The Real Threat to the California Real Estate Market

After a worryingly bone-dry start to 2025, we’ve finally had a little rain around here, and I guess more than a little more rain down in Southern California, to help extinguish these horrific fires.

Unsurprisingly, there’s fresh talk of the doom loop that California is alleged to be in. There’s talk by some in the real estate industry about the “triple threat” that property owners, or would-be property owners, are facing:

High Prices
Rising Mortgage Rates
Soaring Insurance Costs

In other words, California real estate is just too damn expensive, and getting more so.

Affordability today is about as bad as it’s ever been. Only 16% of California households can afford the median-priced home which is almost $900,000 – and that’s with a 20% down payment.

But I don’t think that any of these three threats is really the root issue facing the California real estate market. The real issue, if you ask me, is lack of supply.

Simply put, there are just too few people who want to sell their homes. There’s been a shortage of homes for sale in California for at least the past dozen years, since the real estate market recovered in about 2012 after the 2008 mortgage crisis. For all the the talk of an exodus out of California, you sure wouldn’t know that from the very few homes for sale.

There are a couple of big reasons I think people don’t sell their homes and move, and they are related. The first is that we are seeing nearly 50 years of Proposition 13 in action. In California, the longer you own your home, the cheaper it gets to own it. That’s a strong incentive to hold onto your home for decades, keeping it off the market.

The next reason is that homeowners are often facing enormous tax consequences for selling. A married couple selling their home can only exclude $500,000 in capital gain from tax when selling. This $500K limit has been in place since 1997 – and far too many California homeowners would exceed that if they sell. It’s not uncommon for homeowners to end up paying hundreds of thousands of dollars in capital gains taxes. And it’s worth noting that $500,000 in 1997 dollars is worth almost $1 million today.

Prop 13 isn’t going away any time soon – although it was modified a few years ago by Prop 19. And while Prop 19 did probably get some people moving, fewer people are selling today than before Prop 19 was passed.

Fortunately, there was a bill in the U.S. Congress, co-sponsored by California Congressman Jimmy Panetta, which would double the capital gains tax exclusion, and then index it to increase with inflation thereafter. The More Homes on the Market Act is a bill whose time is long overdue, and we can all hope that it will see its way into law in 2025.

There’s only one thing that stands a real shot at improving affordability in California to the point where the younger generation has a reasonable shot at home ownership, and that is increasing the supply. Despite all the talk about cutting regulations and increasing density, the housing construction numbers have barely budged.

Meanwhile, California is sitting on hundreds of thousands – probably millions – of spacious single-family homes occupied by one or two senior citizens. It’s far more home than they need and many would prefer to move and downsize, but the tax implications are just too dire for them to do so.

If you ask me, whatever can be done to incentivize California homeowners to sell en-masse must be done. Because as Joel Singer, the former C.E.O. of the California Association of REALTORS famously said, “at some point, a supply problem becomes a demand problem.”

And we can already see the demand problem, with many younger Californians pulling up stakes and moving out of state, where they have a shot at homeownership. We can see this with companies moving out of Silicon Valley because they can’t attract the employees they need, because they can’t afford to pay them enough to buy a $2 million house in Santa Clara county.

If we want to fix the affordability issue, we really need to take a good hard look at what we can do to quickly and substantially increase housing supply in California – that’s the only thing that will bring relief to beleaguered homebuyers. And the quickest and cheapest route is to strongly incentivize current owners to sell to the next generation. If we can do that, pricing will take care of itself to the point where mortgage rates and insurance costs will cease to be the threats that some people think they are.