InspireMyCapital.com | Why Now is NOT the Time to Invest in the L.A. Housing Market
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LA Sunset X

15 Sep Why Now is NOT the Time to Invest in the L.A. Housing Market

I love Los Angeles having lived here most of my life.  The yearly sunshine, diverse neighborhoods, architectural homes, and the proximity of the mountains and ocean is relatively unmatched anywhere else in the country.  Let’s face it, L.A. will always be at the forefront of housing demand.  In fact, home prices have mostly recovered from the 2007 crash, even over-corrected in some hot L.A. areas, with rents at all-time highs and vacancies of rental units at all-time lows.

So why, as an investor, is L.A. nearly LAST on my list in our current housing climate?

Many reasons.  Most importantly, as an astute investor you have to recognize that there are cashflow markets and there are appreciation markets across the county – each with their own risk/reward profiles and each serving a different investment strategy.  Simply choosing to invest in a property because of its proximity to your home is a recipe for disaster and will likely not meet your investment goals.  Yet most investors do this very thing because they feel most in control.

In today’s real estate market, cashflow markets tend to be in the South and Midwest parts of the country where the land is cheap and the replacement costs of homes are more than their current value.  They also tend to be strong rental markets where you can purchase properties for a song compared to the West Coast.  They didn’t get hit too hard by the housing crash but also won’t appreciate as fast as their West Coast cousins.  In terms of rental properties, you can conservatively expect returns of 3-5 times as high as similar properties on the West Coast (yes, you read that correctly).

The West Coast, on the other hand, has always been an appreciation market.  Those who bought and held properties twenty or thirty years ago have seen their investments multiply by a factor of 5x or 10x.  Even those who bought in the late 1990’s to early 2000’s and held them for a just a few years benefitted tremendously from the run-up of real estate prices (if they got out at the right time).

But when you look at rental returns, we get a different story altogether.  Rents (although increasing) have never been able to keep up with skyrocketing home prices and thus the returns of the West Coast have lagged behind other parts of the country.  For example, Los Angeles is a city where over 50% of the population rents, a city with less than 3% vacancies (one of the lowest in the country), and a location that will always command a strong rental market.  Yet, the investment returns on rental properties in L.A. is downright terrible.

So if L.A. is not an investor-friendly rental market for cashflow, what about holding properties in L.A. for long-term appreciation?

Historically, this argument made a lot of sense up until about 2000 (before the drastic run-up in home prices) and then not again until maybe 2009 (bottoming of home prices after the crash) in which it stopped being logical shortly thereafter.  The fact is that L.A. home prices have risen so dramatically over the past two years (25% in 2013 alone) that pricing in many L.A. neighborhoods is currently at over 90% of late 2006 highs.  And let’s all agree, home prices at that time were uber-inflated, anyone with a pulse could get a mortgage, and banks were handing out free money to those who already owned a home.

But is there room for further growth in L.A. home prices?

Some make strong arguments that there’s only one L.A. and that people will always pay a premium to live here in the year-round sunshine.  Or that L.A. is cheap compared to the rest of the world’s most desired places to live and will continually draw new buyers willing to pay more for housing.  But it’s hard to ignore the facts:

1)   Mortgage rates are hovering near historic lows

2)   Housing inventory in L.A. remains extremely low (although increasing which will further deflate or restrict growth of home prices)

3)   Housing prices have been stagnant since October 2013

4)   Home sales are down and dropped 12% in July 2014 from a year earlier

5)   Affordability (number of people that can afford a home) dropped below 20% in 2013 as wages have not increased with home price run-ups the last few years

6)   Rents are at all-time highs in L.A. and don’t have much room to grow further.  This restricts home price increases as returns would drop even lower with any rise in home prices.

Right now L.A. is clearly NOT an attractive real estate investment for cashflow or long-time appreciation.  As L.A. real estate experiences huge price cycles, the time to buy is at the low and we are clearly at or nearing a peak.  This is not to say that prices won’t again skyrocket to levels we haven’t seen before, but the data indicates they will likely come down before going up again.  Fortunately, there are many other more secure, passive ways to invest in real estate while you wait :-).

If you’d like to discuss how best to use this information in your investments, please feel free to contact us at 626.788.9700 or click here.