The housing market bottomed in early 2012 due to a combination of restricted inventory, record low mortgage rates, and increased investor participation in the housing market. I thought the rally was a seasonal bounce, and I was not convinced of the durability of this bottom until it became clear the banks were going to kick-the-can forever, and Ben Bernanke pledged to keep mortgage interest rates low for as long as possible.
My perception of the power of Bernanke’s statement contained a hidden assumption, that the federal reserve would be able to keep interest rates low through continued quantitative easing. I am now calling into question that assumption. Recent events show that the federal reserve is losing control of the long-end of the yield curve, and mortgage interest rates are rising rapidly and apparently out-of-control. Since I am willing to question my beliefs and change my mind as data presents itself, I felt it was time to review whether or not this housing recovery is truly tenable.
I am not surprised that the housing market found support from institutional and small investors. If a cashflowing asset becomes cheap enough, investors will buy it for the cashflow alone even if prices are dropping. Once private equity funds got involved, the bottom was imminent, but I still believed it would take a few more years due to the huge shadow inventory. It took me a while to fully understand, but once I realized that the banks had morphed must-sell shadow inventory into can’t-sell cloud inventory, I realized they could engineer a rally fueled by private equity investors and cause the housing market to bottom prematurely.
Similarities to the 2009-2010 tax-credit bear rally
One of the many reasons I didn’t believe in the durability of the 2012 market bottom early on was because we had seen failed attempts at housing market manipulation before. In 2009 a series of tax credits pulled demand forward and caused a brief market rally despite the continuing overvalued condition in many markets. The result of this manipulation was quite predictable, and I repeated over and over again that the rally would fail as the stimulus was removed. When the tax credits expired, prices immediately reversed and headed lower for 18 consecutive months.
The recent housing market bottom had all the earmarks of the previous failed manipulation. This time, rather than tax credits, the stimulus was record low interest rates. As I demonstrate in the chart above, it wasn’t until rates fell below 4% that the market bottomed. It wasn’t until Bernanke pledged to keep these rates in place for years if necessary that I was convinced we wouldn’t see a repeat of the stimulus hangover of 2010-1012. The recent spike in rates calls all this into question. It’s also why the mainstream media is eagerly spinning the potential catastrophe by claiming low mortgage rates won’t squelch the so-called housing recovery.
Ted Kolko, Chief Economist — June 12th, 2013
The recent rise in mortgage rates has made buying a house a little more expensive …
A little more expensive? That isn’t how Mr. Kolko described the situation in another recent article: “In the past year, buying a home has become at least 20 percent more expensive,” said Kolko. “For young first-time homebuyers who don’t remember life during and before the bubble, these rising costs are a rude awakening.”
For this article, the analysis is spin and propaganda NAr style. Therefore he is downplaying the impact rather than providing the more honest assessment of the other article.
Buying remains cheaper than renting so long as mortgage rates are below 10.5%. At 3.9%, the current 30-year fixed rate according to Freddie Mac, buying is 41% cheaper than renting nationally….
This is a study designed to give a result that favors generating commissions. It’s the same kind of crap I lampooned in yesterday’s article. If it’s 41% cheaper than renting now, it must have been well over 50% cheaper to own than to rent at the bottom.
Mortgage rates would have to rise a huge amount – to 10.5% – to tip the math in favor of renting, which isn’t impossible. Rates were that high throughout the 1980s, but have been consistently below 10.5% since May 1990. …
Each local market, of course, has its own mortgage rate “tipping point” when renting becomes cheaper than buying a home. At 3.9%, buying is cheaper than renting in all of the 100 largest metros, which means the tipping point is above 3.9% everywhere.
Does this pass the sniff test? If you compare the cost of ownership to the cost of a rental, do you find properties in every market where it’s cheaper to own? Not by the math I use.
His methodology incorporates long-term appreciation which introduces a number of flawed assumptions. I argued with people in 2006 who claimed the market was not overvalued because after five years of home price appreciation of about 10% and 5% yearly increases in rent, it was cheaper to own than to rent. When I pointed out their analysis was flawed due to their poor assumptions, they were eager to point out the error of my ways.
The cost of ownership calculations I provide each day are a static analysis looking at current conditions. Assumptions about the future are too sensitive to small changes in the inputs to be accurate. Plus, it introduces unnecessary variables to an already complex calculation.
But it will take big rate increases to turn off prospective homebuyers.
Will it really? Isn’t this just wishful thinking expressing the collect angst of the entire real estate industry?
We know it is.
Rising interest rates has everyone who makes a living from real estate transactions afraid about what will happen next. The best evidence is the proliferation of articles telling us it isn’t going to be a problem.
By Jason Gold — July 3, 2013
Mortgage rates have been scraping the cellar floor in recent years, bottoming out at around 3.5 percent for 30-year loans. Economics 101 says cheap money can’t last forever and, sure enough, government backed mortgage giant Freddie Mac reported last week that fixed rates jumped, now up a full percentage point, to 4.5 percent.
If Economics 101 says cheap money can’t last forever, then why has every financial reporter for the last year been telling us that cheap money was going to last forever? Perhaps because they wanted us to take comfort from the nonsense they were peddling because they wanted to provide investors assurance rather than information?
In housing finance circles, there’s been a lively debate over the recent surge in housing prices: Is the sector’s recovery real – that is, built on market fundamentals? Or are we seeing yet another housing bubble inflated by the Fed’s policy of monetary easing?
I haven’t really seen any lively debates on this issue. The reality is that we are reflating the old housing bubble on low interest rates brought about by fed policy. The only real debate is about what happens when this artificial stimulus is finally removed, and we are starting to get data back on that. It appears that any pullback in stimulus is going to cause interest rates to explode upward.
When there’s a glut of potential borrowers, banks can cherry pick the most credit-worthy.
Is there a glut of potential borrowers now? I’m sure there is a long line of Ponzis lining up for more free money, but few qualified borrowers (you know, those who will pay back the money) are looking to borrow right now.
But as rates increase, they’ll probably be forced to open the credit tap a bit wider, and this will allow more borrowers who may have previously not qualified, to obtain mortgages.
No, they won’t be forced to do anything. They will likely continue to only give loans to people who will pay them back because with the FHA and GSEs aggressively pursuing buy-backs on bad loans, lenders have risk of loss if they underwrite to deadbeats. And that’s a good thing.
What if the investors disappear? Another force many believe has been the prime driver of a housing recovery are investors. From mom and pop retirees all the way to giant hedge funds, certain cities have seen hordes of private investors, many who have the resources to make all cash offers, come racing to town and drive up prices. It’s hard for average homebuyers to compete with these deep-pocketed financiers.
But while cash investors have flocked to the housing market because low prices and increasing rents made this a great time to invest in homes, low rates also meant investor cash had limited places to seek higher returns. Rising rates will change all that. As rates increase and house prices keep rising, often dramatically, investor returns will begin to diminish, and that means that money will need to find other assets that offer higher returns.
What hasn’t been discussed much is what happens to competing investment alternatives as rates rise. Why would a private equity fund keep bidding up house prices chasing lower and lower returns when they could instead buy low-stress short-term debt instruments making better returns? Rising interest rates make the cap-rate requirements go up on all investments.
Realistically, this group won’t disappear, and if prices do fall again, they will become more active and absorb any inventory they can at lower prices — unless interest rates rise much higher and they can get much better returns elsewhere.
That’s not all bad. It will allow working families previously pushed out by investors to come back into the market and start buying homes.
So will rising mortgage rates abort the housing recovery? Not likely. Assuming we aren’t talking about more big jumps like we saw last week, housing markets should be able to absorb gradual increases.
That’s a nice assumption, but it isn’t what we are currently seeing in the bond market. Rates have climbed a full percentage point, or about 25% in relative terms, since mid May.
In fact, higher rates could cool down some overheated markets, such as we’ve seen in Phoenix, where housing prices have been soaring at more than 20 percent a year. A slowdown in price increases seems more likely than the dramatic drops – 30 to 40 percent – that followed the popping of the housing bubble in 2007.
The main reason the 2009-2010 tax credit rally failed is because it failed to achieve escape velocity. The housing market rally was supposed to be self fueling as legions of imagined fence-sitters were supposed to carry the market forward forever. That didn’t happen because they used these fence-sitters to create the initial rally. There was nobody left to carry the market forward.
This time around, investors caused the market to bottom, and it’s hoped these imaginary fence sitters will again emerge to carry the market forward. So far, this isn’t happening. First-time homebuyer participation is at near-record lows, and the best indicator of escape velocity, mortgage purchase applications, is only showing the faintest signs of life. Unless we see a steady and significant rise in purchase applications, this market will not achieve the highly sought after escape velocity either.
So will the market reverse and head lower?
Does this mean we are due for another crash, or perhaps another 18-month slide? I don’t think so. The final crutch holding up the housing market is inventory restriction, and that shows no sign of changing.
The new inventory coming to market is priced at WTF price levels necessary to liquidate cloud inventory. These prices won’t be lowered because sellers neither want to nor have the ability to. So what happens when a lot of inventory comes to market that nobody can afford?
It sits there.
I foresee a period of market standoff where sellers are priced in the clouds and unable to lower their prices, and the bulk of buyers, the 70% to 85% that typically use financing, are priced out of the market. As long as interest rates remain too high and incomes remain too low, this standoff could persist indefinitely, and very low transaction volumes will be the new normal.
Perhaps realtors will lobby Congress to force banks to foreclose and sell at prices the majority can finance. We know they will pressure whoever they need to in order to generate sales commission. But in all likelihood, this lobbying will fall on deaf ears because with $1 trillion in exposed mortgage debt, the banks are in no position to foreclose, sell for market, and recognize losses.
Without low mortgage rates and higher wages to make buyers able to finance the prices needed to liquidate cloud inventory, I don’t see any other way forward at this time. Cash investors will dominate the market, and sales volumes will be very, very low.
Come back tomorrow for a special post
I know many of you read every day, but for those that don’t, I implore you to come back tomorrow and read my special “fictional” essay on Las Vegas: a wretched hive of realtor scum and villainy. It’s an over-the-top description of three crooked realtors I had the misfortune of dealing with in Las Vegas.
They could have gotten more
The former owners of today’s featured property made the mistake of only going halfway Ponzi. The fools that went all out and extracted every penny of equity the moment it appears reaped the most benefit from the housing bubble. The ones that tried to be prudent — but failed — still lost their house and their credit, but they left a lot of equity in the property that evaporated when housing crashed.
The former owners of today’s featured property doubled their original mortgage, so they don’t look like they were trying to be prudent, but considering the value of their property more than tripled, they could have extracted much more.
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Proprietary OC Housing News home purchase analysis
1128 North LOUISE Dr Anaheim, CA 92805
$424,900 …….. Asking Price
$163,000 ………. Purchase Price
10/17/1994 ………. Purchase Date
$261,900 ………. Gross Gain (Loss)
($33,992) ………… Commissions and Costs at 8%
$227,908 ………. Net Gain (Loss)
160.7% ………. Gross Percent Change
139.8% ………. Net Percent Change
5.2% ………… Annual Appreciation
Cost of Home Ownership
$424,900 …….. Asking Price
$14,872 ………… 3.5% Down FHA Financing
4.40% …………. Mortgage Interest Rate
30 ……………… Number of Years
$410,029 …….. Mortgage
$115,019 ………. Income Requirement
$2,053 ………… Monthly Mortgage Payment
$368 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$89 ………… Homeowners Insurance at 0.25%
$461 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$2,971 ………. Monthly Cash Outlays
($487) ………. Tax Savings
($550) ………. Principal Amortization
$24 ………….. Opportunity Cost of Down Payment
$126 ………….. Maintenance and Replacement Reserves
$2,085 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$5,749 ………… Furnishing and Move-In Costs at 1% + $1,500
$5,749 ………… Closing Costs at 1% + $1,500
$4,100 ………… Interest Points at 1%
$14,872 ………… Down Payment
$30,470 ………. Total Cash Costs
$31,900 ………. Emergency Cash Reserves
$62,370 ………. Total Savings Needed