Bold California housing market predictions for 2017

The housing market will flourish or flounder depending on mortgage interest rates.

For each of the last three years, I made a series of bold predictions for the upcoming year. You can judge for yourself how I did:

Bold California housing market predictions for 2014

Bold California housing market predictions for 2015

Bold California housing market predictions for 2016

2016 Review

My thoughts about 2017 are the same as they were last year, so let’s start be reviewing those observations. My updated observations are in [brackets].

It’s all about interest rates

yellen_raise_ratesWhatever is going to happen in the housing market in 2016 [and 2017] depends entirely on the course of mortgage rates. Why? Because housing markets are very interest rate sensitive due to the lack of affordability products.

Since I am very poor at accurately forecasting interest rates, rather that forecast what will happen, I want to outline what will happen depending on the course of interest rates. [The chances of rising rates are higher this year with an improving economy and the accepted notion of Trump’s policies contributing to inflation.]

What happens in housing in 2016 [and 2017] depends almost entirely on what happens with mortgage interest rates. Affordability will be the major housing market issue of 2016, and the inescapable math of higher mortgage rates means that rising mortgage rates will hurt sales or prices. Due to cloud inventory, I don’t believe prices will go down. If prices do drift lower, the inventory will dry up, sales volumes will drop, and prices will be forced up by competition among the few active buyers.

[Nothing substative changed during 2016. The economy got better, so interest rates will be under more pressure, but income growth is also on the rise, so affordability will worsen, but not necessarily collapse. My thoughts on the impact of rising mortgage rates hasn’t changed, but the thresholds may be 1/4 to 1/2 point higher.]

If Mortgage Rates Stay Low

If mortgage rates remain below 4.25%, both sales and house prices will rise next year. The economy is improving, and with an improving economy will come increased demand. If this demand is amplified by super-low rates, housing will do well [which it did].

If Mortgage Rates Rise a Little

If mortgage rates settle between 4.25% and 4.75%, sales will be down while prices drift slowly upward. A reduction in sales volume always proceeds price, and as long as mortgage rates stay below 4.75%, the pressure on pricing won’t be enough to overcome the inventory restrictions of cloud sellers.

If Mortgage Rates Rise a Lot

If mortgage rates rise above 4.75%, sales volumes will be severely impacted and prices may drift gently lower. The increased cost of financing will not allow buyers to bid high enough to support current prices. The discretionary sellers active in the market will be forced to lower their prices if they want to sell. The activity of these few discretionary buyers will cause prices to drift down at higher mortgage rates.

If Mortgage Rates Skyrocket

If mortgage rates rise above 5.25%, the housing market will be a catastrophe. Homebuilders won’t be able to sell anything, homebuilding unemployment will rise, triggering a recession, and the housing market will experience record low sales volumes and prices 5% or more below today’s levels. I consider this scenario very unlikely largely because the federal reserve would never allow it. They will start buying mortgage bonds again before they let housing kill the recovery.

My best guess

I stated in several recent posts my belief that sales will be lower in 2016 than 2015.

[I was wrong in 2016 because mortgage rates trended lower all year, bottoming near record lows before the election. Without this boost, sales probably would have been lower in 2016. Since I believe mortgage rates will move somewhat higher, I’m doubling down this year. I predict 2017 home sales will be worse than 2016, probably on par with 2014’s dismal numbers. This despite a continually improving economy.]

We have clear proof that rising interest rates kill home sales, and interest rates are expected to rise next year, pricing out many marginal buyers. This will come as a complete shock to housing market analysts who uniformly believe sales will rise next year due to improving employment increasing demand. None of them appreciate the sensitivity of the housing market to interest rates. By this time next year, the pundits will finally get it.

I believe a strengthening dollar will continue to attract more foreign money and keep bond yields very low, even as the federal reserve raises short-term rates. This will keep mortgage rates below 4.5% and keep the air in the reflated housing bubble. The consequences of mortgage rates above 4.5% are too severe to the real estate industry, so I believe federal reserve policy will continue to favor low mortgage rates.

[The last time we had a sudden rise in rates (2013 Taper Tantrum), after the dramatic rise, rates trickled down for over 3 years. I wouldn’t be surprised to see steady or even slightly falling rates as the bond market realizes Trump isn’t Jimmy Carter, and although Trump’s policies may be inflationary long-term, they won’t cause hyperinflation overnight.]

Other predictions

In 2016, many loan modifications will redefault, and many HELOCs will blow up. These loans will be can-kicked like every other bad real estate loan over the last nine years. While this may hurt the bottom line for bankers, it won’t create any must-sell inventory likely to push house prices down. [That happened, and the can-kicking will continue.]

Also in 2016, HELOC abusers will be further enabled by lenders. We won’t see the craziness of the housing bubble because house prices aren’t moving up that fast, and the cost of borrowing and spending that appreciation is much higher. While HELOC abuse won’t get out of control, it will almost certainly get worse. [HELOC abuse is growing, but it isn’t crazy yet.]

Another wildcard for 2016 is the activity of Chinese Nationals. Over 2015, higher house prices turned off this buyer group, and capital controls made it more difficult for them to get their money out of the country. These trends should worsen next year, eliminating a vital component of local demand. That being said, it could easily turn out the exact opposite if Chinese leaders loosen capital controls. [Chinese capital controls tightened, loosened, then tightened again as the government wants to slow the flow of capital out of the country, but it doesn’t want to endure the pain of the measures necessary to stop the flow. See: Home sales weaken as Chinese investors sour on US real estate.]

Overall I don’t see this as a bad time for housing or the economy. If not for the specter of rising mortgage rates, I would be very bullish. My monthly reports still report the market as relatively affordable despite high prices. We are not currently in a housing bubble, and although rising mortgage rates have the potential to cause house prices to top out, I don’t believe that will happen in 2016.

[And I don’t believe house prices will crash in 2017 either.]

What’s ahead in 2017

My first prediction is above: sales will be weaker in 2017 than 2016 due to rising mortgage rates. This will surprise all the pundits who claim that rising wages and an improving economy will overcome the impact of rising rates.

Perhaps this one isn’t controversial, but I haven’t heard it articulated elsewhere: First-time homebuyers will be priced out of every market in California. The median home prices will rise above the FHA loan limit across the state leaving first-time homebuyers without inventory within their price range.

Nearly all new construction in California will be high-density, mostly apartments, but some attached for-sale product as well.

Dodd-Frank and the Consumer Financial Protection Bureau will survive unscathed by Republican assaults (as will most of ObamaCare). Credit standards will not loosen significantly.

Trump will pass tax reform that includes a higher standard deduction, weakening support for the home mortgage interest deduction.

Not housing but… Donald Trump will take credit for everything good in the economy, whether he had anything to do with it or not. Democrats were infuriated by his loose command of facts before, but this emerging trait will make their heads explode.