Feb072017
Affordability is the major housing market headwind of 2017
Home price affordability will be the biggest issue in housing in 2017, particularly if mortgage interest rates rise.
Over the last 40 years, California inflated three different housing bubbles. Starting in the 1970s with regulations like CEQA, California began to restrict growth. This inhibited builders and developers from bringing new product to market to meet demand in many areas. As a result, demand pressures caused prices to rise. Rather than react to rising prices as a deterrent to buying, the sudden upward price movements served as a catalyst for even more buying as homeowners became speculators hoping to cash in on rapid appreciation.
As with all financial manias where asset values become detached from fundamentals, the first three housing bubbles all resulted in housing busts with each one being more severe than the last. As a result of the most recent horrendous crash in housing values, government regulators stepped in and put new rules in place designed to prevent future housing bubbles from inflating. For single mother housing assistance support kindly follow the link.
(See: New mortgage regulations will prevent future housing bubbles) For as cynical as I am about the ability of regulators to get anything right, the rules put in place, if enforced, will do much to prevent future housing bubbles. Donald Trump believes he can roll back or eliminate these safeguards. I believe he will fail.
The housing bubble of the 1970s was inflated because lenders abandoned long-held standards for debt-to-income ratios. Prior to the housing bubble of the 1970s, lenders would only allow a front-end ratio (the percentage of income directly attributable to housing costs) of 28%. Further, lenders would only permit a back-end ratio (total debt service as a percentage of income) of 36%. These standards were completely abandoned during the 1970s because lenders reasoned that with 10% yearly wage inflation, a borrower’s onerous front-end ratio in the early years would become affordable after a few years of steadily rising wages. Of course, they were wrong.
The housing bubble of the late 80s and early 90s was inflated by lenders who again allowed debt-to-income ratios get out of control, and they experimented with “innovative” loan programs such as interest-only and negative amortization. And the latest housing bubble was inflated by the proliferation of those same toxic loan programs.
The common denominator behind the previous housing bubbles was an abandonment of affordable debt-to-income ratios and the use of loan products that don’t amortize. Shockingly enough, regulators figured this out, and the new qualified mortgage rules specifically ban interest-only and negatively-amortizing loans. Further, these rules but a cap on debt-to-income ratios of 43%. This effectively eliminates the primary tools lenders have to inflate housing bubbles.
Affordability Ceiling
Lenders don’t set out to inflate housing bubbles. The pressures on lenders to obtain business prompts them to expand loan programs and develop “innovative” loan products in order to keep sales volumes up when prices reach the limit of affordability. Sellers could always rely on lenders to arm borrowers with dangerous loans to finance ever-higher asking prices. That will not be the case in the future.
The result of the new regulations will be a much more rigid ceiling on affordability. Borrowers will be required to document their income, and that income will be applied to amortizing loans with a reasonable debt-to-income ratio. They can either afford the property or they can’t; their bids will be limited.
If borrowers don’t have the ability to raise their bids due to limits on financing, then future housing markets will be very interest rate sensitive. Rising interest rates will lower the affordability ceiling if salaries don’t rise to compensate.
It’s harder to smooth out interest rate fluctuations
With the normal mechanisms for smoothing out interest rate fluctuations banned, house prices and sales volumes will be dictated by the course of interest rates. It’s widely believed mortgage interest rates will rise in the future. I once asked What will a long-term rise in interest rates do to home prices? Based on what we’ve seen over the last four years, we can expect sales volumes to plummet when interest rates rise, and if they rise high enough, price pressure will mount. We won’t see a crash without must-sell inventory, but we may see air pockets where prices drift lower as discretionary sellers decide they want to get out.
If prices were to remain at the upper limit of affordability for a long period of time — and they have been held there for four years now — the rate of price increase would slow dramatically until it only matched the rate of wage growth and inflation, assuming interest rates remain steady.
Affordability will be the major housing issue of 2017; of course, this will get perverted into a loan qualification standard issue by the real estate community chafing against the ban on affordability products, but the core issue will be affordability because interest rates are likely to rise in 2017, and when they do, affordability will crumble.
Will affordability problems in 2017 cause a bust? That depends on what you characterize as a bust. If affordability becomes a problem, prices may not go down due to cloud inventory, but sales volumes could see a significant drop, which would be completely against the consensus opinion of economists. If we get a housing “bust,” and it’s a real possibility, it will be a bust in volume, not in price.
Half a million dollars for a 2 bedroom home in Compton: Hipsters and gentrification lovers unite!
In the last housing mania, people drank multiple rounds of the Kool-Aid and lost all perspective. That is to be expected when we live in the land of Hollywood and living in a world of make believe is pretty much par for the course. In fact, faking it until you make it is now a legitimate way to make a living. Doctored up photos with so many filters you would think you are purifying water to drink out of the L.A. River. SoCal is the land of rental Armageddon and delusional Taco Tuesday baby boomers who run around with their ugly looking dogs in “baby” strollers and think their crap shacks are worth one million dollars. So in the last mania, areas that were legitimately tough somehow carried ridiculous price tags. The pitch was that an area was going to gentrify because “no more land is being made!” or that it was in the county. We are now seeing some outrageous prices in areas that still have legitimate struggles. Today we go back to Compton.
From what you hear from the house horny crowd, this is a great deal! Don’t wait and give your mortgage broker a call! Don’t miss out on this boom. Trump is a real estate guru therefore all real estate is going to go up in their mindset (as if Trump is concerned about Compton or California for that matter).
The mania and Kool-Aid is running freely at this point.
Since we have a shortage of construction labor right now, and since the building industry relies on inexpensive laborers from Mexico to do much of it’s work, will Trump build his wall with illegal aliens?
Bloomberg: Trump Wants to Build a Wall. Finding Workers Won’t Be Easy
President Donald Trump’s proposed border wall faces many obstacles. One of the tallest: building it without undocumented workers.
A labor shortage has left few hands to build houses and factories in the region, where wages have already been rising and projects delayed. Now, the president’s plan for “immediate construction of a border wall” will force the government to find legal builders for a project that could employ thousands if not tens of thousands. About half of construction workers in Texas are undocumented, and nationwide 14 percent lack authorization for employment in the U.S., according to the Workers Defense Project, an Austin group that advocates for undocumented laborers.
“If he is going to build a wall with legal workers in Texas, he is going to have a very hard time,” said Stan Marek, chief executive officer of Marek Brothers, a Houston commercial builder. “There is a real shortage of legal labor.”
The wall, whose cost has been estimated as high as $25 billion, is shaping up to be one of America’s biggest public-works projects since the building of the Hoover Dam during the Great Depression. Trump, who has promised to create jobs by investing more than half a trillion dollars in massive infrastructure projects, will face practical obstacles. While many people think of the border as little more than desert, the almost 2,000-mile terrain includes sand dunes, arroyos and craggy mountains. New roads and temporary concrete plants may have to be built to reach the most desolate areas.
“Contractors in general throughout the country have been saying it’s been difficult to get workers,” said Ken Simonson, chief economist at the Associated General Contractors of America. “Getting workers who would be vetted to work on government projects and then getting them to these locations, which are pretty far away, would be among the many challenges in getting this done.”
Labor shortage is pretty bad right now. A family member who runs a house framing business can’t get enough people and will take almost anyone no experience necessary.
I saw recently that construction-related employment in Orange County has risen 9.3% year-over-year for the last four consecutive years. Given all the people who left the industry in the previous six years, such tremendous employment growth was bound to cause shortages.
This article is wishful thinking. There are already contractors that have experience building other sections of the wall, and government contracts pay way better than the private sector. There won’t be a problem finding American workers that want to make double their normal salary in exchange for living in the remote desert.
Can you imagine the scandal if any illegals are caught working on the wall? Yikes!
I’m sure the press would love that. I think George Lopez had a comedy routine about that, asking who do they think will build the wall.
2016’S Homeownership Rate Was The Lowest Since 1965
Yesterday, the Census Bureau released its measure of homeownership for 2016 and the annual average for 2016 was 63.4 percent. That’s the lowest rate measured since 1965 when the homeownership rate was 63 percent.
2016 was also the twelfth year in a row in which the homeownership rate was lower than the year prior. In other words, the homeownership rate in the US has been falling since 2004.
I don’t mention this as evidence one way or another about the state of the US economy. The homeownership rate should not be seen as some sort of general index about prosperity in the United States or anywhere else. After all, homeownership rates in Switzerland tend to be considerably lower than those in the United States. Switzerland’s homeownership rate is approximately 45 percent. Meanwhile, the homeownership rate in Italy, where the economy is on the brink of a banking crisis, is quite high, at 72 percent.
https://staticseekingalpha.a.ssl.fastly.net/uploads/2017/2/2/saupload_horate_thumb1.png
From the evidence I have seen home ownership impedes the free flow of labor throughout the country hindering job promotion/opportunities. The “ownership” society programs should be completely abandoned with the government taking a neutral posture.
The logic of your words fall on deaf ears in Washington. The cult of homeownership as the bedrock of society is still worshiped there.
I think they encourage it because it traps their voting base locking them into power.
Increasing Mortgage Rates May Increase Downward Pressure On Housing Demand
Today, the Financial Times reported that mortgage rates hit a 2017 high. The following chart from the St. Louis FRED’s system is a bit behind the article’s data, but it also shows that mortgage rates are higher:
https://staticseekingalpha.a.ssl.fastly.net/uploads/2017/2/1/saupload_fredgraph_2B_25283_2529_thumb1.png
At what point does this impact the housing market? We don’t know – there is no basic rule of thumb linking basis point increases in mortgage rates with home sales. However, data shows that both new and existing home sales may be peaking:
https://staticseekingalpha.a.ssl.fastly.net/uploads/2017/2/1/saupload_fredgraph_2B_25284_2529_thumb1.png
The above chart shows new and existing home sales. Both sets of data are recalibrated to a base 100 beginning on the last day of the last recession. Existing sales (in red) have been reported at the same level (~110 on the chart) since July 2105. This is by far the larger market. New homes sales (in blue) increased in 2H 2016, but have since printed at approximately the same level.
At some point, interest rates will increase to a level where they will construct demand.
Danger: Financial Deregulation Is A Very Bad Idea
President Trump’s wants to weaken, if not eliminate, the Dodd-Frank Act; and he wants to remove the requirement that financial brokers act as fiduciaries when advising clients making retirement investment decisions.
These are bad ideas. To be fair, the plan will not harm everybody, just almost everybody; and they will help some, at least in the short run. If you want to understand who the losers and winners will be, ask yourself who were the winners and losers during the lead up to the global financial crisis, the crisis itself, and the fallout thereafter.
During the housing bubble, financial services firms benefitted by allowing homeowners with unsound financial situations to buy homes by taking out subprime mortgages they would not be able to service. Many of these home owners benefitted before the crisis, but once the crisis hit lost their homes, and in many cases their jobs too. In the lead up to the crisis, financial services firms collected large fees related to those mortgages, and greatly magnified those fees by trading associated financial derivatives.
I suggest that President Trump’s plan will set a future crisis in motion. A good way to understand the negative dynamic that his plan will generate is to take a look at the Rethinking the Financial Crisis, a collection of readings edited by luminaries Alan Blinder, Andrew Lo, and Robert Solow, which was jointly published by the Sage Foundation and the Century Foundation.
In this volume, my colleague Meir Statman and I discuss the tug-of-war that characterizes the ebb and flow of financial regulation in the U.S., as we swing from strong regulation to weak regulation during periods of economic expansion, and then from weak regulation to strong regulation after periods of crisis. One reason why the country swings from one regulatory extreme to the other is our collective susceptibility to recency bias, the psychological pitfall in which we attach too much importance to recent events relative to past events. Recency bias is an important feature of the financial instability hypothesis, the framework developed by the late economist Hyman Minsky whose brilliant work explains how financial crises develop.
President Trump succumbs to some of the most important pitfalls psychologists have identified when it comes to forming judgments and making decisions. One such pitfall is availability bias, the tendency to form judgments based on information that is readily available and easily retrieved from memory, relative to information that requires more effort to generate.
Information that comes from personal experiences is readily available. The Wall Street Journal quotes President Trump’s rationale for weakening Dodd-Frank. President Trump speaks about “so many people, friends of mine” that “can’t get any money because the banks just won’t let them borrow” with the reason being “the rules and regulations in Dodd-Frank.”
Not all crashes are created equal.
The 08 housing downturn was triggered at the bottom. A ‘pull-down’ type of crash. The foundation crumbled (subprime), structural implosion followed. A quick crash to a bottom.
The current downturn is the opposite of 08…triggered at the top. A ‘push-down’ type. Higher-end props cut price, pushing the tiers below, lower. A long slow bleed type of crash, but much more painful; ie.,
peoplespeculators are buying the dips, all the way down.You heard it here first.
As affordability wanes and as wealthy investors find opportunities to earn returns better than residential real estate, the money that flowed into this space since the crash will start to move out. The phenomenon you describe is probably how it will go down.
Yeah, I’m watching this in the San Diego area. The bulk of the available inventory is over $1 million and sits for a long time followed by yuge price cuts and then eventually sells.
Even in Orange County, the $1.5M+ market struggles. There is a limit to how many buyers those price points can support, but there is no shortage of homeowners who believe their property warrants that level of pricing.
Reality bats last.
3 reasons why Goldman Sachs is shifting its economic outlook
After President Donald Trump won the election, economic markets surged with hope as many economists predicted growth due to Trump’s stimulus plan.
Even consumers were more optimistic after the election, hopeful of a future of economic growth and new jobs.
However that optimism, being called the Trump Effect, could be dying as economists reverse their predictions for 2017.
It seems Trump’s intense focus on issues such as trade tariffs and immigration has Goldman Sachs economists doubting the possibility of financial stimulus, according to an article by Julie Verhage for Bloomberg.
From the article:
“Following the election, the positive shift in sentiment among investors, business, and consumers suggested that the probability of tax cuts and easier regulation was seen to be higher than the probability of meaningful restrictions to trade and immigration,” Goldman Sachs Group Inc. economists led by Alec Phillips wrote in note published late last week. “One month into the year, the balance of risks is somewhat less positive in our view.”
Here are the three reasons Phillips lays out as the reasons for the shift in sentiment:
1. Obamacare struggle is a sign of things to come
Phillips explains that instead of quickly replacing the Affordable Care Act, Republicans are facing many obstacles, perhaps a sign of what’s to come for future financial stimulus plans.
2. Polarization of political parties is getting worse
Cooperation between the two political parties looks further out of reach one month into the new administration, leaving economists to presume issues requiring bipartisan support will face major obstacles.
3. There’s a real possibility of market disruption
Economists insist that Trump’s actions in trade and immigration will do little to support the economy, and could even disrupt it.
https://www.bloomberg.com/news/articles/2017-02-06/the-mortgage-bond-whale-that-everyone-is-suddenly-worried-about
I have a difficult time imagining that would actually happen. If it did, Coastal properties would weaken in sales volume and then in price, perhaps considerably.
I wonder if this future scenario could play out here in California:
1.) Home buyer purchases overpriced house in 2017. $700,000+ and pays real estate taxes based on this 2017 purchase price (about $8,400 year)
2.) Zoom ahead 3 years to 2020 and Moody’s Analytics was right and rates are at 6.0% House price on that same 2017, $700,000 shack would have to drop to about $582,000 to equal the monthly payment of the $700k shack at 4%, but the yearly tax on that same house drops to about $6,984
So, will future home owners that bought at overpriced prices in 2017 be happy with paying a higher tax rate than those purchasing lower priced homes in 2020?
And assuming Trump doesn’t totally eliminate the mortgage interest deduction, the 2020 home buyer can make a bigger deduction from their taxes, due to higher interest rates.
But, you can never really lower your property taxes. Except for purchasing at a lower price.
You can appeal your property taxes to get them lowered. I did so several times during the downturn.
Ah! Didn’t know that was an option! Good to know!
Yeah, it’s not something you want to have to do, but the option exists.
It isn’t permanent though. Proposition 8 allows them to raise your property taxes until it hits your previous Proposition 13 limits.
Another good quote from this Bloomberg article:
Anything that removes demand from the mortgage bond market is bound to cause mortgage rates to rise.