If you haven’t noticed, inventory in the real estate market feels like it’s getting tighter and tighter (because it is). It’s not a localized issue; it’s being seen across most housing markets in the country. However, it’s particularly prevalent in California.

This article will discuss how interest rates became so high and how buyers and sellers should approach this market.

California’s Housing Crisis: Fewer Residents, More Households

California’s housing crisis is no secret. We have too many households, too much demand, and insufficient new inventory. While over the last decade, California lost nearly 800,000 residents, the number of households has increased by over 800,000. How? Well, because fewer people are spreading across more households. Families are having fewer or no children, parents live in different homes, or there’s less cohabitation among young adults. All these scenarios result in more households with fewer residents.

Oakland is the poster child for this phenomenon. The city saw a population decline of 14,000 and a housing unit increase of 8,000. And yet, as of December 2023, Oakland’s housing market prices are up 5.9% year-over-year, there are fewer homes on the market than last year, and the market remains highly competitive.

Santa Cruz saw a slight increase in population, growing from 60,593 to 61,950 over the past ten years, but its number of housing units increased by only 220. This scenario has largely been driven by residents of Santa Cruz having more children, and by shared university housing.

Limited housing supply has been a primary driver of rising housing prices. But furthermore, it’s what’s held property values aloft during current economic conditions.

The Pandemic Era

During the Covid-19 pandemic, there were fears of a housing market crash, but instead, we experienced the opposite. The Federal Reserve supported the economy by holding its interest rates at nearly 0%. That’s free money.

Instead of a market crash, we saw a surge in demand, contributed by:

  1. Remote Work: Remote work requires space in a home to work. Buyers and tenants found themselves in need of larger living spaces to accommodate home offices and virtual schooling.
  2. Urban Exodus: The ability to work from home allowed urban workforces to live virtually anywhere. Areas like Santa Cruz welcomed new residents from San Francisco and other regions of the Bay Area.
  3. Low Interest Rates: Historically, low mortgage rates have made home-buying more affordable and attractive. Buyers, particularly first-time buyers, flooded to the market looking to upgrade their living spaces and capitalize on inexpensive financing.

Conversely, while demand grew, the supply side of the housing market struggled. After the housing market crash of 2007, new construction projects came to a screeching halt and didn’t pick back up to previous levels. Pandemic-induced lockdowns and social distancing measures led to significant disruptions in construction activities. Supply chain issues further exacerbated these delays, leading to a slowdown in the completion of new housing projects.

Furthermore, many homeowners were reluctant to sell their properties during the pandemic, fearing health risks and uncertainties about finding new housing amidst the competitive market. This reluctance further tightened the already limited supply of homes for sale.

Santa Cruz Market Consequences

The mismatch between high demand and limited supply led to a heated housing market.

In 2021, the Santa Cruz Real Estate market saw:

  1. A Tightening of the Rental Market
  2. Displaced wildfire victims and a return to in-person college classes.
  3. Rapid Price Escalation
  4. Home prices soared as bidding wars became commonplace. The increased competition among buyers led to homes selling rapidly, often above the asking price.
  5. Affordability Challenges
  6. The escalating prices, while beneficial for sellers, posed significant affordability challenges for buyers. This situation raised concerns about the long-term sustainability of the housing market boom.

Inflation and Interest Rates

As the US economy proved surprisingly resilient during the pandemic, inflation steadily began climbing. In March 2020, inflation was down to 0.12%, but by March 2022, it was over 8%. While economic growth is important, there is nothing more dangerous to economic stability than rampant inflation. As a result, in 2022, the Federal Reserve was forced to take swift action. To curb inflation, the Fed increase interest rates for the first time since 2018.

The first federal funds benchmark increase took place in March 2022, increasing to the range of 0.25% to 0.50%. By December 2022, the Fed had brought the federal funds interest rate target range to 4.25% to 4.50%. A year later, the federal fund range is now 5.25% to 5.50%. The current lending environment doesn’t represent anything like what homebuyers, sellers, or investors were experiencing 18 months ago.

Real estate prices are closely linked to the interest rate markets. When the Fed raises interest rates, banks also increase their rates for consumer and business loans. Therefore, there’s less money available for consumer spending. For example, increased rates for business loans can cause companies to halt expansions and hiring, reducing consumer and business spending thus potentially lowering the value of a company’s stock. An interest rate hike in real estate increases mortgage financing costs, making real estate less attractive to homebuyers and investors. ​

Current Mortgage Rate Trends

While mortgage lenders take direction from the Federal Reserve, consumer mortgage rates do not run parallel to the Fed’s rate. In fact, mortgage interest rates are usually considerably higher. The gap between a consumer loan and the Fed’s rate represents the “spread.”

The “spread” can be influenced by:

  • Risk and profit margins of the lender.
  • Market conditions.
  • Inflation expectations.
  • The secondary market rate expectations.

The spread affects the interest rates consumers pay on their mortgages just as much as the federal fund rate. A higher spread typically means higher mortgage rates, while a lower spread can lead to more affordable borrowing costs.

Due to market volatility and uncertainty, the spread increased even faster than the Fed’s rate. By June 2022, the average 30-year fixed mortgage rate was 5.2%, which then hit over 7% by the end of October 2022. Today, most homebuyers are getting loans between 7-8%.

How Do Higher Interest Rates Impact Buyers?

Interest rates directly impact buyers’ mortgage borrowing capacity, and therefore demand.

Let’s look at a basic example. The purchase of a $800,000 home with a sizeable $200,000 down payment will have a $600,000 loan. In 2021, at a 3% interest rate, their monthly payment would be roughly $2,530. Getting the same loan today would have a 7.5% interest rate and a $4,195 monthly payment.

But what’s most important is to note how this impacts buyer lending capacity. Assuming there are no debts, to qualify for a $600,000 loan at 3%, household would need to be roughly $120,000. At today’s 7.5% rate, household income needs to be about $180,000.

To put that into perspective, a household earning $120,000 will likely have a maximum lending limit of $400,000 today when it was previously $600,000. High interest rates are forcing once-qualified buyers to remain renters or continue living in their current properties until market conditions change.

Statistics Santa Cruz, ca

Statistics Santa Cruz Real Estate, Ca

Where is the Santa Cruz Housing Inventory?

Imagine you’re a homeowner who purchased the previously mentioned $800,000 property in 2020. You enjoy a comfortable $2,530 monthly mortgage payment, and perhaps your income has increased from $120,000 to $140,000. You’d like to move because you don’t love your neighborhood as much as you’d hoped.

Before signing a listing agreement with a real estate agent, you smartly contact your mortgage broker to find out how much you qualify for. You’re shocked to discover that even with the proceeds from your current property, you would only be eligible for a $440,000 loan, giving you a total purchase power of $640,000.

Much like this example, many Santa Cruz homeowners are trapped in a situation where if they sell, they will be forced to downsize significantly or move to a less expensive area. Most choose Option C, which is to remain in their property.

Can you see how when this scenario is repeated thousands of times, it impacts the resale market?

High interest rates have caused the housing market to freeze. Would-be sellers have little motivation to list their homes, therefore limiting inventory and keeping buyers hungry for options.

Why Are Housing Prices Still Increasing?

While home prices aren’t climbing quickly, they are still going up. According to Redfin data, Santa Cruz has seen a 0.05% increase in median sale prices over the past year. Sale prices continue climbing despite high interest rates. How?

While there’s been a sharp decline in buyer demand, inventory remains tight, which means that there’s still not enough new listing inventory to satisfy buyers. The decline in listings is evident in sales volumes. The drop in listings is clear in sales volumes.

Let’s look at Santa Cruz’s April sales volume data over the past three years. April is typically one of the busiest months in the housing market, making it an excellent month to reference.

Year Sales Volumes
2021 62
2022 51
2023 14

Source: Redfin

This year, residential sale volumes dropped 72.5%. While May and June were not as dramatic, sales were still low.

When homes in Santa Cruz are listed, they are being sold faster (fewer days on market) and for more money. It’s a good climate for sellers who are motivated to sell, but it spells out an undesirable future for buyers waiting for interest rates to drop.

What’s Going to Happen When Interest Rates Start to Drop?

When the Federal Reserve eventually shifts gears in response to stabilized inflation or economic changes, we can expect a corresponding decrease in interest rates. This relief will likely lead to a reduction in mortgage rates.

Lower mortgage rates will improve the borrowing capacity, reigniting interest in the housing market. Buyers previously priced out will re-enter the market, seeking to take advantage of more favorable lending conditions.

For current homeowners with low mortgage rates, the drop in interest rates may present an opportune moment to consider selling. As buying power increases, they may find it more feasible to move or upgrade without the financial constraints imposed by previously high rates. But will this be enough to bring balance to the housing market? Probably not.

We will likely see transaction volumes rise again, but we will also see home prices climb. We know there are thousands of dormant potential homebuyers. When they re-enter the market with renewed borrowing capacity, competition will increase. It’s easy to envision returning to a market rampant with bidding wars.

Should You Buy in This Market?

If you can afford a home or investment property that fits your needs while interest rates are high, then purchasing now is a smart financial decision. Home prices are still rising and will likely increase faster when rates drop. The option to refinance is always available, which can help reduce payments in the future.

However, buyers in this market need to be patient. With low inventory comes limited options. Buyers with specific requirements could end up waiting months for the right listing.

Keep your pre-approval current and your eye on the market. The right opportunity will come up, and that’s when you make your move.

Kelsey Heath

Kelsey Heath is a real estate content specialist with an extensive background in residential, industrial, and commercial property. She has been involved in the industry for a decade as a professional and personal investor, gaining a deep understanding of the market and trends. With a passion for written communication, Kelsey loves helping people understand the sometimes-complicated concepts behind real estate and is now a sought-out guest and ghostwriter.
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