Housing market stuck in rut

If the country as a whole is in the middle of a housing market drought, conditions look especially parched in California. 

New homes listed for sale fell by more than 17% in San Francisco, compared to the same time last year, according to online real estate broker Redfin. There were double-digit year-over-year declines in listings in San Diego, Riverside, Anaheim too. Of the 10 metros where new listings fell fastest, five were in California. 

“The number of transactions have absolutely slowed down,” Amy Kong, a real estate agent who works in and around San Francisco, said. “As everyone knows, it’s because of the higher interest rates and the affordability, which is just really, really low.”

Part of the market slow down can be blamed on a nationwide financial pathology that dates back half a decade, Daryl Fairweather, Redfin’s chief economist, said. As mortgage borrowing costs have whipsawed from ultra-low to harrowingly high over the last five years, the gap between what most current homeowners pay for their mortgage and what they would pay if they were to borrow and buy again has reached historic highs. That makes this an inauspicious time for most homeowners to sell.

But as with so many of the nation’s housing woes, things are even worse in California thanks to the specific “dysfunctions” of our market and the particularities of our property tax system that date back to the 1970s, Fairweather said. 

Taken all together, California homeowners “have extra reasons to stay put,” she said. 

That means fewer opportunities for aspiring homeowners, more pressure on the rental market as discouraged would-be buyers find themselves shunted there and prices that are likely to remain persistently high, despite high interest rates meant to cool things off.

California’s housing market has been in a kind of holding pattern for years, Oscar Wei, economist with the California Association of Realtors, said. “I thought by now we would see sales coming back up a little bit more,” he said. 

Unanswered questions about the future of the economy, tariffs and what they might mean for inflation, the stock market and how all of the above will influence interest rates are likely holding both buyers and sellers back, he explained. 

And then there’s the persistent borrowing cost gap, which economists dub the “lock-in effect.”

In an effort to jump-start an economy that had ground to a halt during the early days of the COVID-19 pandemic, the Federal Reserve brought borrowing rates down to near-zero. Homebuyers tapped those low rates to buy homes. Existing homeowners scrambled to refinance to lower their costs. 

Two and half years later and facing the new crisis of rapidly rising prices, the Fed jacked borrowing costs back up. For homeowners who took out fixed-rate mortgages (most do) when borrowing costs were low, the sudden rate bounce made selling a home with plans to buy a new one — and in the process losing the coveted low rate in exchange for a high one — a losing financial proposition. 

An analysis by economists at the Federal Housing Finance Agency found that the majority of borrowers in mid-2024 had a rate below 4%. A typical new mortgage, on the other hand, is likely to come with a rate of more than 6.5%.

That difference comes with a steep financial price tag. If the average mortgage payer were to swap out their existing loan for one at the new rate, they would pay another $398 per month, the agency researchers estimated. 

The effect is even more pronounced in California, where property values are particularly high. The median sales price on a single family home across the state is just shy of $900,000, according to the state association of Realtors. 

Even small changes in interest rates on such a massive purchase add up.

The cost of moving is steep, especially in California

The estimated change in monthly payments for the average borrower if they were pay the same mortgage at current interest rates.

A typical California borrower would pay an extra $675 every month if they were to take on the same mortgage at current rates, according to the Federal Housing Finance Agency report. In San Francisco, it’s an extra $915. That’s a compelling reason not to sell. 

California homeowners have even more reasons to hunker down.

Since 1979, when the prior year’s Proposition 13 went into effect, property taxes in California have been tied to the purchase price of a home and only allowed to increase at a modest rate. With real estate prices across the state trending upward ever since, that’s created yet another kind of “lock-in effect:” The longer that a person owns a home, the less they pay in property taxes compared to a new buyer. 

“When people are doing the math about how much money it would cost them to move and they look at the mortgage expense, and then on top of that, the property tax expense, it’s not worth it,” Fairweather said. 

Absent an influx of new listings, aspiring homeowners looking for the opportunity to buy will need to wait on new construction to deliver. But new supply has essentially flatlined over the last decade, despite a bevy of state legislation aimed at boosting more development. Fairweather said she isn’t optimistic that that’s likely to change soon — and the lock-in effect on property owners is one reason why. 

“I’m skeptical that owners of single-family homes are going to give up the land to actually build enough housing to make a difference,” she said. “It’s good that all those laws change, but I feel like they might be muted in their impact because of all the other forces that are pointing towards single-family neighborhoods staying exactly the same.”