Housing in California – July/August 2006

According the California Association of Realtors, the median price of an existing home in California increased by 6.2% in June ($578,000) and sales declined by 26.3% compared to the same period a year ago. This is the first time since November 2001 the back-to-back (May and June ’06) monthly median price of California homes have not increased by double-digit percentages. Obviously the market is slowing down in terms of sales but prices continue to rise; however the rate of price increase is declining.

Although mortgage rates softened a bit in July, they had inched up for five consecutive months between February ’06 and June ’06. Thirty year fixed mortgage rates averaged 6.68% during June ’06 compared to 5.58% in June ’05. Rising rates have been one of the factors underlying recent sales slowdown of existing homes.

The ten California cities with the highest median home prices in June 2006 were:
Beverly Hills: $1,877,500
Burlingame: $1,725,000
Manhattan Beach: $1,575,000
Los Altos: $1,543,500
Newport Beach: $1,347,250
Saratoga: $1,309,000
Mill Valley: $1,294,500
Palos Verde Estates: $1,225,000
Orinda: $1,207,500
La Canada Flintridge: $1.150,000

It is not surprising to note that five of these cities are part of Southern California Riviera and the remaining five are in the San Francisco Bay Area.

The ten California communities that experienced the highest existing home appreciation in June 2006 include: Delano (94%), Beverly Hills (45%), Barstow (37%), Culver City 935.5%), Porterville (45%), Paramount (31.7%), Inglewood (31.3%), Laguna Hills (30.6%), Arroyo Grande (30.5%), and California City (28.3%). None of these cities are in the San Francisco Bay Area; they are mostly in Southern California and Southern Central Valley.

From an existing home annual sales growth (% change –May ’05-May’06)) and price change (same period % change) perspective following is the pattern on a region-by-region basis:
Region                           Change Sales (%)  Change Price (%)
California                          -26.3                          6.2
Central Valley                    -34.5                          2.6
Los Angeles                      -17.0                         11.9
Sacramento                      -38.7                          0.6
San Francisco Ba               -21.0                          3.6
Riverside/San. Bernardino  -33.5                          7.4

All of the above regions show a price increase and a sales decline. The only regions that show price declines (not shown above) between June ’05 and June ’06 are: Santa Cruz County, Palm Springs/Lower desert, and Northern Santa Barbara County. There are no California regions that show increasing sales of existing homes for the period.

Undoubtedly residential real estate is slowing down in all regions of the state but price are still holding firm.

The Fed and the Economy – July/August 2006

On June 29 the Fed in order to ward off inflation raised the Fed Funds rate to 5.25% bringing up the overnight lending rate to its highest level since June 2004.and this was the 17th straight increase in the Fed Funds rate since that time.

In response to the softening in the inflation fighting language used by the Fed chair Mr.Bernanke in his July 19 testimony in the Senate banking Committee hearings the stock market celebrated the possible end in interest rate hikes via a 212-point rise in the Dow on July 20, 2006. The market enthusiasm was not sustainable and did not last more than a day in light of the fact that significant inflation risks remain because of high-energy prices. The onset of serious geopolitical events in Middle East in the last few weeks exacerbates the energy price risk further.

The minutes of the Federal Open Market Committee (the committee that decides on interest rate policy) meetings of June 19-20 reveals significant concerns about the recent rise in the core inflations rate (the CPI minus energy and food prices) which suggests that high energy prices are now getting broadly transmitted into the economy.

According to the U.S. Department of Labor the economy added 113,000 jobs in July 2006 down from the June increase of 124,000 jobs. The U.S. unemployment rate also increased in July to 4.8% from 4.6% in June. This is the highest-level of national unemployment we have had since February 2006 (July unemployment in California stood at 4.9%).

Another clear indication of a slowdown in the economy is that the second quarter 2006 real GDP growth was only 2.6% compared to the blistering pace of 5.6% in the first quarter.

The Department of Labor also reported that average hourly earnings rose for the month by 0.4% to $16.75 in July. This was comparable to the 0.5% wage increase in the month of June. Higher wages mean higher inflation unless the effect is offset by higher productivity.

In light of the June and July data we would say that the next move of the Fed is a toss up. The Fed will be tracking the core rate of inflation, job and wage growth, and productivity growth, as it makes a decision about the next move relating to the Fed Funds Rate in the August ‘06 meeting.

My hope, given the mixed messages from the recent data, is that the Fed will take a pause before it raises rates for the 18th time as current policy will have an impact on the economy for the next six and months and beyond.

Commercial Real Estate – July 2006

For nearly two years U.S. commercial vacancy rates have declined. Average vacancy rate in 72 major office markets across the country in the second quarter stood at 13.8% compared to 14.2% in the first quarter of 2006.Declining vacancy rate has triggered rent increases of 2% for each of the two quarters of this year—another clear sign of a recovery in the commercial real estate market.

The national aggregate vacancy rate data does not give us an accurate picture of office market recovery, as there are large differences among the different U.S. regions. The differences among the various markets reflect the uneven nature of job growth across the country. (Job growth is the prime driver of commercial space use) Another factor in the current resurgence is that smaller companies have created most of the new job growth and this has been a problem for cities that are dominated by major corporations and not hosts to small and medium sized businesses. Other factors that have influenced commercial development in various regions include business friendly local governments and local or regional limitations on office space construction

A key question about the sustainability of commercial real estate in the U.S is what impact will rising interest rates have on the industry? After all interest rates affect commercial mortgage rates just as they affect home mortgage rates.

The major difference between residential and commercial mortgages is that in the former case buyers are mostly private individuals who are sensitive to rate changes compared to the latter where investors are a diverse group that include institutions such as pension funds that can pay cash and not borrow money.

There is another factor underlying the surge in commercial real estate—- strong international demand for U.S. commercial properties. Australia and Germany are the leaders in the foreign stampede to acquire American properties. Why? There are four cogent reasons: a) declining value of the U.S. dollar relative to Australian dollar and the Euro (Germany) that makes U.S. properties more affordable, b) the pull of the number one economy in the world—the U.S., c) flight to safety- (lower political and economic risks in the U.S. than in Europe and Asia), and d) fair laws and highly developed U.S. financial markets attract institutional investors such as pension funds from Australia and Europe.