Previously published March 22, 2011

It appears that California residential real estate is in the second dip of a double-dip decline. California home prices, and sales, crashed at the beginning of the recession. Then, last year they picked up in the first half of the year, a result of temporary government programs and optimism unsupported by economic fundamentals. Talk of green shoots and a real estate recovery was all over the internet and traditional media. Then, like air slipping out of a balloon, the optimism disappeared, as predicted gains failed to materialize. Finally, we started seeing declining prices again.

California led the original real estate collapse, though California home prices remain well above prices in most other markets, and California appears to be leading the new decline. In fact, this decline is very unlikely to be as widespread among states as was the previous decline. Home prices here are likely to decline more than in most other states because California is now seeing an economic feedback from economic activity to real estate prices. States like Texas and North Dakota are unlikely to see residential real estate markets anywhere near as weak as California’s.

While home price declines originally caused economic declines, economic weakness is now contributing to yet more California’s home price declines. California is almost unique in its weak economic prospects, a result of almost continuously bad policy initiatives over the past couple of decades. This weak economic activity, particularly weak job growth is providing a new source of weakness in California home prices.

The impact is not universal. Upper-tiered markets remain stronger than more affordable markets. This is a reflection of the fact that demand for many of California’s most desirable areas is independent of local economic activity. Monterey, Santa Barbara, and Napa are really national, perhaps international markets.

By contrast, demand for many of California’s inland areas is only driven by local economic area job creation, within a remarkably large commuting radius. No job growth; no housing demand. End of story.

California’s commercial markets were hit much later than its residential markets, because it was falling economic activity that caused the decline. Commercial lease rates and property values are directly tied interest rates and the economic activity the property generates. As economic activity declined, vacancy rates increased and lease rates fell. Unfortunately, California’s economic recovery will almost surely lag the United States recovery. This implies that commercial prices are unlikely to significantly increase within the forecast horizon.

Retail properties, in particular, are likely to be very weak for a very long time. Besides weak economic activity, brick and mortar retailers are facing increasingly tough competition from internet sellers. Ultimately, it is likely that we will need less retail space per unit of population. California industrial space may also see long-term weakness, as the State continues to de-industrialize.

Office space markets are a harder call. California retains its natural and cultural amenities, even as its economic vigor subsides. Because of new communications technology, many, particularly top end, office jobs can be located just about anywhere. That would allow, say an executive suite in Santa Barbara or an engineering unit in Orange County, while much of a company’s workforce is in Texas, or even China.

Construction of residential and commercial properties has collapsed, a result of the weak demand we’ve outlined above. We see nothing that would cause any significant change in construction activity.

With few exceptions, it appears that 2011 will be another tough year for those who make their living in California real estate markets.