Dec152015

Bold California housing market predictions for 2016

House prices and sales in 2016 depend almost entirely on what happens with mortgage interest rates

“Those who have knowledge, don’t predict. Those who predict, don’t have knowledge.”

Lao Tzu

economic_forecast

Each year I like to make a real market forecast. I try to examine current conditions, consider how these conditions change, and form an opinion of how these conditions effect housing. It’s the opposite of the trend extrapolation nonsense passed off as forecasting by most housing market analysts. I try to focus on areas where my forecast falls outside the consensus view. Regurgitating consensus cud doesn’t make the analysts bolus any more palatable.

The consensus opinion this year, like every year, is for sales and home prices to rise 3% to 5%. A few plucky forecasters may depart from this range by a percent or two, but none have the courage to buck the herd.

Most economists who bother to make predictions offer vague predictions that allow them to claim clairvoyance even when they completely blow it. Further, some of these economists rewrite history to claim they predicted something they didn’t with hopes that nobody calls them on it.

bears_were_rightAnother tendency among these economists is to make predictions with low thresholds for success that may or may not have a causal relationship to the outcome. For example, if I predict house prices will rise in 2016 because Millennials will buy more homes, have I really predicted anything?

Millennials are entering the time in their lives and careers when most people buy, so Millennial homebuying is bound to improve a little, thus the low threshold for success. House prices may go up because interest rates fall, an event independent of the activity of Millennials, but if house prices go up, I look correct even when I wasn’t.

Another common trait is to blame some completely unforeseen exogenous shock, like bad weather, when the prediction fails. The failed forecaster usually just combs the headlines for anything out of the ordinary and makes a causal connection where none really exists.

With all the nonsense surrounding these forecasts, it shouldn’t be surprising that some people are sick and tired of them.

Attention Forecasters: STFU!

It’s that time of year again when the mystics peer deep into their tea leaves, entrails and crystal balls to divine what’s ahead.

Which means it’s also time for my annual reminder: These folks cannot tell the future. Ignore them.

Most forecasters are barely familiar with what happened in the past. Based on what they say and write, it is apparent they often do not understand what is occurring here and now. Why would anyone imagine that they have the slightest clue about the future?

This is not my opinion, but a simple statistical fact: The data overwhelmingly show that the skill set of the predictive pundits is no better than a coin toss. The odd person gets these forecasts about the economy and stock markets right each year, but the lack of any sort of consistent winners and losers means that, mathematically, it is a random outcome.

At least the bank’s behavior is still predictable.

foreclosure_fortune

Every major academic study proves that “we stink at making predictions about the future,” he says. …

Morgan Housel, a columnist for the Motley Fool and all-around sharp observer, took O’Shaughnessy’s observations a step further: He looked at the average Standard & Poor’s 500-stock index forecast made by the 22 chief market strategists of the biggest banks and brokerage firms from 2000 to 2014.

On average, these annual forecasts missed the actual market performance by an incredible 14.6 percentage points per year (not 14.6 percent, but 14.6 percentage points!) It is also noteworthy, Housel added, that “from 2000 to 2014, the 22 strategists on average did not forecast a single down year, ever.” During that period, the Nasdaq crashed 78 percent and the Great Recession sent the major averages down 57 percent. The strategists failed to anticipate any of it.

“Professional market forecasters are often called dart-throwing chimps,” Housel said. “It turns out this might be an insult to chimps.”

option arm development team

It’s all about interest rates

Whatever is going to happen in the housing market in 2016 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.

What happens in housing in 2016 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.yellen_raise_rates

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.

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.

misfortune_teller

My best guess

I stated in several recent posts my belief that sales will be lower in 2016 than 2015. We have clear proof that rising interest rates kills 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.

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.

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.

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.

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.

cautiously_optimistic

[dfads params=’groups=3&limit=1&orderby=random’]
[dfads params=’groups=23&limit=1&orderby=random’]
[listing mls=”OC15261322″]