As I review the housing numbers each month, I see local housing prices rising quickly and no return of inventory to blunt the increases. Given those conditions, it’s likely that prices will continue to rise in 2013, perhaps significantly. What’s somewhat surprising to me is that my purely mechanical rating system continues to show improvements in market timing. I thought that rising prices would reduce affordability and cause the ratings to drop. That isn’t what’s happening. The declining interest rates have more than offset the rise in prices. In fact, housing affordability as measured by the monthly cost of ownership was at the lows for the year in November and December of 2012. There is still plenty of room for prices to be pushed higher before payment affordability becomes a problem.
Despite the bullish signs, there are many reasons to believe the recent market recovery is just another artificial market manipulation destined to fail when the artificial constraints and props are removed. One of the few remaining housing bears, Mark Hanson, reminds us why the so-called market recovery is not as robust as portrayed in the mainstream media.
by Mark Hanson on January 7, 2013
The overarching problem in resi housing is that it takes massive direct stimulus in order for it to respond.
This is one of the inconvenient truths the bulls don’t want to acknowledge. The interest rate stimulus over the last six years has been tremendous. We have quite literally cut interest rates in half since mid 2006. This increases payment affordability significantly. Rather than watch the nominal price of houses overshoot historic norms to the downside, by reducing interest rates, house prices are supported at inflated levels while the monthly cost of ownership overshoots to the downside. Payment affordability is the lowest relative to rents back to the limits of my data in 1988, perhaps ever.
For example, we saw conditions similar to what we are seeing today off the 2009/10 Home Buyer Tax Credit.
And we all know how that turned out. What happens if interest rates rise to 4% this year?
Now, 6-years after housing rolled over the sector to responding to unprecedented rates stimulus and the Federal / State Gov’t and banks’ national supply suppression efforts vis a’ vi mods, workouts, new laws, and outright delays.
Interest rate stimulus and supply suppression is what caused the bottom in 2012. These are artificial market manipulations, not the workings of a capitalist free market.
This time around the sector only responded after they pushed mortgage rates to levels that made it prohibitive NOT to borrow and buy and inventory to levels not seen in a decade.
As I stated above, my mechanical reports are very bullish right now. The payment affordability is so good, it’s cheaper to own than to rent in most markets, and in some markets its MUCH cheaper to own than to rent. These conditions make it prohibitive to stay on the fence. Anyone who can buy should buy with these conditions in place despite the risks.
They literally had to eradicate foreclosures and re-lever millions of bad borrowers into more exotic and toxic loans than from which they defaulted from in the first place through ‘modifications and workouts’ in order to set a stage in which housing would not drop.
Mark is correct in pointing out that the terms of most loan mods strongly resembles an Option ARM. Most of these mods have teaser rates which will rise to the market over time, many have negative amortization or interest-only features recently banned under qualified mortgage rules, and since missed payments, penalties, fees, and lost interest were merely tacked on to the loan balances, many of these borrowers are deeply underwater and have growing balances. This is one of the many reasons most of these loan modifications will fail.
So in short, we have a housing market almost exclusively dependent on rates stimulus and supply suppression. They rigged the market creating absolutely unsustainable supply and demand conditions — in the midst of a severe stimulus hangover from the 1.5 year long home-buyer tax credit that ended mid-2010 — and still residential housing could not reach escape velocity in 2012 and the YoY Case-Shiller did not even come within a country mile of the 15% increase in purchasing power (on flat incomes) buyers enjoyed from the 30% YoY drop in rates.
The reason escape velocity was not reached is because all along they haven’t thought this through well enough. As with the 6-year perma ZIRP and QE stimulus policies – they thought would be short term intrusions that lit the market on fire from which a self-perpetuating recovery would occur — it’s not turning out this way. That’s because everything in housing and mortgage markets’ bones wants to de-lever, which takes ‘decades’ not ‘years’. And the constant re-leveraging efforts only serve to lengthen the time it takes to truly de-lever.
What astonishes me is that policy makers truly believed they could ignite a self-perpetuating rally in the housing markets by applying short-term artificial stimulus. The only reason I think they may have moderate success in supporting prices now is because they are committed to near-permanent stimulus and inventory control for as long as it takes for housing to recover. Basically, we are committed to a path of housing market nationalization.
Where Escape Velocity Resides
In single family housing specifically, the 20+ MILLION mortgage’d homeowners without the equity to sell (pay a Realtor 5% and put 10% to 20% down on a new house) and rebuy (good credit and stable employment) is a perfect example of how much de-leveraging still must occur.
This is why the move-up market is nearly dead and will continue to be for another decade or longer. A third or more of a typical market is completely absent because they either bought too late in the rally or they HELOCed themselves into oblivion.
This group in a negative and ‘effective’ negative equity position throughout history has always been the sectors largest cohort of demand and supply. Now they are all dead to the market; they are zombies. They must be replaced in order for sales volume and prices to increase.
The main reason the conforming limit was raised from $417,000 to $729,750 in 2008 was to replace as much of the move-up cohort as possible with first-time homebuyers. There will be continued pressure to raise this limit in the future to bail out the banks, but so far, the Obama Administration has resisted this pressure and actually lowered this limit on GSE loans. Continued financial pressures at the FHA may compel them to do the same. Any continued lowering of the conforming limit will have a dramatic chilling effect on the move-up market.
In times of massive stimulus other cohorts show up to fill in some of the hole — private and insti investors for example — but they don’t have the numbers, capital, or staying power to sustainably replace the 10s of millions of zombie homeowners that 6, 16, and 60 years ago were the sectors drivers.
The sad part is that If they would have just let another 6 to 10 million foreclosures actually occur over the past 4 years there would have been demand for the purchases and lots of rental demand for all the investor landlord trades. Now they have neither.
I have long argued that foreclosures are essential to the economic recovery. More foreclosures would have hastened the deleveraging process, made houses more affordable, and put stable homeowners with equity in properties rather than zombie loanowners. Of course, such deleveraging would have cost the banks billions of dollars, so we took another path.
Why will 2013 bring better conditions?… Will mortgage rates go even lower than 3.5%?
Will income or take home pay increase dramatically?
No. Not in the face of continued high unemployment.
Will employment improve especially among the younger household formation cohort?
No. Unemployment among younger households will recover last.
Will taxes or energy prices drop?
No. Not a chance.
Will rents increase amidst the greatest surge in multi-family construction and rehab in decades?
No. As new supply comes on line, recent rent increases should moderate substantially.
In 2013 fundamental macro conditions must improve dramatically in order to achieve the same results as the housing and mortgage sectors from unprecedented rates stimulus in 2012. This is a stretch by any measure.
On residential the more likely outcome for 2013 is:
a) The only way for rates to improve from here is for banks to cut spreads. And with 2013 destined to bring lower resi refi and auto lending and looking to be the year that hundreds of billions in legacy mortgage and housing legal issues are settled or lost, this is a stretch. And remember, to get the same effect as 2012 YoY, rates would have to drop from 3.5% today to 2.625%.
b) The surge in multi-family starts and completions back to 2006 levels will reduce rents and demand for single family purchases.
c) The macro economy with respect to GDP and jobs remains lackluster — the consumer is falling apart right now — and the all-important first-time buyer can’t perform like they did in 2012.
d) 6 million mortgage mods and workouts continue to re-default at record levels.
e) 20+ million mortgage’d homeowners at 80% LTV or greater — without the equity to sell and rebuy (the lion’s share who sit above 60% total DTI) — will keep defaults elevated
This group will also be the source of many new short sales, assuming they don’t decide to default and squat.
f) Investors who have underpinned resi housing move past the ‘landlord trade’ as relative yields are viewed as undesirable. That’s of course unless prices fall, which on a YoY basis I think will occur.
As prices move higher, cashflow investors lose interest. Perhaps some momentum buyers will take up the slack, but those will not be the professionals and hedge funds backed by billions of dollars.
g) Refi burnout: Refi fundings down 33% if rates stay at 3.5%. If they rise to 4%, refis down 50%. If they rise to 4,5%, refi’s down 67%. No matter how you slice it the drop in refi’s in 2013 is a serious consumer and macro economic headwind. …
The Bottom Line
The 2012 stimulus and supply deprived housing trade is now in the books. Thinking 2013 can outperform is extremely wishful. In my coverage universe I must rather press our China bounce related bets than anything related to US housing or the US consumer for that matter.
Real estate is a hotbed of magical thinking. I think most people believe 2013 will dramatically outperform 2012. They will be disappointed. I still think 2013 is a good time to buy, not because prices are about to skyrocket, but because current buyers can lock in a cost of ownership relative to rents that is the lowest in a generation. Buying for cashflow is always a better long-term strategy than buying for appreciation. And over the long term, you usually get both.
The Option ARM that Fannie Mae bought
Many Right-wing pundits blame the GSEs for the housing bubble. In reality, the housing bubble was inflated by private firms bankrolling stupid loans through the secondary mortgage market. Late in the bubble rally, the GSEs, in response to dwindling market share, did contribute to the demand for these toxic products by purchasing them for their own portfolios. Today’s loan was one of the Option ARMs they bought in 2005.
The former owners were minor Ponzis through most of the bubble. They did increase their original $133,487 first mortgage to a $174,000 first mortgage, and they took out a $68,000 HELOC, but by the standards of their peers, they were lightweights. However on 7/27/2005 they took out an Option ARM with a 1% teaser rate for $348,750 and piled on a $40,000 HELOC. That was enough to do them in. It looks like they rode out the teaser rate period, and defaulted in early 2012. Fannie Mae didn’t let them squat very long and took the property back at auction on 9/28/2012.
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Proprietary OC Housing News home purchase analysis
$414,900 …….. Asking Price
$135,000 ………. Purchase Price
9/3/1998 ………. Purchase Date
$279,900 ………. Gross Gain (Loss)
($33,192) ………… Commissions and Costs at 8%
$246,708 ………. Net Gain (Loss)
207.3% ………. Gross Percent Change
182.7% ………. Net Percent Change
7.8% ………… Annual Appreciation
Cost of Home Ownership
$414,900 …….. Asking Price
$14,522 ………… 3.5% Down FHA Financing
3.51% …………. Mortgage Interest Rate
30 ……………… Number of Years
$400,379 …….. Mortgage
$114,406 ………. Income Requirement
$1,800 ………… Monthly Mortgage Payment
$360 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$104 ………… Homeowners Insurance at 0.3%
$417 ………… Private Mortgage Insurance
$275 ………… Homeowners Association Fees
$2,955 ………. Monthly Cash Outlays
($341) ………. Tax Savings
($629) ………. Equity Hidden in Payment
$16 ………….. Lost Income to Down Payment
$72 ………….. Maintenance and Replacement Reserves
$2,074 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$5,649 ………… Furnishing and Move In at 1% + $1,500
$5,649 ………… Closing Costs at 1% + $1,500
$4,004 ………… Interest Points
$14,522 ………… Down Payment
$29,823 ………. Total Cash Costs
$31,700 ………. Emergency Cash Reserves
$61,523 ………. Total Savings Needed