Southern California living, as Mary Poppins would say, is perfect in practically every way. This makes Southern California’s luxury housing markets world markets. As such, these markets will outperform the local economy.
We’ve seen an impressive run-up in Southern California home prices over the past couple of years. Much of that run-up was the result of investors purchasing lower-end properties for rental income and expected future capital gains. This was a necessary correction after the excesses of the housing bubble, but that process has mostly run its course. I expect to see relatively modest increases or possibly even declines in middle and lower-end markets in the next few years.
Luxury markets are another story. The key to understanding Southern California’s luxury housing markets is to understand that these markets are not entirely local markets. In many ways, Southern California luxury housing markets are world markets, and world demand is mostly independent of local economic activity.
Southern California has a rare and attractive combination of amenities and cachet. Few people would choose to live in Detroit without a strong economic reason, but that’s not true for Southern California. Southern California is different. People want to live here, and those who can afford it come from all over the world. Even in the unlikely event that Los Angeles’ economy went the way of Detroit, people would want to live here.
To be sure, demand can be volatile. Local demand will fluctuate with the fortunes of local industries. In particular, we’ll see demand drop when companies leave the region, taking their executives with them. Unfortunately, these days we seldom see demand increase because a company moves to California.
Eventually though, world demand for Southern California living overcomes local economic conditions. So, while Los Angeles County may be down hundreds of thousands of jobs from its pre-recession high, its luxury home markets are doing quite well.
World demand can fluctuate, too. During the crisis that followed the Lehman Brothers collapse, real estate demand decreased almost worldwide. Most of the demand decline in luxury markets was a result of uncertainty, as most of the wealthy who were the source of the demand were not really hurt all that much. Those wealthy with typical balance sheets and outside the finance and construction industries were minimally impacted. What losses they did experience were recovered quickly with the recovery of equity markets.
So, why did we see reduced demand for luxury real estate? Because buyers were nervous. Risk premiums went through the roof in late 2008. While it turned out that the wealthy generally did pretty well in the recovery and far better than lower-income people, it was hard to see that at the time. There appeared to be a real risk of the massive wealth losses among the wealthy, similar to what we saw in the Depression.
This is the key to Southern California’s luxury home market going forward. Regardless of economic conditions, there are always large numbers of wealthy people in America and around the world, and many would like to live here. It’s just a matter of if they are complacent enough to spend the money. A Southern California luxury home can cost tens of millions of dollars. Even the very wealthy, perhaps excluding young sports and entertainment figures, only make that large of an investment when they are relatively confident about their continued security.
Right now, they are confident about their future, and that means continued demand for Southern California’s luxury home markets. I’d say the complacency is probably justified.
That’s not to say there aren’t risks: emerging markets are fragile. Middle East tension is high and China’s economy is increasingly risky. Market participants are concerned about the Fed’s taper. The United States’ economic growth is slow and volatile. Still, only the perpetual doomsayers expect another event as disruptive as the events that followed the Lehman Brothers collapse.
I expect that luxury home markets across the country, places like Santa Fe NM; Jackson Hole WY; Lake Placid NY; Carmel CA; and yes Southern California will outperform typical residential home markets. Prices and sales are likely to be strong.
Dr. Bill Watkins is the executive director of the Center for Economic Research and Forecasting at California Lutheran University.