OC housing market ricochets off affordability ceiling
When the restriction of MLS inventory caused the housing market to bottom, prices were well below their historic relationship between the cost of ownership and the cost of rental. The undervalued condition didn’t last long as the 18 month rally from March of 2012 to September of 2013 coupled with the interest rate surge of June 2013 dramatically decreased affordability in the Orange County housing market.
From the time prices began to rise, the big question overhanging the market is what would happen to sales volumes and pricing when the market was no longer undervalued. I speculated that appreciation would dramatically slow down, but I also figured that momentum might carry the market higher, particularly since such a high percentage of sales were all-cash. The story is not yet written as next spring will bring a fresh crop of buyers to the market, and the affordability ceiling might yet be breached, but based on the activity in both the new home market and the resale market over the last 60 days, the market appears to have ricocheted off the ceiling and reversed.
Housing bulls touted the year-over-year price gains and sales volumes increases as a sign of a robust market recovery. Housing bears pointed out these gains were caused by a huge and artificial reduction in MLS inventory, record low interest rates, and temporary demand stimulus from all-cash buyers. At this point, inventory is higher than a year ago, house prices are high enough that all-cash investors are losing interest, and mortgage interest rates are nearly 100 basis points higher than the record lows. If the bulls are right, none of this matters, and house prices will pause briefly for the fall and winter before resuming their steep upward climb. If the bears are right, the elimination of the three ingredients propping up the market should cause a significant slowdown in sales and a modest pullback in prices.
The September data favors the bears. Home sales volumes plummeted in September, dropping 18.4% from the previous month. The decline was so sharp that the year-over-year numbers are no longer positive. This is a huge setback for the market. All the momentum is gone. Further, both sales prices and list prices were flat for the month. Many properties that fell out of escrow during August came back to market with price reductions. Today’s featured property was listed in early August for $814,000. Today, it’s listed for $750,000. Those kind of price reductions are common.
Only time will tell if this is more than a seasonal pullback. The market may regain its footing next year and make another run at the previous peak; however, with the loss of momentum, and more importantly, the loss of affordability, it doesn’t seem likely that 20% yearly price gains are on the horizon.
Ben Bernanke and the US Federal Reserve have done all that mere mortals can do to repair the housing market post-financial crisis, but despite tarting up the mortgage industry like Cinderella for the ball, buyers are not jumping into the golden carriage to attend the best party ever staged.
How can this be, when house prices are supposedly climbing across the States? The latest Case-Shiller Index was up more than 12 per cent over the past year. The devil is in the detail – the most recent month-on-month increase slowed to just 0.6 per cent, and it is who is buying that is relevant.
Those who can afford to upgrade or buy a second home are doing so, with private equity and hedge funds bolstering transactions. But the average American is still cleaning up their balance sheet, using cheaper 30-year fixed mortgages to refinance. Insiders say the balance between those taking out mortgages in the purchase money market to buy properties versus refinancing is far from healthy, with a skew to the latter.
Others not on the property ladder are having hopes of home ownership dashed as interest rates and prices climb.
When will first-time homebuyers return to the market? It will take longer than most want to believe. The cohorts who would ordinarily be buying homes now are over-indebted and underemployed.
Many now hand over a regular rental cheque to the likes of Blackstone, the biggest owner of single family homes in the US.
Why is this important? Because it tells a tale of the struggle that the Fed is facing when it agonises over the data to decide when to begin tapering QE. The US government shutdown has created some distraction – and even stopped the data flow – but tapering remains the ultimate worry.
Unfortunately, both the Fed and the government want out of the mortgage market at the same time. The Fed wants to taper, and President Obama wants to wind down Fannie Mae and Freddie Mac, the mortgage finance companies taken over by the government a few years back. These entities, along with government agencies, guarantee 90 per cent of all mortgages, as US banks say they can’t make money from the low interest rate environment, and provide products like the very low rate 30-year fixed mortgage popular with homebuyers.
So interest rates have to rise sharply for the US to encourage private capital to take over from Fannie and Freddie.
I recently wrote that Tightening government lending standards would bring back private lending, but someone in the comments posted this great post on Naked Capitalism: Why the US Mortgage Market Will Remain Heavily Dependent on Government Support. Higher interest rates and higher costs of borrowing on government loans may not be enough. There are structural problems in the private securitization model that are not easily overcome. However, despite the other limitations, nothing will happen until interest rates rise to provide a risk-adjusted return to mortgage investors.
We also witnessed the money market race ahead and lift 30-year interest rates in a taper experiment when they expected QE to be wound down in September.
It is not a stretch to understand why Bernanke is worried about higher interest rates snuffing out the housing market – once the missing piston in the U.S. economic recovery.
It’s also not a stretch to see why the federal reserve did not taper at the last meeting. Higher mortgage interest rates just stalled the housing market. New home sales got whacked, and even the realtors lament low demand, low supply, and collapsing first-time homebuyer market.
Despite these problems and concerns, I don’t think this is any reason to be alarmed that house prices are about to go into any kind of long-term decline. If anything, this pullback in prices combined with increased inventory makes this a favorable environment for house buyers. Buy the weakness on the dips to get the best prices.
[idx-listing mlsnumber=”MB13204062″ showpricehistory=”true”]
1155 NORBY Ln Fullerton, CA 92833
$749,900 …….. Asking Price
$393,000 ………. Purchase Price
2/13/2003 ………. Purchase Date
$356,900 ………. Gross Gain (Loss)
($59,992) ………… Commissions and Costs at 8%
$296,908 ………. Net Gain (Loss)
90.8% ………. Gross Percent Change
75.5% ………. Net Percent Change
6.1% ………… Annual Appreciation
Cost of Home Ownership
$749,900 …….. Asking Price
$149,980 ………… 20% Down Conventional
4.46% …………. Mortgage Interest Rate
30 ……………… Number of Years
$599,920 …….. Mortgage
$148,320 ………. Income Requirement
$3,025 ………… Monthly Mortgage Payment
$650 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$156 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$3,832 ………. Monthly Cash Outlays
($730) ………. Tax Savings
($796) ………. Principal Amortization
$247 ………….. Opportunity Cost of Down Payment
$207 ………….. Maintenance and Replacement Reserves
$2,760 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$8,999 ………… Furnishing and Move-In Costs at 1% + $1,500
$8,999 ………… Closing Costs at 1% + $1,500
$5,999 ………… Interest Points at 1%
$149,980 ………… Down Payment
$173,977 ………. Total Cash Costs
$42,300 ………. Emergency Cash Reserves
$216,277 ………. Total Savings Needed