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Will California Prices Limit Future Growth?

June 19, 2001

Article by Lesley Hensell

California is a Garden of Eden
A paradise to live in or see
But believe it or not
You won't find it so hot
If you ain't got the Do Re Mi
"Do Re Mi"
Woody Guthrie, 1937

The advice to "go West young man" may have been first issued in the late 1800s, but Americans today still are filing toward the Left Coast at unprecedented rates. As the economy slows across the country, real estate experts are questioning how much additional growth California can handle.

For years, Californians and their businesses have suffered from a supply shortage in housing and other types of real estate, leading to vastly inflated prices. In some markets, decent housing cannot be bought for love nor money.

Even as the economy gears down and demand for housing diminishes slightly, California's vacancy rates remain unbelievably low. Despite downward economic pressure, multi-family housing vacancies still are expected to decline in Los Angeles, Riverside and San Bernardino, while remaining steady in Orange County, according to Marcus & Millichap's National Multi Housing Group. Apartment vacancies are rising only in the San Francisco Bay area, where ridiculously low availability will keep the region among the country's tightest.

A lack of affordable housing is only one of the state's difficulties. In the late 1960s, California spent about 20 percent of its gross domestic product (GDP) on infrastructure such as roads, utilities and transportation. Today, that number has plummeted to 2 percent.

To compare, rapidly developing countries spend about 30 percent of GDP on infrastructure, said Stuart Gabriel, director of the Lusk Center for Real Estate at the University of Southern California.

The lack of infrastructure spending has only been exacerbated by the state's energy crisis, which has forced rolling blackouts at the cost of millions to businesses. State power purchases drew down the accrued $6 billion state surplus by 66 percent during the first quarter of 2001, a reduction which will further reduce investments in housing, transportation and other infrastructure.

"California's population boom, with all its great diversity, offers an excellent climate in which to do business. It is the responsibility of the state's government leadership to formulate infrastructure initiatives that allows California's businesses to reap the rewards this great state has to offer," Gabriel said.

Gabriel has served on the economic staff of the Federal Reserve Board in Washington, D.C. He is currently director of the American Real Estate and Urban Economics Association.

Gabriel is concerned that the exploding population and job market in California over the last decade has greatly outpaced the number of residential housing permits issued, thus putting significant pressure on housing availability and prices. Dramatic population growth will continue, he said, with the state expected to grow by 10 million people per decade between 2000 and 2020.

These 10 million new residents will form 3 1/2 million new households, about 45 percent of which will be in Los Angeles. According to estimates of the California State Department of Finance, homebuilders will need to add 220,000 new housing units a year to accommodate the projected population growth.

"Unfortunately, the 1990s rebound in homebuilding was anemic at best," Gabriel said. "For example, 1999 was considered a boom year for home building in California with the issuance of 140,000 residential permits. If that trend continues, California will face an increasing housing deficit in coming years."

During recent decades, much of the state's growth has been fueled by businesses relocating there from other parts of the country. Nice weather, great atmosphere and cultural attractions lured these companies to sunnier pastures.

Early spring, however, saw the first of the turning tide, as some 24 x 7 businesses announced plans to cut and run. Since they could not guarantee a steady flow of electricity to their facilities, these companies decided to leave the state before the situation got any worse.

But as housing and other real estate costs continue to rise, electricity becomes iffy and infrastructure crumbles, will the masses still flock to California? And will residents accept more infrastructure-related taxation in a state that already collects a goodly sum from its people?

The price of California dreaming is getting awfully steep -- even if you do have the "Do Re Mi."