Jul172014
Are today’s homebuyers tomorrow’s bagholders?
Today’s high home valuations are only justified by record low interest rates. Will today’s buyers become bagholders when interest rates rise?
Will rising mortgage rates cause house prices to crash again? It’s a valid question, and a valid concern for today’s homebuyers. Nobody wants to be an underwater bagholder trapped in a debtor’s prison awaiting lender approval of a sale to move on with their life. At a minimum, the prospect of rising rates curbing appreciation should temper buyer’s enthusiasm toward making a fortune on home-price appreciation.
How likely is it that rising mortgage rates will cause house prices to tumble? Let’s look at the possible scenarios.
We’ve already seen that higher house prices caused a decline in sales volumes this year. The lack of affordability products is preventing lenders from inflating another housing bubble, but it’s also pricing out marginal buyers, and with weak job and wage growth, there aren’t enough buyers to sustain last year’s sales volumes. This has also kept mortgage rates low as lenders keep the cost of borrowing down to facilitate any sales at all.
Any rise in mortgage rates would cause sales volumes to decline even further, so less capital is deployed in home mortgages. Right now, investors are willing to buy low-rate mortgages because the competing investment alternatives are not attractive, but when the economy picks up, this capital may flow elsewhere.
So let’s assume an improving economy and rising rates at the federal reserve dries up the flow of capital into mortgage loans. With the low demand from buyers, less capital is needed, so better competing investment alternatives won’t necessarily cause mortgage rates to go up. Low demand for mortgages and low supply may maintain a balance.
If the economy improves and creates jobs with high wages, that will increase the demand for housing, but only to a point. People can only afford what they can afford, and if they start bidding up mortgage rates due to a lack of available loan capital, the buyer’s borrowing power will decline, and home sales may go up, but prices will not.
The only way to overcome the problem is for a surge in high-paying job creation. If we create many, many more high paying jobs, the people who get these jobs will be able to afford housing even at higher interest rates and higher prices, but how likely is that? Nothing in today’s economic environment suggests we are about to see a big increase in job creation or increases in pay.
Irrespective of what happens with wage and job growth, it’s unlikely rates will rise and cause house prices to fall. Falling prices would cause listings to evaporate as cloud inventory sellers take their over-priced homes off the market. The lack of supply will force buyers to bid more, pricing out more marginal buyers, and sales volumes would crumble. Rising mortgage rates lead to lower sales volumes or lower house prices, and with the cloud inventory management of supply, it will most likely lead to lower sales volumes.
Chinese Sellers
Another reason today’s homebuyers should be concerned about future home prices is the deflating Chinese property bubble. The deflating Chinese real estate bubble could destabilize the world economy, and more importantly to local buyers, a crash in Chinese real estate would not just remove a component of local demand, it could turn Chinese buyers into desperate sellers.
In the short term, a full-blown Chinese property crash could increase US sales as desperate Chinese try to move their money overseas in what they perceive as a safe haven of Coastal California real estate. We could see a sudden surge in Chinese purchases followed by an abrupt stop when the Chinese government shuts off the flow of capital out of China.
Wealthy Chinese who aren’t leveraged may weather the storm and hold their US properties, but with years of cheap debt and moral hazard from Chinese central banker bailouts, many Chinese are extremely leveraged, and they may sell their US holdings to pay domestic bank obligations. It wouldn’t surprise me to see capital repatriation under penalty of death if the Chinese government is desperate for for foreign capital. But for now, Chinese are still buying, but that may soon change.
China Fuels Surge in Foreign Purchases of U.S. Housing
By Nick Timiraos, Jul 8, 2014
Foreign purchases of U.S. real estate jumped by 35% last year, and the Chinese led the way, according to a survey released Tuesday.
Chinese buyers have become the largest source of foreign cash in the U.S. residential real estate market, accounting for nearly one in four dollars spent by foreigners on American housing last year, the National Association of Realtors said in its annual survey of international property sales.
China accounted for $22 billion in international sales for the 12 month period ending March 2014, or 24% of all foreign sales, up from $12.8 billion, or 19%, during the year-earlier period. …
Does anyone think this flow of capital is sustainable, particularly given the collapse of its domestic real estate market?
In recent years, American real-estate markets have been viewed alternately as a safe haven and a bargain amid concerns over geopolitical instability or unsustainable asset values abroad.
Overseas buyers tend to hunt for trophy properties. This helps explain why the median purchase price to international clients ($268,284 last year) is significantly higher than for all sales ($199,575). That’s particularly true of Chinese buyers, where the average purchase price topped $590,000 and the median exceeded $523,000. Canadian and Mexican buyers, by contrast, appear to buy much more modest homes.
That comports with what we’ve seen in Coastal California. Anecdotally, it’s been reported that 80% of Irvine’s new home sales have been to Chinese nationals. That number seems high to me, but there is no question that Chinese nationals buy many homes here.
With these uncertainties, it’s an important question as to whether today’s buyers will be tomorrow’s bagholders.
Homeowners: A new class of fools
Todd Schoenberger, Thursday, 10 Jul 2014 | 12:26 PM ET
When Kimberly walked up to the front door of a beautiful, 7,500 square foot colonial, anchored in a terrific cul-de-sac in northern Baltimore County, she said to herself: “All my life I thought this was what I wanted. But as beautiful as this property is, I see nothing but a money pit and a trap.”
The 32-year old congressional aide who was arriving at the house for a charity event chose to satisfy her curiosity by exploring the grand rooms and perfect fixtures, only to finally decide, “Yeah, not only would I never buy an individual house, I’d be shocked if my friends would as well.“
I recently asked, Is current housing weakness a fundamental shift away from home ownership? It may be.
Kimberly is not alone in her thoughts as more and more young professionals choose to live in an urban, agile setting rather than be susceptible to a life of endless house maintenance, limitless property tax hikes, and a concrete burden of never being able to sell unless at a fire-sale price.
Owning a home isn’t just for suckers, as I stated in my CNBC column in November of last year; it’s creating a class of fools for those who do buy, because so many Americans continue to think home ownership is the passport to the so-called American dream.
Headline news stories about rising interest rates and lack of supply are pushing people to make irrational decisions and, inevitably, finding themselves in the unenviable land of buyer’s remorse. And with a clear demographic shift, such as the millennial generation Kimberly and her peers find themselves in, the short-term and long-term prospects for the real estate sector are horrifically scary.
If the days of buying on faith in home price appreciation are over, I welcome the change.
2014 was expected to be real estate’s Gatsby year. After promising sales numbers in 2012 and 2013, this was going to be the year we were going to hear how homeownership wasn’t just a stable investment, but also the gateway to American prosperity. Sales and contracts jumped, including home values as reported from Case-Shiller. The former, however, is top-heavy as the most expensive properties are mostly selling; thus manipulating the data, as seen in the following chart from the National Association of Realtors:
One thing I don’t recall mentioned on your site (excuse me if I missed it) are the PMI payments the banks are getting for borrowers in default. The banks may actually be getting paid for many of the houses in the shadow inventory. That may be why they are in no hurry to put them on the market. If so, the expiration of those policies may incentivize the banks to finally foreclose and put the houses up for sale. I don’t know what the average term is for a PMI policy, but it would be interesting to see if there is a correlation between the term length, and the rate at which houses are released on the market.
The banks are getting some cashflow on shadow inventory houses through loan modifications, and that’s exactly why they are in no hurry to foreclose. The PMI generally goes to a separate insurance company, and those companies are greatly benefiting from lender can-kicking as their claim payouts have fallen significantly.
June Sales Volume Lowest Since 2008
http://www.propertyradar.com/reports/real-property-report-california-june-2014
The polar vortex continues to linger.
The problems is we are at pre-crisis levels of foreclosure now…
Mortgage foreclosures hit lowest level since mid-2006
Foreclosure activity in June dropped to its lowest level nationwide since before the housing bubble started to burst nearly eight years ago, a new report said Thursday.
The number of homes facing bank auctions, default notices and scheduled auctions totaled 107,194 last month, down 16 percent from June 2013, according to RealtyTrac, the housing industry research firm based in Irvine, Calif. June’s total was the lowest since July 2006, the company said.
“Nationwide foreclosure activity in June reached an important milestone,” Daren Blomquist, a RealtyTrac vice president, said in a prepared statement. “Over the next six to nine months, foreclosure numbers should start to flatline at consistently historically normal levels.”
Read more here: http://www.kansascity.com/news/business/article742736.html#storylink=cpy
Without question, less homes in foreclosure can contribute to lower sales volumes.
Still – overall inventory continues to rise while sales are falling like a rock.
Also, Housing starts plunge sharply in June
http://www.cnbc.com/id/101844350
I think the PropertyRadar report is excluding the sales of new homes which makes the drop look worse than it is. For Orange County, sales are only down 1.2% from last year thanks to a 62% surge in new homes being sold.
http://www.dqnews.com/Charts/Monthly-Charts/OC-Register-Charts/ZIPOCR.aspx
As for housing starts, the number is actually 7.5% higher than June of last year, and May and April also beat last year. The first three months of this year didn’t beat 2013 thanks to the Polar Vortex, as you astutely pointed out. 🙂 Notice that month-over-month starts also declined last year from May to June, but it had no effect on the long term trend of higher year-over-year starts.
http://1.bp.blogspot.com/-CH7U1clXw0o/U8fdxDJZxEI/AAAAAAAAfwE/i3NuKXOaww8/s1600/Starts20132014June.jpg
Good insight.
Lenders have chosen to freeze the market by forcing owners to ask more than buyers can pay and by refusing to foreclose or approve short sales. I’m surprised the NAr isn’t lobbying to force banks to approve more short sales or foreclose to add more supply at affordable price levels.
Foreclosure Activity Falls below Pre-Crisis Levels
Can-Kicking is the new normal
In an important signpost of recovery, foreclosure activity in the United States has fallen to levels not seen since before the financial crisis began, according to a report issued by RealtyTrac Thursday.
The Midyear Foreclosure U.S. Market Report showed that a total of 613,874 properties in the United states in some stage of the foreclosure process in the first half of 2014. The number represents a 19 percent decrease from the previous six months and down 23 percent from the first half of 2013.
At the halfway point of 2014, a total of 315,895 U.S. properties have started the foreclosure process, a figure on a pace to reach more than 630,000 for the year. If that pace holds it would represent a significant decline from the 747,728 foreclosures reported in 2013.
“Nationwide foreclosure activity in June reached an important milestone, dropping to levels not seen since before the housing price bubble burst in August 2006,” said Daren Blomquist, Vice President at RealtyTrac. “Over the next six to nine months nationwide foreclosure numbers should start to flat line at consistently historically normal levels.
The report also includes data for the month of June which showed that 107,194 U.S. properties had a foreclosure filing, a 2 percent drop from the previous month. Filings are down 16 percent year-over year from June of 2013.
A total of 47,243 U.S. properties started the foreclosure process for the first time in June. The June figure is down 4 percent from the previous month and down 18 percent from a year ago to the lowest level since November 2005.
But it’s too early to throw a victory parade.
Nine states recorded a foreclosure activity increase in the first half of 2014 compared to a year ago, including New Jersey, which was up a staggering 54 percent.
“There continue to be concerning trends in some states and local markets that clearly indicate those markets are not completely out of the woods when it comes to the lingering foreclosure problem left over from the housing bust,” Blomquist continued.
“While it’s important that any remaining foreclosure infection is addressed promptly to keep it from festering, foreclosures are no longer a widespread contagion threatening to derail the housing market’s return to full health.”
BofA’s $30B litigation problem is getting worse
Bank of America’s (BAC) mortgage-related litigation costs are something the banking giant wants to put behind it, but good luck with that, because it’s only going to get worse before it gets better.
Over the past two years, BAC has incurred $20 billion in litigation charges at the same time that its net income over those two years was $11.9 billion.
But that’s just the tip of the iceberg.
This quarter, Bank of America reported that its second-quarter profits plummeted 43%, largely attributed to falling mortgage revenue and increasing litigation costs.
BAC’s real estate services division was an albatross around the bank’s neck, posting a loss of $2.8 billion in the second quarter of 2013, compared to losses of $930 million in the second quarter of 2013.
BAC made just $13.7 billion in home loans in the second quarter, a free fall of almost 50% from the second quarter of 2013, while first mortgage originations flat out crashed, falling 60% year over year.
BAC’s mortgage services portfolio collapsed from $780 billion to just $760 billion, down from $986 billion a year ago.
Add that to today’s earnings statement, which has BAC reporting the lowest net interest yield in the company’s history at 2.22%, and what you get is really troubling.
Above that neck draped with the albatross is BAC’s head. And above BAC’s head hangs the Sword of Damocles in the form of an ongoing investigation by the Department of Justice for fraudulent mortgage securities practices during the financial crisis.
Fed wants to remain accountable to no one
The Chair of the Federal Reserve Board Janet Yellen deliver her semi-annual Monetary Policy Report and completed her second day of testimony Wednesday, this time testifying before the House Committee on Financial Services.
Chairman of the House Committee Representative Jeb Hensarling (R-Texas) signaled early on that, although the report that Yellen submitted to the house was identical to the one that she offered the Senate on Tuesday, the tone and topics of conversation would be different. It was the toughest round of questioning she has faced since assuming the chairmanship of the Fed earlier this year.
Hensarling opened the hearing by making a strong opening statement in favor of a Republican bill that calls for more transparency from the Fed in its policy making decisions and requires central bank to follow mathematical rules when considering when to adjust monetary policy such as interest rate adjustments.
Yellen delivered an opening statement of the same tenor as yesterday, emphasizing that, while the economy had improved, the economic recovery was still too fragile to deviate from current Fed Policy.
When pressed by Hensarling about her position on the House bill, Yellen echoed her testimony to the senate on Tuesday that the Fed is as open in its process as is appropriate and that making policy decisions on the basis of a mathematical formula would be problematic.
She characterized the Fed as the most transparent central bank in the world and made the case that she needs flexibility when setting Fed policy.
“It would be a grave mistake for the Fed to commit to conduct monetary policy according to a mathematical rule,” she told the Committee. “It is utterly necessary for us to provide more monetary policy accommodation than those simple rules would have suggested.”
She balked at the assertion by Representative Bill Huizenga (R-Michigan) that the bill allowed the Fed control because it gave them the ability to set the rules that it would follow before any congressional oversight took place.
She cited a lack of evidence that adopting stringent rules was a prudent way to set monetary policy. Later she would add that if the rules had been in place during the financial crisis they would have performed “miserably” and produced “dreadful” results. “A rule is useful input, but I just won’t go further than that,” Yellen said
I’m in mid-30’s age bracket, as are most of my friends. Some of us were fortunate enough to be able to buy during the downturn of 2010-2012 and get excellent-to-decent deals.
Of the remaining friends that I speak to, almost no one is actively looking to buy in today’s market. It’s not a matter of affordability. These are young professionals with good jobs and (mostly) 100k range incomes. They could easily qualify for a starter home in Anaheim, Fullerton, Garden Grove or a condo in some of the nicer coastal neighborhoods. Nor is it a matter of interest. Just about all of my friends are interested in purchasing “at some point.”
Rather, it’s a matter of psychology. I feel like the general consensus out there amongst the average buyer is that prices are at their peak right now. The scars of 2007 are too fresh – nobody wants to be that person that pays top dollar only to see their home erode in value by 40%. Whether that is true or not remains to be seen, but I don’t see a ton of organic demand for housing in the current SoCal market.
I hope that psychology doesn’t change. What you are describing amoung your friends is a complete purge of kool aid among Coastal California potential homebuyers. Without kool-aid to motivate stupid buying decisions, inflating a new bubble is much more difficult.
I disagree. If someone feels ready, they will buy. One of our newer engineers who recently finished his 1 year probation just closed on a house. He had been actively looking for three months. He wants to have kids, feels his job is secure, and doesn’t care what the market is going to do. As long as it was in his price range and specific neighborhoods he was bidding on it.
There are eight married engineers in our office and all have a mortgage. Out of the 9 unmarried engineers, three have a mortgage and two are looking casually.
Price inflate in the last 30-40 years was due to the drop in rates going from 15% to 3% at the low for the 30 year. The FED printing has created this massive distortion in home prices relative to income for areas with healthy economic activities due to the low borrowing cost. Even when rates stay low for a very long time, prices will just appreciate according based on the ebb and flow of the economy and the investment community. But perpetual low rates has the potential to ignite another RE bubble. And I believe some areas already in bubble prices not because of rates but due to hot money such as Bay Area and SoCal.
We heard the other day Microsoft was laying off 6000 employees. That number just tripled to 18,000.
12.5K jobs will come from Nokia. The rest (5.5K) are coming from Microsoft. This will be the largest round of layoffs in Microsoft history – dwarfing the 5800 laid off in 2009.
Looks like Microsoft isn’t alone – IBM, Intel, Cisco, and HP are all in the process of laying off ~5% of their employees. Lots of good jobs and salaries going away, likely never to return to our shores.
http://www.reuters.com/article/2014/07/17/us-microsoft-employment-idUSKBN0FM08K20140717
http://www.usatoday.com/story/tech/2014/07/17/microsoft-job-cuts/12772901/
I’m betting a lot of these lay-offs are either trouble makers or older folks being cajoled in to early retirement. Either way, this is deflationary. If tech and or manufacturing jobs do comeback, it will not be in those highly paid “designers/professionals” type of positions but rather assembly or technician with medium to below average pay. This is the reality until the next big innovative wave comes along. Again the cycle of innovation goes something like 50 years. But I better stop before I’m being confronted again for my cycle talk.
So much for a surge of hiring for highly paid jobs…
I believe the advice given to those looking to buy a car is to not get caught up in the payment. If you target a payment amount, you are ignoring how much they are actually charging you for the car. The current housing mantra is to focus on the affordability of the payment so you will not pay attention to the hundreds of thousands of dollars you are risking in lost value. We can debate short term interest rate hikes, but I am not aware of anyone that thinks interest rates will remain at zero for 15-30 years. A house purchase today is almost guaranteed to be a loss in equity tomorrow. It is hard to mentally fathom spending $600k with almost an additional $400k in interest and then selling for $400k.
The government would love to leave investors and the Chinese holding the bag. No tears shed for the rich or the outsiders. However, the real public outcry should be from the Millennials. The Baby Boomers have already taken away the affordable education (that they demanded), taken away the Social Security benefit (that they demanded), and now are taking away the affordable housing (that they demanded). Not to mention the entitlements that are leaving the National Debt at insane levels. Grandpa is looking to screw over his grandson at every turn. Where is their rebellion to being left to hold the bag? AARP would be having a fit if the roles were reversed. How can they be so willing to be abused so bad?
In another ten years or so when the bulk of baby boomers have retired, there will be a huge entitlement battle. It’s hard to imagine the workers winning that one considering retirees vote in much higher percentages than working people, and the size of their generation is so large. I expect they will vote themselves even larger entitlements.
Uhhh – hey Lee? Remember that clip you posted on Monday with the head of the IMF going on and on about 7s?
MH-17, a 777, just got shot down on 7/17. Wow.
I’m guessing all these articles about Millenials never wanting to own a home will be proven wrong in about 5 years when they start having kids, just as all the articles about Boomers downsizing at retirement have also been wrong. The urban core lifestyle only suits young hipsters without kids. Most people with six-figure incomes don’t want to raise their kids in an apartment.
Just wait, in a few years Kimberly from the article is going to be knocked up and in full nesting mode, demanding her baby’s daddy fork out for the most house they can afford. LOL..
The Millennials will buy eventually, but they may not drive out to Hesperia to buy a McMansion. The woman in the article was reacting to a massively overbuilt and opulent Mansion. I don’t foresee a tiny house revolution, but the next generation may be happy with 2,400 SF instead of 3,500 SF.
I’m currently happy with 1500 SF. The max space I’ll probably buy is 2000 SF. For all I know, I might be living there for the rest of my life. Right now I’m not too happy about the yard work (removing weed). I’m 31 years old BTW.
That’s the funny thing about the article. It’s gauging the reaction of a 32 year old about buying a 7,500 sq.ft. colonial mansion, as if that was a typical housing choice for her age group prior to the housing bust. Somebody just starting out is probably going to select a house 10-20% that size.
I follow this blog because I live here in Bend, Oregon where much of the Southern California/Las Vegas (stereotypical) real estate mentality is hard at work. What happens in Southern California in the last boom-bust-boom cycle has occurred even more dramatically here. Local banks are now offering zero down loans and loans to those that have recently had a foreclosure. I guess the inventory was getting just a bit too high and we haven’t quite (almost) made it back to 2007 peaks.
http://www.bendbulletin.com/exports/newsletters/main/2245992-151/lenders-offering-no-money-down-mortgages?entryType=0#
Thank you for your comments and insights.
I know a local architect who built a $2.5M mansion on a golf course in Bend. He sold it for about $900K in 2009. The ups and downs in the second-home communities was truly remarkable.
Paulson: Buying a house still best investment
Looking at today’s economy and housing market, billionaire money manager John Paulson said in an interview with CNBC that he still believes buying a home to live in is the best investment possible.
“I still think, from an individual perspective, the best deal investment you can make is to buy a primary residence that you’re the owner-occupier of,” Paulson said Wednesday at the Delivering Alpha conference presented by CNBC and Institutional Investor.
“Today financing costs are extraordinarily low. You can get a 30-year mortgage somewhere around 4.5%. And if you put down, let’s say, 10% and the house is up 5%, which is the latest data, then you would be up 50% on your investment,” he explained.
“And you’ve locked in the cost over the next 30 years. And today the cost of owning is somewhat less than the cost of renting. And if you rent, the rent goes up every year. But if you buy a 30-year mortgage, the cost is fixed.”
http://www.housingwire.com/articles/30688-watch-buying-a-house-still-best-investment
Oh lookie…someone who went long housing about 15 months ago is out making the media rounds telling ‘muppets’ that he still believes a consumption item/speculative commodity is the best investment possible. [email protected] ribsplitterconflictofinterest.
Reality is, he needs as many muppets as possible to believe it so he can sell the highs.
Bond yield dip huge today with the 10 year dipping almost 0.1%. 10 year treasury are now 2.44%, this will provide some help to affordability. But I guess only some are biting due to the worry that rates will shoot up which in turn putting pressure on price and equity. So much for the bears chanting of rates going up RE prices crashing…It is in FED and government best interest to keep it as low as possible for as long as possible since they too have an adjustable mortgage called the national debt and FED bond balance sheet. Government is getting more powerful everywhere so they will suppress rates down for a while but it won’t last forever.
Whenever I see bond yields drop like that, I brace myself for more bad economic news. When the fed began the taper in January, rates should have begun to rise, but instead they fell. As it turned out, that drop foreshadowed a 2.9% contraction in the first quarter. What do falling rates today tell you?