Apr282014

Should new housing bubble fears stop home shoppers?

Rather than react with excitement and increased urgency, potential homebuyers fear rapidly rising home prices signal a new housing bubble. Does it?

home_price_appreciation_fairyCalifornia endured three large housing bubbles since the early 1970s. Each one was kicked off by a huge house price rally, inflating prices well beyond any reasonable fundamental measure. From early 2012 to mid 2013, the house price rally was just as steep as previous price surges, but not as long in duration. Cautious home shoppers fear this latest rally may signal yet another housing bubble, but rather than purchase for fear of being priced out forever, buyers wait or decide to safely rent instead.

I consider this cautious behavior a great sign for housing. In the past, realtors could have scared buyers into action or appealed to their greed, but today those tactics fail more often than they work, partly because buyers are still weary after the recent bust, and partly because realtors have no credibility. Potential homebuyers react today with fear and trepidation when prices rise for no reason, as they should. Belief in the magic appreciation fairy is dead.

To determine if a housing bubble exists, potential homebuyers need a measure of value to base their decision on. The main reason I developed the system on this site that displays the cost of ownership calculations compared to rent is to establish a benchmark of reasonable value. In short, I want to identify housing bubbles and help people avoid them. I saved many people from financial ruin by writing about the last housing bubble. If I had this site with these calculations in place back then, I could have saved many more; next time, it will be different.

The most recent data is clear: we are not in a housing bubble — at least not yet. The long-term chart below has three important lines: median resale (purple), rental parity (green), and historic value (orange). For the last nine months, those three lines have been one on top of another, strongly implying a fairly-valued market.

OCHN_OC_Housing_Market_Report_2014-4

Relative to rent, house prices are similar to the stable period from 1993 to 1999. And the new mortgage regulations will prevent future housing bubbles because the “Ability to Repay” rules will prevent reckless lending. That being said, it’s always wise to be cautious. If we do start inflating another housing bubble, it will show up in the data, and I will sound the alarm.

A new housing bubble?

Analysis finds home prices are rising at an unsustainable rate and that many mortgages would not perform well under economic stress.

By Edward J. Pinto and Stephen D. Oliner, April 23, 2014, 6:47 p.m.bagholder

Even though the recent financial crisis is barely in the rearview mirror, risk is starting to build once again in both the U.S. mortgage and housing markets.

Contrary to the prevailing view that only borrowers with pristine credit records can get a mortgage these days, many risky loans are still being made.

Barney Frank, co-author of the Dodd–Frank Wall Street Reform and Consumer Protection Act, was recently interviewed about the lobbying to water down the law. He lamented that the elimination of the qualified residential mortgage standard made it possible to underwrite many sketchy home loans without endangering the banking system and running afoul of the qualified mortgage rules.

A new index published by the International Center on Housing Risk at the American Enterprise Institute measures this risk month by month, based on about three-quarters of all home-purchase loans extended across the country. And the index clearly shows that many of today’s mortgages would not perform well under stressful conditions. This conclusion holds for the nation as a whole and for nearly every state individually, California included.

Here’s why. In recent months, fully half of all the home loans covered by the risk index had a down payment of 5% or less.

(See: The minimum down payment should be at least 10%)house_poor

With so little money down, those borrowers would be underwater with only a modest decline in housing prices. In addition, for nearly half of the recent loans, borrowers’ monthly payments on their mortgage and other debt exceeded 38% of their pretax income, the traditional threshold for acceptable payment burdens. Such borrowers could find it difficult to make their monthly payments if they came under even moderate economic stress, such as a temporary layoff or a reduction in work hours.

Many loans are above 38% because the new threshold is 43% (See: Will lenders circumvent the 43% debt-to-income cap?) Their study is measuring for standards they know most mortgages won’t meet.

The Federal Housing Administration is the prime source of this risk. It now guarantees more than a quarter of the newly originated home loans, and it does so with little regard for risk. Under the banner of expanding homeownership, the FHA provides risky loans to households that often lack the resources to make the payments if anything goes wrong.

This was done purely as a bailout for the banks to prop up prices at artificially high levels to maximize the capital recovery on the bank’s bad loans — at taxpayer expense.

Home prices are also rising at an unsustainable pace. For the nation as a whole, prices increased 11% last year, according to the S&P Case-Shiller index. The jump was even larger in the major California markets: 21% in Los Angeles, 23% in San Francisco and 19% in San Diego.

Homeowners over the last two years enjoyed a significant increase in the value of their homes, despite the leveling off over the last several months.

OCHN_OC_Housing_Market_Report_2014-4

The Fed’s easy monetary policy, which has kept mortgage rates very low, has been a key factor behind the rise in house prices. Another factor has been strong investor demand for distressed properties. At the same time, the supply of available homes has been limited.

Those three sentences nicely sum up the 2012-2013 house price rally.magic_house_realtor

Housing starts, while up from their lowest point, remain well below normal, in part because builders shed capacity during and after the recession. Reflecting these factors, house prices in the hotter markets around the country may already be above the levels warranted by household income, rents and other economic conditions.

Does this mean we are likely to see another housing bubble? That’s hard to say. Nonetheless, the risk of a price overshoot of some magnitude is especially high in California.

The need for the data on the cost of ownership found on this site will help combat the overshoot by dissuading some buyers from overpaying.

According to Fitch Ratings homes in Los Angeles, San Francisco, Oakland and San Diego are overvalued by 20% or more. Other analysts see California markets as fully valued rather than overvalued. But even if this is correct, it is worth noting that historically, many areas of California have had extremely volatile home prices.

Given that risk is rising, how should a prospective California home buyer decide whether to jump into the market? Start by comparing the price of a home you are considering to what it would cost to rent.

I couldn’t agree more. I’m actually pleasantly surprised to see this idea promulgated in the mainstream media. Everything I’ve worked to accomplish on this site is based on that idea.

OCHN_OC_Housing_Market_Report_2014-4

Even if a house appears to be a good deal, the more important question is whether it’s something you can comfortably afford. To gauge whether the mortgage you would be taking on is affordable, …

We publish a guide to rent or own decision, and a home financing guide to address affordability.

With house prices already up substantially from their lows, today’s home buyers need to pay close attention to risk. Prospective buyers can protect themselves by using newly available tools to analyze local market conditions, and by realistically assessing their own financial situations before making such an important decision.

Home shoppers today are right to be concerned about another housing bubble. It wouldn’t surprise me at all to see a reaction bubble form over the next few years as housing stimulus designed to bring up the non-performing markets overcooks our market. (See: Overcooking a recovery ripens a housing bubble) The tools on this site are designed to help spot this bubble if it forms and direct people to the properties with the best cost-to-rent ratio available in the market. Perhaps the new mortgage regulations will prevent future housing bubbles, or perhaps not. It’s best to be cautious and prepared.

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