Will fall and winter see a significant pullback in house prices?

House prices show a consistent seasonal pattern. Prices generally rise during the spring at their fastest rate. During the fall they slow down, and during the winter, when sellers who missed the spring rally get more motivated to sell, prices generally decline.

At the end of each spring selling season, it’s possible to make an educated guess as to the direction and magnitude of the price movement in the fall and winter. In 2010, the expiration of the tax credits made a strong pullback a likely and predictable result. In 2011, the complete lack of a spring rally portended severe price declines in the fall and winter. In 2012, the complete lack of inventory and upward price movement made a fall and winter pullback unlikely.

Now it’s 2013, prices are rising rapidly, and inventory is still restricted. Ordinarily, I would surmise that prices would not decline during the off season. However, the recent spike in mortgage interest rates has pummeled affordability, and it appears likely the momentum of the market will stall.

The main variables to consider are inventory and interest rates. New inventory has been slowly coming to market, but mostly this is cloud inventory priced to sit. Lenders are processing very few foreclosures, so must-sell inventory is almost non-existent. That would suggest prices won’t decline much. However, if interest rates remain above 4.5%, demand will wane, and buyers will not be able to raise bids to afford the cloud inventory prices. If interest rates move to 5% or higher, either the market will see very low sales volumes, or prices will fall. Perhaps we will see some combination of both.

The one factor that may carry the market through is unsatisfied demand. Many buyers have been frustrated by the rapidly rising prices and crazy competing offers. If demand cools from the marginal buyers with cheap money, the stronger buyers may finally get their chance to buy a house. If this unsatisfied demand remains active, sales volumes may remain healthy and prices will hold steady. This seems a likely scenario.

Why Home-Price Gains Will Slow Amid Higher Mortgage Rates

By Nick Timiraos — July 8, 2013, 4:27 PM

Home prices moved up at a torrid pace during the first half of the year, but don’t expect them to keep pace during the second half.

The big spike in mortgage rates over the past two months has reset the housing market and figures to take a bite out of demand at a time when more sellers have listed homes for sale and when price gains have tested investors’ purchasing appetites.

Mortgage rates, which stood at a low of 3.59% at the beginning of May, jumped to 4.58% during the last week of June, according to the Mortgage Bankers Association. Rates rose even more last Friday, after a strong jobs report firmed up investors’ expectations that the Federal Reserve would begin to curtail its bond-buying program later this year.

A rule of thumb holds that every one percentage point increase in interest rates reduces affordability by 10%, so the recent move in rates just made homes about 10% more expensive to buyers who need to finance their purchase.

There’s no one in the business right now who doesn’t think the market hasn’t taken a step back. The evidence is all around us,” said Glenn Kelman, chief executive of real-estate brokerage Redfin. The number of Redfin customers who requested tours during the last week of June was down 5% from the average for the previous three weeks, while the number of customers making offers was down by 8% and the number of new customers edged down by 2%.

The bulls have postulated rising rates would not impact market demand because house prices are still relatively affordable. Apparently, this is not the case.

Here’s a look at seven areas to watch during the second half of 2013:

1. What will higher mortgage rates do to housing demand? Rates are now at their highest level in two years. For borrowers with less than a 5% down payment, the effective mortgage rate is at its highest level since mid-2009 because loans backed by the Federal Housing Administration now carry higher annual insurance premiums. …

First-time homebuyers participation is already at record lows. The foundation of the housing market is stretched more than bulls realize.

But the bad news is that the level of rates may matter less than the speed of any increase. A sharp spike in interest rates—even to a level that is still historically low—represents a large payment shock to home shoppers. …

2. Don’t higher mortgage rates help in the short run by bringing more buyers off the fence? Not really. There’s little evidence that higher rates create new demand, even if they accelerate purchases from households that had already decided to purchase. Pending home sales in May rose sharply by 6.7% from April to their highest level in six years, but that spike could easily be reversed in June and July.

So much for the bull’s contention that rising rates bring out the fence-sitters. It’s very likely demand will fall due to higher rates and the end of the prime buying season.

3. Who is knocked out of the market by rising rates? The jump in rates should be felt everywhere, but the entry market and the high-end market could see a bigger pinch. First-time buyers and others who were already stretching to qualify for a loan and scrape together the down payment could find themselves unable to buy the house they thought that they could back in April.

With first-time buyer demand already at record lows, rising borrowing costs are not a plus to the market.

An entirely separate class of buyers—Mr. Kelman calls them “buyers of opportunity”—didn’t really need to buy a house, but they were willing to consider a $1-$2 million home-purchase back when rates were at 3.5%. Now, it may be less compelling, ….

The move-up market was already hurting due to a lack of equity. Take away motivation among the few buyers with equity, and sales could decline quite sharply.

4. What does this mean for investors? … There have been signs, however, that higher home prices have prompted investors to dial back their purchases because it’s become more difficult to dig up bargains, even before rates began to rise.

Investors buy for rental cashflow. Higher prices and softening rents in the markets where investors were most active will make them less eager to keep buying. Further, higher interest rates will drive up the cost of capital forcing the institutional investors to raise their expectations for cap rates further reducing investor demand.

5. How fast will inventory rise? Even before rates increased, the number of homes offered for sale was rising at a slightly faster pace than it normally does during the spring, even though inventory in May was still around 10% below last year’s level. One sign that inventory has picked up is that competitive offer situations are dropping. The share of offers written by Redfin agents that faced a competing offer fell to 69.5% of offers in May, down from 73.3% in April. One year ago, some 69.3% of offers faced at least one competing bid.

Markets that have seen larger increases in listings have seen even bigger declines in multiple-bid situations. In Orange County, Calif., where the inventory of homes for sale is up by more than one third since March, some 84% of homes where Redfin agents wrote an offer in May had competing bids, compared to 94% in April. In San Diego, some 73% of offers in May had multiple offers, compared to 87% in April.

Eighty-four percent of homes having competing offers is still very, very high. (Of course, listing agents are liars, so it may not really be that high.) This signifies a significant amount of unsatisfied demand. This may carry the market through the winter as frustrated buyers come out seeking opportunities they did not have this spring. In fact, it’s probably more likely this latent demand will prevent any significant pullbacks this fall and winter.

6. Is this the end of the housing rebound? It depends on how much higher rates rise. For the last 18 months, home prices have shot up against a backdrop of fewer homes for sale—particularly distressed properties—and stronger demand. Housing bulls have argued that this recovery has been driven by fundamentals such as household formation, even if it has been accelerated by low rates.

Can anyone be taken seriously who contends the market rally is based on fundamentals? Unemployment is high, first-time homebuyer participation is at record lows, wages are stagnant, household formation is low, and loan originations are moribund at 1990s levels. The market really is engineered by a combination of restricted inventory and low interest rates.

Bears have argued that the recovery has been mostly artificial, driven by cheap debt. The gyrations in bond markets are going to pull back the curtain on just how much the current recovery has depended on ultra-low mortgage rates. …

The mortgage interest rates are only part of the equation. The market will continue to be held together by restricted inventory. With 25% of borrowers underwater, and another 20% barely above, nearly half the normal inventory is simply not on the market, and it won’t be until prices move higher.

Rising mortgage rates are actually a positive, says John Burns, chief executive of John Burns Real Estate Consulting, because they should produce more sustainable price increases. “I don’t think it’s the end of price increases, but I think they’re going to moderate significantly,” he said.

Most economists now agree the rebound rally is over. 20% year-over-year gains are going to an end. It’s been a great run for the few that managed to buy between mid 2011 and early 2013.

7. When will we know how much rising rates have reset the market? … The Case-Shiller index is reported with a two-month delay, meaning that July prices won’t be reported until the end of September. Much of the price data out over the next two months won’t reflect the impact of rising rates.

The first sign of trouble will be an “unexpected” sharp decline in sales volumes. And even this may not occur if unsatisfied buyers turn out when the marginal buyers are removed from the market.

Most likely, we will see an extended flattening of prices through next spring. We may see a dropoff in sales, but I don’t see the conditions forming to make a significant drop in prices over the fall and winter.

9 months was long enough to go Ponzi

The former owner of today’s featured property was a near-peak buyer. She bought the property on 8/29/2005 for $325,000. She only put $33,000 down. Based on her timing, you wouldn’t think she had time to start a Ponzi scheme, but she refinanced with an Option ARM with a 1.47% teaser rate on 3/3/2006 for $333,000. She got her down payment back plus another $8,000. Not bad for about 9 months of loanership.

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9863 CORNWALL Dr Huntington Beach, CA 92646

$389,000 …….. Asking Price
$325,000 ………. Purchase Price
8/29/2005 ………. Purchase Date

$64,000 ………. Gross Gain (Loss)
($31,120) ………… Commissions and Costs at 8%
$32,880 ………. Net Gain (Loss)
19.7% ………. Gross Percent Change
10.1% ………. Net Percent Change
2.3% ………… Annual Appreciation

Cost of Home Ownership
$389,000 …….. Asking Price
$13,615 ………… 3.5% Down FHA Financing
4.52% …………. Mortgage Interest Rate
30 ……………… Number of Years
$375,385 …….. Mortgage
$114,463 ………. Income Requirement

$1,906 ………… Monthly Mortgage Payment
$337 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$81 ………… Homeowners Insurance at 0.25%
$422 ………… Private Mortgage Insurance
$210 ………… Homeowners Association Fees
$2,957 ………. Monthly Cash Outlays

($432) ………. Tax Savings
($493) ………. Principal Amortization
$23 ………….. Opportunity Cost of Down Payment
$69 ………….. Maintenance and Replacement Reserves
$2,124 ………. Monthly Cost of Ownership

Cash Acquisition Demands
$5,390 ………… Furnishing and Move-In Costs at 1% + $1,500
$5,390 ………… Closing Costs at 1% + $1,500
$3,754 ………… Interest Points at 1%
$13,615 ………… Down Payment
$28,149 ………. Total Cash Costs
$32,500 ………. Emergency Cash Reserves
$60,649 ………. Total Savings Needed
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