May102013

The housing bears are rightfully frustrated

House prices are rising rapidly, and the conditions creating this rally will persist for the foreseeable future. Prices will continue to rise until affordability becomes a limitation, or cloud inventory makes its way to the market, and even then prices will continue to rise, just less rapidly than they are today. As long as prices are financeable and supply is limited, buyers will bid up prices on the available housing inventory and prices will keep going up. This sounds like the ideal set of circumstances for continued price appreciation, so why are the housing bears still roaring?

Because its a completely artificial market price manipulation masking weak underlying fundamentals.

The bearish case for another leg down in housing points out most of these structural defects. Unemployment is still high and job growth is very weak. The demand for housing is not coming from owner occupants getting new jobs, which is really the only long-term driver of housing prices. Further, the lack of supply is a direct result of a relaxation of government accounting rules and a can-kicking loan modification program at the banks. In other words, its a policy driven supply shortage. If lenders or regulators change their policies, supply could come back in amounts large enough to push prices back down.

Despite the good arguments bears have, house prices are going up. The good analysis housing bears are doing is falling out of favor as financial reporters prefer to interview bullish hacks who give them soundbites to make their readers feel good. I know the frustration of not being taken seriously. For the first year of my writing, nobody wanted to believe house prices would crash, and few took me seriously. For those that still cling to the bearish arguments, today is just as frustrating. However, there is one key difference between then and now; the housing bears are right, but prices will go up anyway.

Like so many other epic bubble years’ housing market explosion epicenters, Las Vegas real estate caught fire again pushing prices up 30% YoY vs the 10% national average.  This statement alone should raise a plethora of red flags to anybody remotely familiar with the sector.  But to Wall Street, which has a memory of about 9 months at best, this is what a “housing market recovery” looks like this time around.  I beg to differ.

I recently pulled comps for all the properties owned by my funds. The rate of appreciation on these properties is remarkable, particularly on the low-end. I strongly believed house prices in Las Vegas would appreciate because they were ridiculously undervalued. I purchased a property in 2012 for $10,000 less than its 1992 purchase price. That’s crazy. However, I didn’t believe prices would appreciate for another few years, and quite frankly, I wish they weren’t. There aren’t many deals in Las Vegas, and the ones that are out there don’t provide the great cashflow returns of the deals I bought from 2010-2012. Since I don’t plan to sell any properties, appreciation is irrelevant. I would gladly surrender the appreciation to date for a chance to buy more properties at 2011’s prices.

That’s because there is little about the past year of ‘better’ housing market data that is rooted in economic fundamentals (things that drive “durable housing market expansion).   It’s not like house sales volume, rents, jobs, or income is surging.   It’s not like supply is so ‘low’ because demand is surging;  rather, it’s because 6 million units of supply headed for market was rented back to its’ legacy owners by the banks and gov’t in the form of mods;  several states made it virtually illegal to foreclose;  and foreclosure timelines were being stretched out 15 days for every 30 that passed.

But besides all that, taken in the context of “post-crash” the past year of data are “underwhelming” especially relative to consensus opinion, sentiment, and periods prior to 2007.  That’s because this market is structurally broken. It lacks the fundamentals horsepower imperative to a “durable” housing market recovery.   And without the fundamentals in the drivers’ seat, the past year of housing market activity is more closely akin to a stock market “short squeeze” than anything else.

Every statement Mark makes above is true. This entire rally is artifice by the federal reserve designed to cajole owner occupants back into the market, but since owner occupants are underemployed, over-indebted, have little or no savings, and bad credit, they are not returning to the market in large numbers. Mark’s frustration is palpable, but it’s hard to argue with the tape. It’s very frustrating that the housing bears are right, but prices will go up anyway.

Take Vegas for example. It has gotten some interesting contra-recovery press over the past few days from a couple of market observers noticing things just don’t feel or look right there.

“Lack of Supply” is mostly commonly referenced as the reason house prices in Vegas “v” bottomed.

And with:

  • 10% unemployment
  • 57% of all homeowners Zombified;  underwater, over-levered renters of their own houses (70% in many regions)
  • 25% of all homeowners on modifications and workouts so exotic they would make Angelo Mozillo blush
  • 12% of all houses in default or foreclosure
  • a 50% increase in construction permits
  • Falling Rents – about to get really bad
  • MASSIVE SFR rental supply coming online (some 55k units) and multi-family starts back to 2006 highs.
  • and only 3000 to 4000 sales on avg per month (down YoY for several months running I might add)

it certainly isn’t housing market “fundamentals” pushing up prices.

It is clearly not fundamentals driving the house price rally. Mark is spot-on with his analysis.

Bottom line:  With a fundamentals backdrop as portrayed by the metrics above, Las Vegas — and dozens of other legacy bubble years regions around the nation — should not be performing so well.

They shouldn’t, but they are.

Yes, last year there was a transitory supply shortage amidst numerous wildly over-supplied housing markets, as investor demand collided with massive loan mod intervention and new laws outlawing foreclosure all together.  But that’s neither durable nor a positive…rather, it makes it highly questionable whether the recent performance even can be durable.  It makes more sense that these regions have turned highly volatile and house prices stand just as strong of a chance of declining 10% over the next year as increasing.

It’s not a coin flip. House prices stand very little chance of going down 10% or more this year or next year in Las Vegas or any other beaten down market.

First, something would have to change to force more supply on the market. The banks won’t do this voluntarily as they would rather can-kick with loan mods. The banks won’t be forced to do this as banking regulators are looking the other way. With no must-sell inventory, there will be no decline in house prices.

Second, if house prices did go down, investor activity would pick up. I would buy more houses in Las Vegas if prices were better, and there are hedge funds with billions of dollars that would do the same. Perhaps owner occupant demand couldn’t sustain these markets, but investor demand certainly would if prices fell again.

The only wildcard with any potential to cause a drop in prices is the potential for a huge selloff in the bond market causing mortgage interest rates to rise, but with the federal reserve buying $45 billion per month, any selloff in bonds will just be remedied by more federal reserve buying. Mortgage rates may be allowed to rise slowly, but the federal reserve would step in to prevent any sudden rise.

I spent the better part of six years making the bearish case. I feel the bear’s frustration. I was late to call the bottom because I see the same thing Mark does, and it causes me to wonder how the market manipulators could be successful. I wasn’t convinced until September of 2012 when the supply did not come to market and Bernanke announced a never-ending mortgage bond purchase program. After taking an objective look at the market props in place, I couldn’t remain bearish despite the obvious problems.

It’s a difficult time to be a housing bear.