Jan312017
Rising mortgage interest rates will slow home price appreciation
Higher mortgage interest rates will reduce future loan balances; thus today’s homeowners will not experience the home price appreciation enjoyed by previous generations.
Many would-be homeowners rush to the market to lock in low mortgage rates out of fear of being priced out forever. Nervous buyers fear that if they wait, they will fail to get a place of their own. Due to our chronic shortage of homes, there is some basis for this fear, but potential buyers considered the ramifications of that occurrence, the fear would evaporate.
If today’s homebuyer were to be priced out tomorrow, they probably wouldn’t be alone in that predicament. In fact, if a great many people are priced out by rising mortgage rates, by definition, demand declines. Less demand means less home price appreciation or even price drops.
Does that mean that people shouldn’t buy today and wait for a better day? No. In a market where home prices and rents rise in tandem, like ours has for the last four years, residents are equally at risk of being priced out of rental housing or homeownership. Whenever more jobs are created than houses constructed, people bid against one another for the scarce resource, and both rents and home sales prices rise.
The advantage of buying in today’s homebuying environment isn’t future home price appreciation: the advantage is amortization. Low interest rates loan build equity faster in the early years of a mortgage than high interest rates loans. Between the accelerated amortization and freezing housing costs with a fixed rate mortgage, homeownership is still a good financial move even in a low appreciation market environment.
Home Equity
Where does home equity come from? Does it appear by magic, a gift of the appreciation fairy? Does it accumulate by discipline through paying down a mortgage? Both factors are at work, but unless you believe the appreciation fairy listens to your prayers, the only factor that builds home equity you have control over is the amount of debt encumbering the property.
So how does the appreciation fairy work? In concept house prices should rise gently over time to match the growth of wages in the area. In practice house prices rise and fall violently with changes in financing costs, economic upheavals, a downward substitution effect in supply-constrained markets, and kool-aid intoxication, or as economists prefer to call it, animal spirits.
The underlying determinant of home equity is the difference between the resale value and the debt on the property. Resale value is determined by the activity of buyers in the market, and it’s closely tied to the sales prices of comparable properties in the neighborhood.
And what is the largest determinant of the resale price of neighboring homes? The amount the buyer borrowed. In other words, the biggest determinant of your home equity as a homeowner is the amount of debt someone was willing and able to borrow to buy in your neighborhood.
When a property sells for a new high price, the sale impacts values on all similar properties near the new sale. During the housing bubble, neighbors cheered each new higher comp because it added to their (illusory) net worth. With unrestricted access to equity with no-doc loans and 100%+ LTV HELOCs, everyone near a new high comp obtained free money from foolish lenders funded by even more foolish investors.
The late arrivals to the house party eagerly awaited a greater fool to come along and pay an even higher price so they could pilfer their share of the HELOC booty too. Obviously, under such circumstances, the desire for real estate was infinite, and with no impeding lending standards and an eagerness from investors to fund new loans, actual demand as measured by dollars was very high as well; therefore, we ended up with a massive housing bubble.
When the housing bubble collapsed, prudent lending standards returned, and prices dropped precipitously largely because buyers could not borrow the prodigious sums previously made available to them to bid up prices, putting the banks in a bind as the huge reduction in collateral value backed the bad loans they made during the bubble era.
The price collapse put between a quarter and a third of American homeowners underwater, and if the banks were forced to liquidate, it would cause hundreds of billions in losses bankrupting our banking system and triggering a deep economic depression. Something had to give.
The US government and the federal reserve took a number of steps to solve the problem. First, in early 2009, regulators relaxed mark-to-market accounting rules allowing banks to hold bad loans on their books at a fantasy value to avoid loss recognition, buying the banks time. Further, in order to placate pressure from homeowners to “do something” and to provide lenders with a few additional debt service payments on these bad loans, the government embarked on a series of failed loan modification programs.
These were sold to the public as ostensibly helping struggling borrowers, but they were really designed to allow banks to kick-the-can loan-loss recognition and squeeze a few more payments out of hopeless borrowers before they imploded. These programs largely failed homeowners, but succeeded for bankers by providing operating cash while delaying loss recognition for a later equity sale.
Manipulated Mortgage Rates
Ultimately, banks don’t want to recognize losses. They would far rather delay their necessary foreclosures until the loans had collateral backing, allowing them to recover their capital. However, since potential buyers of these properties couldn’t afford to pay an amount which would recover the outstanding debt, the bubble needed to be reflated before the foreclosures could go forward.
To facilitate reflation of the housing bubble, the federal reserve lowered interest rates to zero, and embarked on a program of buying 10-year Treasuries (operation Twist) and directly buying mortgage-backed securities to ensure the flow of capital into the housing market and dramatically lower mortgage interest rates. At the peak of the housing bubble, mortgage interest rates were between 6% and 6.5%. They bottomed out near 3.35% in 2012 — a near 50% reduction. These super-low interest rates gave buyers the ability to borrow amounts commensurate with peak prices under stable loan terms.
Manipulated Supply
Due to the collapse of prices when the housing bubble burst, comparable sales were far below peak prices, and continued foreclosure processing was keeping prices down. The solution was simple; stop foreclosure processing and restrict inventory until the housing bubble reflates.
Lenders stopped foreclosure processing to dry up the inventory, and underwater homeowners patiently wait to list their properties because if they wait, they might escape through an equity sale, avoiding credit problems. With almost no foreclosures or inventory to burden the market, supply is greatly reduced further facilitating a rapid reflation of the housing bubble.
Once the problem of excessive MLS inventory was resolved, we quickly reflated the bubble to allow lenders to recover capital at peak prices, mostly through equity sales, which is where we are today.
Bills Come Due
There is a secret price for the government’s intervention in housing: when rates rise, borrowers will endure reduced borrowing power, home sales volumes decline, resale values may fall, and home equity may be reduced.
Perhaps wages will rise faster than mortgage rates, but it’s unlikely that wages would rise 12% or more to offset the impact of a 1% rise in mortgage rates. In short, future buyers will likely be less leveraged, and although price declines are not certain, rapidly rising house prices seem an unlikely possibility.
So while efforts to reflated the housing bubble succeeded, and both lenders and existing homeowners rejoice in this success, the rising interest rates to come will surprise many homeowners with an unwelcome decade or two of below-average home price appreciation.
A Down Payment Costs Home Buyers an Average of 2/3 of Annual Income
SEATTLE, Jan. 13, 2017 /PRNewswire/ — Cobbling together a 20 percent down payment on a home costs more than two thirds of the average annual income – one of the reasons potential home buyers say saving for a down payment is among their top concerns.
In the U.S., to buy a median-priced home for $192,500, a buyer must scrape together $38,500 in cash – plus any closing costs and moving expenses – in order to ensure they qualify and get the best terms on their mortgage.
Among large housing markets, buyers in the San Jose, San Francisco and Los Angeles metros must come up with the largest percentage of their income to buy a home – 182 percent of the average annual income to put 20 percent down on the median home.
In San Jose, where the median income is $105,455, a down payment on the median $961,600 home is $192,320.
We have more than enough for a 20% down, but refuse to pay outrageous current prices on what essentially are overpriced turkeys! Fixers priced as if they were turn key beauties! Give us a break!
UH-OH! AMERICANS ARE FLIPPING HOUSES LIKE IT’S 2006 (LIKE THERE IS A HOME PRICE BUBBLE … AGAIN!)
Yes, Americans are “flipping” homes again, just like in 2006. The steps involved in “flipping are: 1) buy a house, 2) apply a fresh coat of paint, 3) trim some bushes, and then 4) resell the home at a profit.
According to Trulia, investors flipping homes account for the largest share of US housing sales since … 2006.
https://anthonybsanders.files.wordpress.com/2017/01/2017-01-25-house-flipping-1.jpg?w=1168&h=544
WHERE are the flippers?
https://anthonybsanders.files.wordpress.com/2017/01/2017-01-25-house-flipping-2.jpg
What do these cities have in common? Look at the housing bubble peak of 2005-2006. It looks like a repeat of the housing bubble (except for Dallas).
https://anthonybsanders.files.wordpress.com/2017/01/flippers.png
If the data is accurate, it is NOT a repeat of credit bubble where credit scores below 620 were common.
Flips as the largest share of US sales isn’t meaningful when sales volume is at historic lows. In 2006, flipping was a sign of the irrational exuberance that existed at that time. You didn’t have to perform a rehab back then. People were flipping brand new homes because values were rising so quickly. I met a guy that made his living flipping brand hew homes up until the music stopped and he lost everything.
Yes, the environment is certainly different now. When I first started writing at the IHB, people used to love the profiles of failed flips. People who were flipping without adding any value were parasites, and people who wanted to buy family homes were pissed because they were forced to overpay due to the flippers. People used to low seeing these guys get their heads handed to them. Today, flippers actually have to add value in order to make any money.
Here in San Diego we’re seeing several “new” builds that are being re-sold after it’s built! So, not actual families buying and moving in, rather damned parasites buying and flipping a new build for the profit!
Assume it takes about 6 months to build a new house and prices are going up about 2% every single month!
So, home sells new for $500,000, six months later, flips it for $560,000 or more!
This is insane and should be illegal!
California Housing Crunch Prompts Push to Allow Building
Marco Gonzalez spent more than a decade suing real-estate developers in California over housing proposals that would have spoiled wetlands and gutted hillsides. The environmental lawyer won cases that stopped scores of units from being built.
Now he is on the opposite side, fighting cities and neighborhood groups in Southern California that fail to provide enough new housing units.
Mr. Gonzalez is among a growing group of advocates across California who are taking a once unthinkable approach to development in their backyards: They are trying to force cities to allow more of it.
The backlash comes as California’s lack of housing supply is becoming a crisis. After a postwar building boom gave birth to a labyrinth of freeways and sprawling suburbs, coastal metro areas in California between 1980 and 2010 added new housing units at about half the rate of the typical U.S. metro area.
During that period, California built an estimated 90,000 fewer units per year than were necessary to keep home price growth in line with the rest of the country, according to the state legislative analyst’s office. California—the nation’s most populous state—ranks 49th in the number of housing units per capita, ahead of only Utah, and it has the second-highest rate of overcrowding in the nation, trailing only Hawaii.
http://rdcnewscdn.realtor.com/wp-content/uploads/2017/01/wsj-graphic-tight-housing-supply.jpg
The supply shortage has driven up prices. In 1970 California home prices were about 30% higher than the U.S. median; today, California is more than 2.5 times pricier. In all, seven of the nation’s 10 most unaffordable markets, based on the amount of income spent on a mortgage, are in the Golden State.
But California’s complex land-use and regulatory structure gives opponents of development extraordinary powers to stymie new projects.
Environmental reviews intended to preserve California’s picturesque coastline and hillsides also provide a means for residents to challenge ordinary development proposals. If a review finds adverse impacts on parking, traffic, noise or air quality, elected officials can’t approve it until they have addressed opponents’ concerns.
Even after a project is approved, opponents can file environmental challenges, a process that can delay projects by two to four years.
Buyers haven’t flocked to new homes this much since the bubble
It’s fairly common to hear that a particular economic data point is the best since the recession. But you’d have to go back a bit further to compare the last time home builder sentiment was so high.
In December, builder sentiment, as measured by the National Association of Home Builders’ housing market index, surged to the highest reading since July 2005 — the height of the housing bubble.
December also marked a fresh high for a key component of the sentiment index, the sub-gauge that tracks perceptions of buyer traffic. The traffic gauge didn’t just reach its highest since the housing bubble last month – it also marked the first time the gauge crossed the neutral 50 line.
http://ei.marketwatch.com//Multimedia/2017/01/25/Photos/MG/MW-FE423_home_b_20170125113256_MG.jpg?uuid=ed022400-e31b-11e6-95af-001cc448aede
As NAHB explains in its release, “The survey also asks builders to rate traffic of prospective buyers as ‘high to very high,’ ‘average’ or ‘low to very low.’ Scores for each component are then used to calculate a seasonally adjusted index where any number over 50 indicates that more builders view conditions as good than poor.”
In other words, in recent memory, builders have only taken a glass-half-full view of their traffic during a time of excessive speculation and frenzied buying.
There’s nothing wrong with that, of course. Builders certainly aren’t behaving in a speculative manner right now. There were 20% fewer new homes available for sale last month than the average over the past five decades, according to Commerce Department data, despite a much bigger population.
If anything, most economists believe they’re being too restrained and conservative. There’s enough demand in the marketplace right now to support much stronger levels of housing construction, analysts say.
Maybe now builders will agree.
And what little is being built are YUGE 2,000+, 3,000+, 4,000+ McMansions that are priced way above the median wage earner!
Where are the “entry level”, “first time home buyer” new homes!?!?! Not in California, that’s for sure! 🙁
New Home Sales Post Highest Yearly Total Since 2007
Sales of newly built, single-family homes rose 12.2% in 2016 to 563,000 units, the highest annual rate since 2007, according to newly released data by the U.S. Department of Housing and Urban Development and the U.S. Census Bureau. New home sales fell 10.4% in December 2016 to a seasonally adjusted annual rate of 536,000 units.
“We are encouraged by the growth in the housing sector last year, and by the fact that builders increased inventory by 10% in anticipation of future business,” said Robert Dietz, chief economist of the National Association of Home Builders (NAHB). “NAHB’s forecast calls for continued upward momentum this year, with housing starts expected to rise 10% over the course of 2017.”
“To ensure sales continue to move forward in 2017, builders need to price their homes competitively, especially given that mortgage interest rates are expected to rise this year,” said NAHB Chairman Granger MacDonald.
The inventory of new home sales for sale was 259,000 in December, which is a 5.8-month supply at the current sales pace. The median sales price of new houses sold was $322,500.
Regionally, new home sales increased 48.4% in the Northeast. Sales fell 1.3% in the West, 12.6% in the South and 41% in the Midwest.
Between rising rates,calpers accounting errors and Calexit it will be very difficult for values to stay any place close to todays prices.Kick in slowing capital inflows from Asia and a strong Dollar and this is your roadmap for future values!
It certainly doesn’t bode well for sales. Prices will probably hold up, but sales will suffer if nobody can afford to finance today’s prices and if foreign all-cash demand drops off.
Even with foreign demand cutting back due to outflow restrictions from their country of origin, we still need a 15% foreign buyer tax in California, just for future protection!
Anyone who thinks housing prices will decline in 2017 has gotten no further than economics 101 and certainly has not studied market history. As an economist and a one of the top selling realtors in the county, selling over 120 properties a year for 6 years staight i promise you that housing prices will rise 12 in southern califoria by the end of 2017 with almost all of that accouring in the spring and summer of this year. Fed watchers are saying the 10 year bond will be raised .25 to .75 basis points this year. And .25 every quarter of 2018. If a new mortgage is $4000 a month today a 1.5% increase in mortgage rates by the end of 2018 would put your payment at $5500 a month. With a 12% rise in prices that would make your payment for the same house today, that was $4000, a month $6160 a month. The market ALWAYS OVERSHOOTS. The crash will occur in the fall of 2018. But even if it does crash housing prices would have to fall 33% for you to have a lower mortgage payment then, at 5.5% than today at 4%. Anyone who is thinking of buying a home in the next 2 years would be a fool not to purchase tommorrow or as close to tommorrow as possible.
Finally housing sales are down because of low inventories. There are far more buyers looking today than 1, 2, 3, 4, 5, or 6 years ago. I promise you that housing prices will go up 12 or more this year. This means a .75% rise in rates buy the end of the year will raise a mortage from $4000 a month to $4,750 a month. Add a 12% increase and you are at $5310 a month. If your mortage is $2000 today it will be $2655 by year end. If your mortgage payment would be $6000 today it will be $7965 by year end. Unless you are getting a 25% raise this year you need to buy today. In OC the home affordability index is at 40. That means 40% of people still have the money to buy a home today. The last crash occured only after the index dropped to 9%
Nobody is suggesting that prices will decline in 2017, unless mortgage rates rise quite significantly, but even then any price decline would be presaged by a huge decline in sales volume. I think most of the readers here are well past economics 101, and the posts on this blog (including this one) shows plenty of market history.
Your reasoning is a bit myopic.
If someone can only afford a $4,000 a month payment today, who exactly is going to be pricing that buyer out and paying $6,160 in 2018? If we assume the person bidding $4,000 today will at best be able to afford a $4,200 per month payment in 2018, isn’t it more likely that prices would fall to match the level of affordability buyers can afford?
If you don’t believe this, I suggest you carefully examine what happened last time buyers couldn’t raise their bids:
http://ochousingnews.g.corvida.com/wp-content/uploads/2015/03/credit-and-housing-bubble.png
Based on what evidence? Redfin doesn’t show this:
http://ochousingnews.g.corvida.com/wp-content/uploads/2017/01/Monthly-Demand-Tour-and-Offer-Indexes.png
Buyer traffic is up at new home communities precisely because there is so few resales available.
Would you care to wager on this? There is zero chance that prices will rise 12% or more this year. If mortgage rates remain low (4% to 4.25%), we might see 6%, but if rates rise to 4.75% to 5% as you suggest, either prices will stagnate, or sales volume will fall off a cliff because nobody can afford to buy.
The same foolish reasoning you expound here is what motivated people to buy in 2005 and 2006 using option arms when affordability was crumbling. The advice is no better today. You’re trying to evoke the same kind of frenzy that lead people to their ruin. You won’t find the readers here will fall for it.
OC home affordability was at 23% in Q3, and that doesn’t factor in the huge jump in rates that occurred in October/November so it could be in the teens now.
http://www.car.org/marketdata/data/haitraditional/HAISoCal/
If supply doesn’t improve, another likely consequence of rising interest rates will be that cash heavy buyers will comprise an even larger percentage of transactions. Meaning that Coastal California real estate will continue consolidate among a smaller percentage of the wealthy elite. The first time home buyer will see his or her opportunities continue to shrink.
Perhaps, but those heavy-cash buyers will also find better investment alternatives in a higher rate environment. Over the last decade, a lot of money flowed into residential real estate despite the meager cash returns because the alternatives were even worse. That situation will change as interest rates rise.