Payment affordability is very high by historical standards. That means people who borrow most of the money to buy a home — which is about 70% of buyers — the cost of monthly payments is low relative to a borrowers income. But is this a good measure of affordability? A recent paper argues it is not. Further, they argue that affordability is still a major problem hindering demand.
I recently wrote about this issue in Record low interest rates fail to spur demand. 
Interest rates are at record lows, and prices are at or below rental parity in most markets, yet demand is low and sales volumes are weak. Most real estate shills blame intransigent buyers. Many realtors believe legions of buyers are fence-sitting due to falling prices. In their world, if buyers could just be cajoled into buying, everything would be okay.
The main reason buyers aren’t buying is because they can’t. The buyer pool has been depleted by the recession. Fewer buyers qualify for loans because they have bad credit from excessive debt loads or a recent foreclosure or short sale. Plus, few people have the requisite down payments to buy a house at California prices. Prices are now affordable on a monthly payment basis, but until people go back to work, repair their credit, and form new households, demand will remain weak. Further, since the collapse of prices has wiped out so much equity, there is no viable move-up market. This will be a drag on high-end pricing for many more years. Expect to see high-end prices languish even after the bottom tier of the market finds stability.
The authors of the paper above have a different view.
Why Housing Affordability Is a Mirage
June 14, 2012, 2:35 PM
Home prices and mortgage rates have made monthly mortgage payments lower than at any time in the past decade. But housing isn’t any more affordable than it was five years ago, during the go-go lending days, after factoring in down payment requirements and other financing terms, according to a new paper.
The National Association of Realtors and other housing economists typically measure housing affordability by looking at home prices and mortgage rates. Prices of course have fallen to nearly 10-year lows nationally, while rates have never been lower. Freddie Mac on Thursday said rates stood at 3.71% this past week for the average 30-year fixed-rate mortgage.
I have made the same argument and same observation in our market. The record low interest rates have made the cost of ownership lower than the cost of a comparable rental and in many areas lower than historic norms.
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But the total cost of homeownership, as a share of a borrower’s income, is the same today as it was during the height of the housing mania, according to the study by Andrew Davidson and Alexander Levin of mortgage consulting firm Andrew Davidson & Co.
The reason: borrowers have to put more money down to get a loan, and the exotic lending products that allowed borrowers to make low initial payments have gone away. That means while the absolute monthly payments are lower, the all-in costs of homeownership haven’t become more favorable. …
“Home affordability needs to be considered in light of the full financing package,” said Mr. Davidson. “During the bubble the low all-in cost of mortgage financing allowed borrowers to purchase homes, even at inflated prices.”
The erosion of down-payment requirements from 2000 to 2006 reduced borrower costs by around 15%, according to Messrs. Davidson and Levin, while tighter down-payment standards since 2006 have raised borrower costs by 22%. That more than offsets the benefit of a drop in interest rates from around 6% to less than 4%.
Their conclusions are erroneous. They have assigned an unrealistically high cost to the equity component of home ownership. Their basic argument is that the increased cost of equity when applied to the increased equity requirement drives up the cost of ownership to match the bubble-era. This is wrong.
First, this is an issue I explored at length in the post on Ownership cost: taxes and opportunity costs:
Calculating Opportunity Cost
Projecting future costs is more an art than a science. Trying to estimate the opportunity costs of an average investor over the life of a 30-year mortgage is a guess at best. However, since this opportunity cost is real, there are useful theoretical models for providing an estimate to use in decision making.
Interest rates on savings are tethered to mortgage interest rates as all debt and deposit instruments are tied together in the web of risk and return in the debt market. The loosely correlated relationship between mortgage debt and reliable savings returns like medium-term Certificates of Deposit is the basis for estimating opportunity cost.
When mortgage interest rates are very high, the demand for money is high, and lenders will be paying high CD rates to try to supply the demand for money through loans. The inverse is also true. When lenders do not need money to loan, interest rates fall, and lenders do not need to pay borrowers much for money. Plus, in a deflationary environment the lender has no reliable customers to loan the money to anyway.
This direct relationship between mortgage interest rates and CD rates — irrespective of how loosely correlated they may be — is the basis of my calculation. I make the following assumptions:
- CD Rates will never fall below 1%.
- As mortgage rates go up, CD rates will go up 66% as fast.
When I put in different test numbers, the stretching spreads this formula creates does re-create the same phenomenon that happens in the real world when inflation expectation is added into the market’s thinking.
We have the ability to override our default settings and put in whatever inputs you believe most accurately reflects your financial situation in our reports.
The paper argues that equity has gotten significantly more expensive as interest rates have dropped, but this is not accurate. Opportunity costs on equity have fallen along with interest rates. Do any of you know where you can find safe investments with higher yields than 2006? I rather doubt it.
Further, this paper uses this falty reasoning and analysis to make its main point that sales are weak despite low interest rates because consumers have a high cost of equity capital. This conclusion is also wrong.
Back to the article:
At the peak of the housing bubble, loan payments were the only cost that borrowers had to consider given the ability to take out no-money-down loans. But today, loan payments constitute roughly 50% of the total cost of ownership “and are rather modest by historical standards,” the paper says. “This explains why the record-low interest rates do not impress borrowers and do not propel home prices up.”
The reason low interest rates have not prompted more buying is not the cost of equity capital, it’s the availability of equity capital. People don’t have the money! They’re broke! It doesn’t matter what value is assigned to capital you don’t have.
This paper attempts to explain the slow pace of sales due as a function of the cost of equity capital. It’s not. The real reason sales are slow despite record low interest rates are as follows:
- With so many people going through foreclosure, the buyer pool is seriously depleted which reduces overall demand.
- With falling prices, few existing homeowners have equity, so the move-up market is effectively paralyzed which also reduces demand.
- The protracted recession has left few first-time buyers with sufficient savings to make a down payment — even a paltry 3.5%.
With fewer total buyers and with the two main sources of buyer equity being depleted, demand is low despite low interest rates. Lenders could reduce interest rates to zero, and it still wouldn’t increase demand much from where it is today. The availability of down payments is what’s keeping demand in check — and that’s a good thing. We tried eliminating down payments during the bubble, and we saw what became of that experiment.
As a further example of this paper’s lack of basic understanding of the issues it explores, I offer the following section on Options ARMs, the Ponzi loans responsible for inflating prices.
The negative amortization volume also has a remarkable coincidence with HPI (home price index) booms and busts, although it remains a chicken-and-egg dilemma.
Option ARMs could only be offered with confidence that home prices would grow. The low-cost financing they offer propels HPI further. Once the HPI reached its peak, Option ARMs stopped being offered. Their death caused HPI to decline deeper as new homebuyers could not afford the prices paid by previous owners who used Option ARMs.
This is not a chicken-and-egg dilemma. This is a PONZI SCHEME! Option ARMs are Ponzi scheme loans. Any loan which does not amortize is a Ponzi scheme loan because it requires rising prices for it’s success. When prices don’t rise, these loans blow up, borrowers stop paying, lenders stop lending, and the resulting credit crunch sends prices spiraling downward. These authors fail to recognize the mechanism by which the housing bubble was inflated and exactly what caused it to pop.
The paper did have a bright spot. The opening paragraphs showed they do understand the dilemma posed by interest rates:
One of the most complex and controversial subjects of home-price modeling is the role of interest rates. … When rates grow, affordability, and therefore, home prices decline. However, over a long period of time, higher interest rates paired with higher income inflation will ultimately push housing values up.
I explored this issue in Will rising interest rates cause house prices to crash?
At today’s 4% interest rates, borrowers can comfortably leverage over five times their yearly income. The 40-year average for interest rates is 9%. At that interest rate, a borrower can only leverage three times their yearly income. The old rules-of-thumb about borrowing three-times income are relics of a bygone era. But what happens if those interest rates come back? Four percent interest rates are not a birthright. In fact, interest rates have only been this low one other time in the last two hundred and twenty-two years.
As is evident in the very long term chart of interest rates above, the interest rate cycle is very long. Alan Greenspan presided over a twenty-five year period of declining interest rates. Much of the increase in value of real estate is attributable to decreasing borrowing costs over that time. Inflation was relatively tame, so Greenspan always had the luxury of lowering interest rates to increase economic activity. Those days are gone.
When the interest rate cycle reaches bottom, the value of the currency declines, and cost-push inflation becomes an issue. As Americans want to buy products from overseas, it takes more and more dollars to do it because the currency is declining in value. Unless we get a commensurate increase in our exports (or cheap money from China), our standard of living will decline. During the cycle of rising interest rates, central bankers raise interest rates to combat inflation and protect the value of the currency, but they are always one step behind. When Bernanke finally does start raising interest rates, we will be embarking on the next multi-decade rising cycle where inflation is a constant problem.
If interest rates go on a sustained rise, financing home purchases will become more expensive. That is the math. The real question then is whether or not these rising interest rates are compensated for by rising wages. If wages rise as fast as interest rates do, then borrowers will still be able to finance large sums, and house prices can remain stable or even rise. However, if wages do not rise as interest rates go up, then loan balances will decline, and house prices will fall again. Given the choice between inflation and falling house prices, which do you think Bernanke or a future central banker will chose? After the all-out effort they have made to prop up house prices over the last several years, I suspect they will chose inflation, a devalued currency, and steady house prices over a strong currency and falling house prices.
So is current housing affordability an illusion?
I don’t think so. Any buyer (who can find a property) can lock in a low fixed-rate mortgage with a cost of ownership less than a comparable rental. That is real, tangible affordability. Sure it would be nice to pay less in total, but that isn’t the world we live in, nor is it likely to be in the foreseeable future.
Orange Overview
Median home price is $399,000. Based on a rental parity value of $520,000, this market is under valued.
Monthly payment affordability has been improving over the last 2 month(s). Momentum suggests unchanging affordability.
Resale prices on a $/SF basis increased to $239/SF to $241/SF.
Resale prices have been weak for 12 month(s). Price momentum suggests weak prices over the next three months.
Median rental rates increased $50 last month from $$2,106 to $$2,157.
Rents have been slowly rising for 12 month(s). Price momentum suggests slowly rising rents over the next three months.
Market rating = 6
Proprietary OC Housing News home purchase analysis 
3901 East ALANDA Ave Orange, CA 92869
$359,900 …….. Asking Price
$150,000 ………. Purchase Price
7/9/1998 ………. Purchase Date
$209,900 ………. Gross Gain (Loss)
($12,000) ………… Commissions and Costs at 8%
============================================
$197,900 ………. Net Gain (Loss)
============================================
139.9% ………. Gross Percent Change
131.9% ………. Net Percent Change
6.3% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$359,900 …….. Asking Price
$12,597 ………… 3.5% Down FHA Financing
3.74% …………. Mortgage Interest Rate
30 ……………… Number of Years
$347,304 …….. Mortgage
$91,746 ………. Income Requirement
$1,606 ………… Monthly Mortgage Payment
$312 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$90 ………… Homeowners Insurance at 0.3%
$362 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
============================================
$2,370 ………. Monthly Cash Outlays
($244) ………. Tax Savings
($524) ………. Equity Hidden in Payment
$16 ………….. Lost Income to Down Payment
$110 ………….. Maintenance and Replacement Reserves
============================================
$1,728 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$5,099 ………… Furnishing and Move In at 1% + $1,500
$5,099 ………… Closing Costs at 1% + $1,500
$3,473 ………… Interest Points
$12,597 ………… Down Payment
============================================
$26,268 ………. Total Cash Costs
$26,400 ………. Emergency Cash Reserves
============================================
$52,668 ………. Total Savings Needed
——————————————————————————————————————————————-
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$445,000 377 South HEATHERSTONE St |
0.19 miles 4 bd / 2 ba 1,632 Sq. Ft. |
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$350,000 11842 South ESPLANADE St |
0.36 miles 4 bd / 2 ba 1,577 Sq. Ft. |
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$250,000 275 South ESPANITA St |
0.44 miles 3 bd / 1 ba 1,246 Sq. Ft. |
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$289,900 285 South ESPANITA St |
0.44 miles 2 bd / 1.75 ba 1,000 Sq. Ft. |
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$340,000 4404 East WALNUT Ave |
0.74 miles 3 bd / 1.75 ba 1,392 Sq. Ft. |
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$499,000 12846 OLD FOOTHILL Blvd |
0.82 miles 3 bd / 1.75 ba 1,538 Sq. Ft. |
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$289,900 18792 East EL SALVADOR Ave |
0.96 miles 3 bd / 2 ba 1,255 Sq. Ft. |
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$339,900 2337 East WALNUT Ave |
1.18 miles 3 bd / 2.5 ba 1,147 Sq. Ft. |
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$425,000 245 North HIGHLAND St |
1.2 miles 3 bd / 2 ba 1,333 Sq. Ft. |
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$395,000 228 North HIGHLAND St |
1.22 miles 3 bd / 1.75 ba 1,422 Sq. Ft. |
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26 Responses to “Is the current housing affordability an illusion?”
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Since the skew-effect of inflation illusion on house prices would also apply when measuring affordablity, indeed, current affordability is clearly an illusion.
People need jobs to buy homes. Who would have guessed that?
Market Hinges on Sustained Increase in Employment: Harvard Study
Sales are down, then they’re up. Home prices are up, then they’ve fallen. Clearly, it has been an unstable journey for the housing market, with hopeful reports dashed by disappointing data a month later. As the market tries to maintain confidence that it’s riding on a recovery that is here to stay, what does it need to continue strengthening?
“What the for-sale market needs most is a sustained increase in employment to bring household growth back to its longterm pace,” the Joint Center for Housing Studies of Harvard University concluded in a report.
“While still in the early innings of a housing recovery, rental markets have turned the corner, home sales are strengthening, and a floor is beginning to form under home prices,” says Eric S. Belsky, managing director of the Joint Center for Housing Studies. “With new home inventories at record lows, unless the broader economy goes into a tailspin, stronger sales should further stabilize prices and pave the way for a pickup in single-family housing construction over the course of 2012.”
However, the Harvard study also noted that the backlog of foreclosures and millions of underwater homes may keep recovery in the owner-occupied market fairly subdued.
While the owner-occupied market is struggling,the rental market, on the other hand, is growing strong and is yet to realize its full potential.
The foreclosure crisis and the aging of the population have already helped the rental market grow, but it may see a wave of demand from the echo boom generation as well.
While definitions vary, the echo boom generation typically includes those born from 1980 to the mid-90s.
As young people under age 25 find it difficult to live on their own, fewer households are dominated by an age-group that has a proclivity towards renting.
If economic conditions improve, echo boomers might find themselves living on their own, leading to an increase in demand in the rental market.
Aside from the rental market, the owner-occupied market may be awaiting a major boost if economic conditions improve and maintain progress.
Recent surveys have revealed that most Americans still aspire to own a home, but it’s the economy that is shaking up their confidence.
“Surveys consistently find that the overwhelming majority of young adults plan to own a home in the future, but many would-be buyers have stayed on the sidelines waiting for the job outlook to improve and house prices to stop falling,” said Belsky. “But as markets tighten, these fence-sitters may begin to take advantage of today’s lower home prices and unusually low mortgage rates. With rents up, home prices sharply down, and mortgage interest rates at record lows, monthly mortgage costs relative to monthly rents haven’t been this favorable since the early 1970s.”
For example, a Fannie Mae survey for May 2012 revealed that 72 percent of consumers believe now is a good time to purchase a house, but the percentage of respondents who said they would buy a house after moving dropped for two consecutive months, averaging 63 percent in May compared to 66 percent in March.
Also, a separate survey from Integra Realty Resources found that 85 percent of potential buyers said market conditions are favorable for purchasing a home, but uncertainty about the economy prevents them from making a purchase.
According to the report, the excess housing supply is due to a sharp slowdown in household growth in 2007–2011, not from overbuilding, and the lack of household growth stems from a decline in the rate at which people form their own households and a drop in immigration.
“The country has seen new household formations fall well below expected long-run rates due to a falloff in young adults being able to move out on their own and a slowdown in net immigration. Even in 2011, fewer than 700,000 households were added and that’s well below the 1.2 million or more annual trend expected under more normal economic conditions,” said Chris Herbert, Director of Research at the Joint Center for Housing Studies.
However, assuming there is a sustained recovery in the next few years, the report expects for the growth and aging of the current population alone, which includes the entrance of the echo boomers into adulthood, to support the addition of about 1 million new households per year over the next decade.
Speaking of jobs….
100% of U.S. Jobs Added Since 2010 Have Been Self-Employment, Contractor, or Other Jobs Without Unemployment Insurance Benefits
http://globaleconomicanalysis.blogspot.com/2012/06/100-of-jobs-added-since-2010-have-been.html
As predicted, new home sales are picking up the slack due to a lack of MLS inventory. The customers who would be mopping up the bank’s mess are instead turning to homebuilders. When the banks start increasing MLS liquidations, look for homebuilders to sputter.
Irvine Co. sells out 4 new-home projects
Irvine Co. says it’s now sold out four new-home neighborhoods in north Irvine this year, bringing its total of completed and sold-off projects to 16 since it began its homebuilding push in January 2010.
Sold out in 2012:
Santa Cruz in Woodbury East, 112 units by Van Daele Homes.
Santa Rosa in Stonegate East, 70 units, also by Van Daele
Capistrano in Stonegate East, 95 units by Irvine Co.’s Irvine Pacific
Montecito in Woodbury, 62 units by Brookfield Homes
When the Irvine Co. restarted homebuilding two-plus years ago, they initially hired builders like Van Daele and Brookfield to construct and market the residences. Irvine Co. now builds and markets their houses on their own through the Irvine Pacific brand.
Early in 2010, it looked like the Irvine Co. was taking a huge gamble in a barely advancing economy. In hindsight, it was near-perfect timing.
All of the neighborhoods opened in January 2010 have sold out and in total Irvine Co. says 2,019 of its new homes have closed sale since January 2010. This year alone, Irvine Co. has sold 525 new homes.
Tom Veal, VP for sales and marketing for Irvine Co. homebuilding efforts, said his company is finding traffic and homebuying at their projects at levels not seen “since the good old days.” Countywide homes sales — new and used homes — run at 2006 levels, DataQuick says.
Veal says the small supply of the old homes for sale — by many counts its been cut in half in two years — has helped Irvine Co. efforts “tremendously.” And the recent surge in buying of resale homes he finds “very encouraging.”
Waiting for el O to explain this.
I have bought 2 properties in the last year and I am under contract for another(pending SS approval).
When the fully impounded mortgage payment is 55% – 80% of rent, I am temped by the cash flow.
People are always ”tempted by the cash flow”. But, the current financial systemic failures are insolvency-based, NOT illiquidity-based.
1) current debt-asset price model is based on the continuance of negative real rates
2) as time passes, rising input/carry costs diminishes cash flow
3) current trust between counterparties is rapidy fading….
..whatever the rate of cash flow may be, since every dollar of the money you think you have is someone elses debt, it’s only as good as that someone elses intent or abilty to pay interest on it.
No. Housing is not affordable. Take that chart of rates dropping and mirror it with the percentage of the market share FHA loans have taken. They should be pointing in almost the exact opposite direction. We’re seeing $120kpy income buyers scraping together 3.5% or getting gifts for the down and closing costs from parents. To me that’s a clear sign that rates could be zero, but if you can’t afford to put some cash into it, the price of the home is unaffordable.
My .02c
Agree. Double income coworker and hubby just bought a nice home and needed help from both of their parents for the down. Wish my parents were able to help or my in-laws willing to.. Nevermind I would still wait to buy.
Since the market is suffering due to lack of down payment money, there will be enormous pressure on politicians to reduce or eliminate them. Obviously, I think this would be a huge mistake, but it wouldn’t surprise me if some bright politician will propose it. realtors will certainly endorse the idea, and with taxpayer backing, lenders won’t have issue with funding it. The result will be to reflate the bubble, completely nationalize housing, and accrue enormous losses to taxpayers.
If the commis were based entirely on the downpayment, the banksters and RE agents would be advocation otherwise. Most people don’t live in a house for the fully amortization period of the loan. Five to ten years is more likely. If the intestest rates goes up without wage increases, the house price will drop. It will be like a ballon payment on the house that due upon moving. Save now — pay later. If the loan owner has no skin in the game with the 0% to 3.5% down and the market drops, the best option is a walkaway loan in non-recourse states. The best option is for the loan owner and not the taxpayers stuck with the bill. Another party with big expenses that will show up on the taxpayers’ bill or kids tax bill years to come.
I feel foolish for not buying and taking the 5% back loan in 2005 for a new house.
Location with timing is everything in this market.
Malinvestment rages-on along with capital destruction…..Calif leading the charge again…… LMAO!
Rancho Financial brings back stated-income mortgages
http://www.housingwire.com/news/afgfdrt
I dislike the general term anyway of housing affordability what with the NAR’s calculations that…”(during) the entire run up preceding a 35% drop in prices, the NAR HAI had but one month where homes where not deemed affordable.” – The Big Picture Blog.
You’ll never hear a NAr agent say housing isn’t affordable.
Yes, I too kick myself for not buying a $1,000,000 home with a Stated Stated Option ARM – one offered by World Savings. I wouldn’t have to have made a payment after 2007. Once Wells Fargo took over they were paying people to get out of the house without credit blemishes, writing down balances left and right. I was at a realtor meeting once where one of the Wells Fargo / World savings employees spoke who was empowered to make credit and value decisions on the spot, no committee, no wrangling, just a look see, a form to sign, and you walk away quietly. Good times!
Not that I wasn’t already hearing a sufficient number of alarm bells when buying in 2007, but when talking to the loan originator associated with the developer, she was shocked that I was insisting on a 30 year fixed mortgage – “Are you sure you don’t want the flexibility and low rate/payment of an ARM or Option ARM. Everyone is using these loans.”
In hindsight, I should have gone with the shortest fixed-period ARM available in 2007. If my rate had been adjusting with the market, since 2008, I would have paid a lot less interest…
Getting a standard ARM in ’06 was one of the best decisions I’ve made. My rate has dropped from 5.125 down to 2.875 most recently. Not only has the interest expense been reduced, but my principal amortization has doubled in velocity. The people that have spent the past 5 years bashing ARM loans really need to distinguish them from Option ARMs which truly are ticking time bombs for most people that have them.
Pure luck on your part muchacho…. deflation was/remains the prevailing influence, hence your rates went down instead of up.
What I cannot reconcile is why would anyone– who believed as strongly as you did that inflation was going to rise– obtain an ARM in the first place……
I have a friend with double my mortgage and half my household income, yet he’s so smug informing me of his latest ARM adjustment. His rate is below 3%. To refi into a fixed-rate loan he’d have to pay 200+ bps more because it’s a jumbo high LTV. So he keeps rolling the dice thinking he’ll refi “when rates start increasing.” Good luck!
el O-
My opinion about inflation was formed post-crash and had nothing to do with which mortgage product to use in ’06. Like IR, I believe that the Fed is always late to the game when it comes to fighting inflation. As for luck, I don’t believe in it. Successful people calculate the odds and make the best decision for their situation, which is what I did in selecting a mortgage, both in ’06 and ’10.
MR says: but my principal amortization has doubled in velocity.
——————————————————
….now back down to Earth….
dude, what has also doubled in velocity is the devaluation aspect of the condo you bought in 06. So, your v in PA is essentially a wash, NOT ”doubled”. just say’n
Oh… but wait…. you calculated those devaluation odds prior to agreeing to the mort payment. LOL!
Believe it or not, devaluation scenarios were something that I considered, although the scope of the crash ended up being larger than I expected.
ARMs are like walking across a road blindfolded. You might get to where you want to be, and you will be blissfully ignorant to the dangers of the journey, but if things go wrong, they can go very, very wrong.
That’s the way I feel. You are gambling with your best expensive. By the way, we can get into a printing war with the Euro IF Greece votes to stay in, we will know after this summer. So, I still think interest rates will go up.
Fixed rate mortgages have risks as well. Lansner used to claim he had the same fixed rate loan since 1994. Thinking about the excess interest he’s paid for all those years makes me cringe.
The argument that fixed-rate mortgages don’t have the same benefits of ARMs is simply wrong. Fixed-rate loans have the same downward-adjusting feature of an ARM through refinancing. Every time interest rates drop, most people with FRMs refinance and lock in the lower rate. Only the ARM can go up.
Let’s be realistic. You were lucky. You caught the last several years of a 30 year down cycle of interest rates. It could have just as easily gone against you. Instead of patting yourself on the back for your good call, you would be watching your payments steadily rise as interest rates go back up.
BTW, now that interest rates are zero and mortgage rates are at unprecedented lows, have you refinanced to a fixed-rate mortgage yet? Or are you planning to ride the payment back up when rates revert to the mean?
As the values of higher end homes drop, due to lack of buyers able to buy up and the many that will hit REO at some point, do you think this will result in a knock down effect on prices down the chain based on what money can get you?
I wonder the same thing. It *seems* like it would logically have to, certainly for the houses in the price category directly below the lower-end of high-end, and if that is the case, it seems like there ought to be a downward ripple effect. But then, nothing about So Cal RE ever seems very logical, so who knows….!
No. They hypothesis is that move-up buyers have dried up because incomes haven’t kept pace with house prices (which means they can’t afford it on the basis of a higher income), and appreciation of their current house has crashed (which means they can’t afford it on the basis of winning at the Ponzi game, i.e. selling their asset to a bigger fool at a much higher price).
So that implies three things:
(1) Some would-be trade-up buyers will lower their sites, and try to move up less. That transfers their buying pressure to lower-priced houses.
(2) Some would-be trade-up buyers will be frozen out of the market entirely, unable to move up or even sideways. So they won’t sell their present house. That reduces the inventory of lower-priced houses for sale.
Both effects tend to stabilize (if not bump up slightly) the price of lower-priced houses, relative to higher priced houses. I think IR has made the point elsewhere that you can expect the higher end to fall for some time after the lower end has stabilized, for more or less just these reasons. Only after the lower end has actually appreciated for a while will the higher end stabilize.