home-sales in each neighborhood over the last decade. It also shows how equity was slashed even faster during the downturn and the amount of negative equity increased. This process has happened the faster and the more pronounced, the more prices actually fell. Note that in this animation, it is assumed that all properties that did not have a mortgage listed were cash purchases, and that no money has been withdrawn from the equity since the time of purchase. Both of these assumptions are overly optimistic, and driven only by data availability: some mortgages may not have been reported, and large amounts of equity have actually been withdrawn. Consequently, the amounts of positive equity are overstated and the amounts of negative equity are understated in the animation. The risk of substantially lower consumption should therefore be considered, especially in areas with very low equity and very high negative equity, such as certain areas within the Inland Empire and Los Angeles.
Property Tax Income as Determined at the Time of Purchase
Thanks to specific legislation, property taxes in California are generally determined at the time of purchase of a property, can only rise by a limited amount (Proposition 13), but can be adjusted downward if the property value shrinks (Proposition 8). The combination of the two propositions poses substantial fiscal risk to local municipalities and ultimately to the State of California, who has to cover any shortfalls of property tax income at least for schools. Other recipients of property taxes such as counties and cities do not have such a back-stop. They thus need to either cut budgets or look for alternative financing sources. In some areas, average property taxes of newly sold homes have halved on average from the peak to the first quarter of 2009, the last quarter under consideration in this study. This implies also lower property tax payments for homes that have been sold in the late bubble years due to Proposition 8. At least for the near future, the outlook for property taxes remains bleak, especially in the areas where property values have fallen the most.
Mortgage default risk increases if the amount of negative equity in a home increases. The more houses in a neighborhood are deep in the red, the more likely will this neighborhood see additional mortgage defaults, foreclosures and thus additional decreases in neighborhood stability and home values. Here we present two simple risk measures, the first called the coefficient of variation, the second the skewness of negative equity. Instead of explaining the idea behind those measures, it shall suffice to explain how to read the color codes. For the coefficient of variation map light green areas are actually the safest, while red and especially orange neighborhoods are at risk. In the skewness of negative equity map, dark green areas are the relatively safest, while red areas are the most likely to see defaults in the future.
The analysis provided here indicates that economic distress on several dimensions is highest in areas where house-prices have risen and fallen the most, such as the central Los Angeles area as well as the California Inland Empire. This economic distress continues as long as house prices do not see a substantial upswing and will likely take years to return to normal. Consequently, even as the national economy and housing market will recover, these areas could suffer prolonged economic weakness.
Data-sources: ACS, Census, ESRI, Dataquick