Housing hits another weak patch as investors balk at high prices. Will housing see another decline similar to 2008 or 2011?
Ever since house prices began a steep, deep, and unprecedented decline in 2008, the government, lenders, and the federal reserve have changed policies and applied stimulus of various kinds to reverse the decline and reflate the previous bubble in order to restore collateral backing to bubble-era home loans to preserve the solvency of our banking system.
Each manipulation and policy change managed to pull demand forward and prompt buyers to act sooner than they otherwise would at price points higher than they otherwise would. When the stimulus was removed, financial gravity took over, and prices went lower.
The latest successful manipulations — mortgage interest rate stimulus and inventory restrictions through loan modification can-kicking and denying short sales — these manipulations caused a furious price rally that nearly reflated the housing bubble.
But did we party too hard in 2012 and 2013? Sales volumes steadily declined since mid 2013, and prices flattened, despite mortgage interest rates falling from 4.5% to under 4% today. Now that the indices are showing this ongoing weakness, many are asking if we will see another stimulus hangover.
Diana Olick | @diana_olick, Tuesday, 7 Oct 2014 | 8:42 AM ET
The headline for much of this year has been that home price gains are easing. Prices are still higher compared to last year, but not nearly as much as they had been. Now, suddenly, it looks as if home values could actually go negative on a national level.
“That will be the first time collectively, as a nation, we’ve seen prices drop since the low point or the trough of the housing crisis,” said Alex Villacorta, vice president of research and analytics at data firm Clear Capital.
Will another price drop vindicate the housing bears? Remember, in the 80 years prior to the housing bust, home prices only went up, which is why people believed home prices never go down. From 2007 through 2009, house prices dropped significantly. Then again in 2010 through 2012, house prices dropped again when the tax credit stimulus was removed. If we see another national price drop this winter, it will be the third decline in the last seven years — an unusual occurrence considering it was preceded by 80 years of steadily rising prices.
Villacorta points to a 1 percent quarterly home price gain from the second to the third quarter of this year. Last year that quarterly gain was 3 percent.
“The discouraging thing about that is, yes, we’re still in the positive, but that 1 percent has been waning from that three percent, and this comes after what should have been the most active buying season in the housing market for the summer that just ended,” he added.
At this point, I think it very likely we will see negative year-over-year numbers for a few months this winter. The weak sales volumes and declining mortgage rates are a sign of overall weakness in the housing market. The decline won’t be large, and due to cloud inventory restrictions and an improving economy, it probably won’t last through the spring, but we probably will see a very brief, very minor triple dip.
So I ask you again, does that vindicate the housing bears?
The take-away from last month’s housing data was that “the market was returning to normal”, which despite the persevering weakness, was viewed as a “great thing”. This overly-simplistic and flawed assumption was made, as the all-cash cohort demand dramatically cooled and distressed supply and sales plunged YoY.
What people are suffering from is a lack of a medium-term memory, as what’s happening today happened in 2007/08; “Peak Housing”.
Back in 2007, the speculators (every ma and pa in America) driven by exotic credit stimulus without a “mortgage loan house price governor” — that drove prices over years of tremendous incremental and pulled-forward latitudinous demand — went away over a short period of time leaving the heavy lifting to weak, end-user fundamentals.
Today the unorthodox, new-era buy to rent/flip speculators driven by Fed stimulus without a “mortgage loan house price governor” — that drove prices through years of tremendous incremental and pulled-forward narrow demand — are going away quickly leaving the heavy lifting to weak, end-user fundamentals.
It was the stimulus-driven, unorthodox “things” that drove the “V” bottom in demand and prices yet again, not coincidentally from exactly the time in 2011 that Twist was first announced and yields plunged. Moreover, a rush of incremental and pulled forward end-user demand caused by the nuclear monetary policy that followed, forced end-users to chase spec-vestors. Before you knew it, spec-vestors and end-users were tripping all over themselves piled 30 deep bidding on houses. Prices surged, as the “mortgage loan house price governor” was removed just like from 2003 to 2007.
There are few important distinctions between the housing bubble rally and the bubble reflation rally worth noting. First, the housing bubble rally was fueled almost entirely by ordinary mom and pop speculators given dangerous loan products that allowed them to borrow double what their incomes could support. The bubble was built entirely on leverage. Everything about the housing bubble rally was unstable — loan terms, borrower capacity, credit history, collateral value — all bogus.
The bubble reflation rally of 2012-2013 was driven by cash investors, a group that never defaults or faces foreclosure, and artificial interest rate stimulus; however, this time the stimulus was delivered through stable 30-year conventional loans, and the income of borrowers was rigorously verified. While it can be cogently argued the mortgage interest rate stimulus may have hangover effects, the way this stimulus was applied was safe and effective.
Although 2003-07 and 2011-13 were basically the same in nature, a big difference is that this stimulus-cycle was much greater in stimulus input over a shorter period of time than from 2003 to 2007. If stimulus “hangovers” are proportional to the amount of stimulus that preceded them, then this one could be a doozy.
I believe it is wrong to suppose that all stimulants are created equal, and their withdrawal should have equal effects. As I pointed out above, the stimulants and their applications were very different in the two rallies, and since the distinctions between the two are material — the bubble relation rally stimulus was applied through stable loan terms and all-cash buyers — the withdrawal of stimulus will not have the same effect. In short, the bubble reflation rally won’t spawn several million foreclosures, a supply of must-sell inventory required to push prices down.
Bottom line:a “Return to Normal” is “Peak Housing” this time around too; a huge headwind — just like the “return to normal in 2007/08″ on the loss of exotic credit — to the consensus estimates of 10% to 20% sales volume gains and 5% to 10% price gains in perpetuity. In fact, organic house prices are already on the down — lagging the persevering demand slump — and likely to drop by 10% to 20% over the next 2 years, down more at the high-end.
I admire that Mark makes a strong and measurable prediction here: “likely to drop by 10% to 20% over the next 2 years, down more at the high-end.” If we even see half that drop, Mark will be hailed as a prescient genius because he is the only housing pundit prediction specific large-scale declines (Keith Jurow is generally more cryptic).
Remember, house demand and prices didn’t crash at Peak-Housing 2007, they simply re-attached to what end-user employment, income, and mortgage credit could support when all of the exotic credit went away. The same thing is happening at this Peak Housing event, as new-era all-cash spec-vestors and foreigners go away.
History is littered with instances of investors and first-timers leaving the market over a very short period of time. And we know, judging by how rough single-family new-home permits, starts & sales have had it, end-user demand is structurally weak and unable to carry this market on it’s shoulders.
While I agree that the market is unable to find support solely from owner-occupants, there is little or no reason to believe investors in single-family rentals will dump their properties.
First, all the investors with significant inventory are seasoned real estate investors who recognize the perils of liquidating illiquid real estate assets. Most, if not all, of these firms have long-term locks on the investment capital, and they are under no pressure to force an unprofitable liquidation to recover capital.
There are many other, less damaging methods of extracting cash if they needed it; they could obtain debt or refinance, sell in bulk to another investor, create their own REIT and sell shares to smaller investors, and any of a dozen other methods widely known to these players. A fire sale scenario simply isn’t plausible.
Housing sits in a precarious position. There is no shortage of houses “in which to live”. Just the opposite, in fact. My research shows that in the past six-years houses were over produced by three million units — SHADOW CONSTRUCTION — while household formation remained weak. Moreover, house prices are too expensive. That is, on a monthly payment basis using the popular loan programs of each era monthly payments for the average house are 35% higher today than in 2006 despite prices being moderately lower.
I’ve read Mark make this statement before. I honestly have no idea how he calculates this unless perhaps he assumes everyone was using Option ARMs in 2006. The math based on conventionally amortized mortgages does not support his assertion. The average cost of ownership in LA County was over $3,000 per month in 2006, and it’s about $2,100 today. Further, during that same period, rents rose from $1,500 per month to about $2,100 per month, so relative to rent, housing is much, much more affordable today than in 2006.
Without foreclosures, short-sales, and spec-vestors house price gains since 2012 would have been notably less. The proof is clear. For example, in CA when stripping out distressed transactions house prices are already flat to lower, YoY. Further, last month NAR announced that the Northeast was the first region to see house prices go red YoY for this stimulus “hangover”. This is important because this is the region with the highest percentage of end-user buyers/least distressed supply, transactions and all-cash spec-vestors. This is an important observation, as demand quickly shifts back atop the shoulders of the end-user buyers from coast to coast.
Bottom line:Without another, larger (than Twist and QE) spec-vestor and end-user stimulus catalyst, this 3rd serious stimulus hangover in 7-years will get worse, while record amounts of multi family and single-family for rent supply hit the market, not a good thing.
Let’s assume Mark is right; I also believe 2014-2015 will reflect the loss of investor stimulus and the slow resurgence of owner-occupant demand. While this transition was not as seemless as hopeful housing pundits imagined, it will occur. Even if the 2014-2015 period is noted as a mini-bust, what form will that bust take?
In my opinion, we will see slow sales rates and flat house prices as weak demand is balanced by restricted supply. Perhaps we will see a few monthly prints showing year-over-year declines, but these will be modest and short lived.