Jun252013

realtors: house price gains unsustainable

Resale prices of used houses in Orange County are rising rapidly. The weakest city in my monthly report was La Palma that has only risen 3.3% year-over-year. On the other end of the spectrum, Dana Point is up a whopping 19.5%! More than half the cities in Orange County are up more than 10%.

When I run my monthly reports, I use the dollars-per-square-foot measure of house prices. It isn’t subject to much distortion based on a change in mix like the generic median price is. It’s a better measure of how much house buyers are getting for their money.

I am not among the alarmists suggesting the recent rapid prices increases are the sign of another housing bubble. Again, I look at the data, and it says that house prices are still undervalued in most OC markets. My methodology is to examine the relationship between the cost of ownership and the cost of rent during the stable period between bubbles from 1993 to 1999. That was the last bottom of a real estate recession. Assuming that represents a stable market value, I compare today’s relationship between ownership costs and rents to the past. Right now, houses are as affordable as they’ve ever been in OC. That means most buyers have room to raise their bids, and it explains much of why house prices have been rising so rapidly.

This may be about to change. Yesterday in the comments, everyone was abuzz with the collapse of bond prices and the near-certainty of rising interest rates. As borrowing costs rise, the excess affordability and undervaluation will rapidly vanish. Since affordability products are now banned by the qualified mortgage rules, payment affordability will be a real barrier to pushing prices higher. I expect future reports to show much less undervaluation in most OC markets, and if rates keep rising rapidly, we may see a mini-bubble as price momentum causes an overshoot to the upside.

Rising Home Prices Are ‘Unsustainable’—Realtors

By: Diana Olick — Thursday, 20 Jun 2013

For six straight months, home prices have been leaping in double digits from a year ago. In May, the median existing home sale price was 15.4 percent higher nationally than May of 2012, according to a new report from the National Association of Realtors.

The Realtors themselves say that kind of jump is “unsustainable.”

Such a candid admission of the truth is truly shocking coming from the NAr.

“Some of the increases can be explained by the fact that it is recovering from an over-corrected situation,” said Lawrence Yun, chief economist for the Realtors. “But with people’s income rising at only 1 or 2 percent and prices rising in double digits, it cannot continue.”

Another shocking admission of truth.

It is actually worse than that. If incomes are rising at 1% or 2% per year, and borrowing costs are also rising, then borrowing power is actually declining. A 3% raise doesn’t help you finance more if borrowing costs rise 5% — and a 5% increase in borrowing costs is only about 0.75% rise in mortgage interest rates. We’ve watched mortgage rates rise from about 3.5% to 4.25% in the last 30 days, so we just wiped out the last two and one half years of wage growth right there.

Part of the steep rise in the median home price can be attributed to a change in the mix of homes that are selling. Sales of homes priced below $100,000 were down 9 percent from a year ago, while sales of homes priced at more than $500,000 were up 33 percent. …

The dollars-per-square-foot measure is far less prone to distortion based on mix. It’s not immune to these problems as larger and higher priced homes tend to sell for less on a $/SF basis than smaller homes in the same market. However, the distortion is not nearly so great as it is with the generic median.

You can at least make an argument that part of the dramatic increase in median home prices can be attributed to the foreclosure discount evaporating. That suggests that overall home price increases may be slightly overstated,” said Sharga.

That would be a good argument. The shortage of REO has caused the discount on these properties to all but disappear locally. And since banks are letting higher priced delinquent borrowers squat, the REO that are processed are almost entirely low-end properties.

Also weighing on home prices are rising mortgage rates. May’s existing home sales report from the Realtors represents closed sales, so contracts and interest rates would have been signed and locked in March or April, before rates began to rise.

I have the same issue in my reports. The interest rate used in the June report was the 3.54% prevalent in May. The latest reading used for June sales is 3.91%. When I prepare next month’s report, I expect the relative undervaluation to be much smaller.

Based on the change in mortgage rates from early May to today, the average buyer would have to pay 13 percent more in monthly payments, including taxes and insurance, according to Mark Hanson, a California-based analyst. They also have to earn 10 percent more in income to qualify for a loan based on a typical qualifying debt-to-income ratio of 45 percent.

These are huge moves especially considering—when purchasing a house using a mortgage—most people buy based on ‘monthly payment and the maximum allowable debt-to-income ratio.’ This means first-timer share will fall even further. They are already at a multiyear low even with record-low rates,” said Hanson.

As usual, Mark Hanson is right on with his analysis. With first-time homebuyer participation at record lows, no equity to support a move-up market, and cashflow investors starting to pull back due to rising prices, rising interest rates will first hurt sales, then prices.

First-time homebuyer participation was at just 29 percent, according to the Realtors, a five-year low. Without these buyers, as investors pull back and prices rise, home sales will likely lose steam. June’s report on pending home sales, or signed contracts in May, will tell just how much rising rates are impacting sales. That report will be released Thursday, June 27.

It is my opinion that prices will continue rising rapidly in most markets until they hit their affordability limits. The strongest markets (like Irvine) will hit these limits first, and the weakest markets will hit these limits last.

However, once we hit the affordability limit, prices will languish. Think about it. What does the future hold for incomes and interest rates?

In all likelihood, income growth will be tepid. We still have a huge unemployment problem, so it’s difficult for workers to demand higher wages. I expect we’ll have lower than average wage growth for the next 10 years, 5 at least, unless the federal reserve prints a lot of money. And even if they did, then it will create problems for financing because a great deal of printed money will cause interest rates to rise even faster as investors begin to fear inflation.

Mortgage interest rates will almost certainly rise over the next 5 to 10 years. Perhaps the rate at which rates rise will be slow, but even 0.5% per year increases in mortgage rates will offset any increases in buying power from rising wages. In other words, borrowers won’t be able to borrow more money to bid up prices. If borrowers can’t raise their bids, house prices will go nowhere.

Flat house prices are probably the best case. In reality, we will likely see periods of volatility with periods of rising rates causing sales volumes to drop and prices to slowly decline, punctuated by periods of falling rates with strengthening sales and prices. During each rally, realtors will call the bottom, then everyone will act surprised and dismayed when rising rates causes prices to weaken again. Oh, the horror of it!

Thanks for that last $150,000 B of A

The former owners of today’s featured property bought near the bottom of the last housing recession back in 1999. The were reasonably prudent with their mortgage up until 2005 when they refinanced with a $227,535 first mortgage and extracted their down payment plus about $30,000. In 2006 they got a $150,000 HELOC from B of A. Perhaps they didn’t use it, or perhaps they got $150,000 from B of A for walking-around money.

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13374 TAFT St #1 Garden Grove, CA 92843

$314,900    ……..    Asking Price
$135,000    ……….    Purchase Price
4/29/1999    ……….    Purchase Date

$179,900    ……….    Gross Gain (Loss)
($25,192)    …………    Commissions and Costs at 8%
============================================
$154,708    ……….    Net Gain (Loss)
============================================
133.3%    ……….    Gross Percent Change
114.6%    ……….    Net Percent Change
6.0%    …………    Annual Appreciation

Cost of Home Ownership
——————————————————————————
$314,900    ……..    Asking Price
$11,022    …………    3.5% Down FHA Financing
4.24%    ………….    Mortgage Interest Rate
30    ………………    Number of Years
$303,879    ……..    Mortgage
$96,523    ……….    Income Requirement

$1,493    …………    Monthly Mortgage Payment
$273    …………    Property Tax at 1.04%
$0    …………    Mello Roos & Special Taxes
$66    …………    Homeowners Insurance at 0.25%
$342    …………    Private Mortgage Insurance
$320    …………    Homeowners Association Fees
============================================
$2,494    ……….    Monthly Cash Outlays

($265)    ……….    Tax Savings
($419)    ……….    Principal Amortization
$17    …………..    Opportunity Cost of Down Payment
$59    …………..    Maintenance and Replacement Reserves
============================================
$1,885    ……….    Monthly Cost of Ownership

Cash Acquisition Demands
——————————————————————————
$4,649    …………    Furnishing and Move-In Costs at 1% + $1,500
$4,649    …………    Closing Costs at 1% + $1,500
$3,039    …………    Interest Points at 1%
$11,022    …………    Down Payment
============================================
$23,358    ……….    Total Cash Costs
$28,800    ……….    Emergency Cash Reserves
============================================
$52,158    ……….    Total Savings Needed
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