May252016
Los Angeles County housing gets less and less affordable
Both rental rates and the cost of ownership rise faster than incomes in Los Angeles County due to an improving economy and a lack of housing supply.
California inflated three housing bubbles over the last 40 years, and perhaps a fourth one inflates now. The collapse of each of the previous housing bubbles coincided with economic recessions, so many analysts incorrectly point to these recessions as the cause of the price collapse. The truth is that each of the previous bubbles inflated because lenders abandoned debt-to-income standards (1970s), experimented with toxic financing and relaxed DTI standards (1990), or completely lost their minds with “innovative” loan products (2000s). The coincidental recessions may have contributed to the problem, but they weren’t the cause, and in the last instance, the recession was an effect.
These bubbles inflate in California because the state endures a chronic lack of available housing supply. When the economy is good, businesses create jobs, which creates housing demand, but local jurisdictions reject proposals for new housing, so no few new houses get built to accommodate the worker with a new job. This causes people to substitute down in quality to obtain housing, and it forces the lowest rungs of the property ladder to put 50% or more of their income toward housing or leave the state.
The economy improves slowly but steadily in California, and although developers are providing more apartments, neither the apartment developers or homebuilders provide enough supply to match the demand; thus the cost of housing rises significantly.
L.A. families fall behind rising cost of living
Carrie B. Reyes
4.6 million of the Los Angeles metro area’s population of 8 million lives below an adequate standard of living, according to a recent report by the Economic Policy Center. In other words, over 57% of Angelinos do not make enough money to get by without outside assistance.
This study is more nuanced than other measures like poverty or affordability since it is extremely localized. An “adequate standard of living” is determined by family size and for the unique costs of everyday living expenses particular to an area. …
California is raising the minimum wage to combat this problem, but without more housing, raising the minimum wage will not be enough.
(See: Raising minimum wage enriches landlords in low-supply housing markets)
What does this mean for Los Angeles’ housing market?
First, the housing expenses calculated by the Economic Policy Center are based on the Department of Housing and Urban Development’s (HUD’s) fair market rents. These are calculated based on real rents for dwellings at the region’s 40th percentile (so, 10% below average).
These calculations assume a single person is living in a studio apartment, a two adult household is in a one-bedroom apartment, and a two adult household with one or two children — like in our example — is in a two-bedroom apartment.
This is to say, if you’re an average four-person household looking to rent your shelter, $1,421 on rent in Los Angeles is a steal. Most families with multiple children are looking for three-bedroom apartments or single family homes. Further, if you’re hoping to get into a neighborhood with good schools, you’re going to encounter much higher rents to pay for this privilege. Thus, what the Economic Policy Center determines as adequate housing is truly nothing more — the housing is generically adequate. …
What happens when the gulf widens between rich and poor? More people are sifted from a previous middle class existence to a sub-adequate standard of living, joining the majority of Angelinos already struggling to make ends meet. …
There is a solution, but it requires change. It requires zoning to accommodate demand, allowing rents to drift down to a reasonable level in the most desirable areas where quality jobs and good schools are located. It also requires curbing speculator activity by instituting regulations to reduce short-term flippers and hit-and-run investors. This will bring more stability to the housing market, specifically fewer bubbles and corresponding bursts. These volatile market aberrations discourage potential homebuyers from entering the market, and further punish homeowners by plunging them into negative equity when the bubble invariably pops.
Of the three solutions above, only the first one, requiring zoning to accommodate demand, will help.
Rents will never drift down in the desirable areas. The best we can hope for is to bring enough supply to market to reduce the rate of rent increases to less than the rate of income growth. Over time if incomes grow faster than rent, housing becomes more and more affordable instead of the other way around.
Going after flippers is always an appealing target, but renovating low-quality housing is a vital function that shouldn’t be discouraged. If there were some way to prevent ordinary people from simply buying properties, sitting on them, and reselling them later for more money, that might help, but there is no good way to separate the wheat from the chaff.
Los Angeles County Housing Market Report: May 2016
Whenever either rental rates or resale home price appreciation exceeds 7%, my monthly reports show a downward sloping yellow arrow to signify that such rates of change are not sustainable. For the last several months, both rents and resales rose faster than 7% on a year-over-year basis.
Rent and resale prices were relatively flat for eight to ten years during the 1990s, but since 2000, both rent and ownership costs rose faster than inflation, mostly due to the lack of supply. As such rates of appreciation are not sustainable, I anticipate another extended period of flat rent and resale price growth in the future.
Los Angeles County home price appreciation during the reflation rally from 2012 to 2015 exceeded the rate of increase during the housing mania.
Both rental rate increases and resale home price appreciation exceed income growth and are ripening for a correction.
The next California housing bust
Over the last eight years, credit quality has been pristine. Only the most qualified borrowers obtain mortgages, and lenders actually verify these borrowers’ ability to repay, something they failed to do during the last mania. The next housing bust, should we endure one, will not be caused by poor lending practices. This doesn’t mean California won’t suffer another housing bust, but if it does occur, it won’t be caused by poor lending practices like the last three busts were.
So what will cause the next bust? Assuming toxic mortgages don’t return and lenders continue sane lending practices, only three causes may precipitate another bust:
(1) repatriation of foreign investment,
(2) rising mortgage rates or
(3) an economic recession.
Exodus of foreign cash
The people who deny a real estate bubble in China are wrong, and the deflating Chinese property bubble could destabilize the world economy, but of greater interest to owners of Coastal California real estate, the deflating Chinese housing bubble could turn local real estate buyers into desperate sellers. The Chinese government could easily stop the flow of electronic capital by decree, and if they exercise this power to shut off the flow of capital leaving China for US real estate, it could cause a sudden and dramatic decrease in house prices.
(See: Chinese government policy change could kill Coastal California housing market)
Rising mortgage rates
I suggested that the market reached a permanently low floor in mortgage interest rates. If mortgage rates were to rise, it would cause a dramatic decline in home sales because cloud inventory restrictions prevents owners from lowering their prices, causing so many problems with housing that the federal reserve would need to increase it’s bond purchase program (printing money) to lower rates to keep the housing market functioning.
If the federal reserve failed to act, and if mortgage rates were allowed to drift up to 5% or 6% or higher, we would endure a complete collapse in sales volumes and massive unemployment among homebuilders, realtors, and mortgage loan officers, causing house prices to fall again, exposing banks to tremendous losses. Given those problems almost certain to accompany higher rates, it simply won’t be allowed to happen — even if that means the federal reserve buys every mortgage in America.
Economic recession
The next correction in California house prices (call it a bust if you like) will be caused by an economic downturn. Previously, such a downturn would lead to foreclosures, and the must-sell inventory would push prices down. That won’t happen next time because lenders mastered the art of loan modification can-kicking, so they would amend-extend-pretend their way through any recession. Therefore, any future downturn will be a long, slow grind similar to the bust of the early 90s.
The downturn will be caused not by foreclosures, but by the lessening of the downward substitution effect. Both rental rates and resale home prices are high and rising faster than incomes because the shortage of supply is forcing people to settle for less. Take away the demand pressure, which a recession does, and both rents and resale home prices stop rising, and if the recession is deep enough, prices go down.
In fact this phenomenon is most acute where the supply is most limited. The most volatile rents occur in the Bay Area because highly-paid tech engineers bid up rents while times are good, and they leave town when the venture capital flow stops. The same is true in Los Angeles too as evidenced by the wild swings in both rent and resale prices in the charts above.
I don’t believe the next housing bust will show dramatic declines in resale prices like the last bust because borrowers are more secure and lenders are more adept at handling troubled borrowers. Plus, resale prices haven’t departed long-term fundamental measures yet either. Depending on the depth of the recession, rents and resale prices may both go down, and that’s what the next housing bust will look like.
[listing mls=”OC16110204″]
U.S. new homes sales hit eight-year high, point to firming economy
New U.S. single-family home sales recorded their biggest gain in 24 years in April, touching a more than eight-year high as purchases increased broadly, a sign of growing confidence in the economy’s prospects.
Tuesday’s report from the Commerce Department, which also showed a surge in new home prices to a record high, offered further evidence of a pick-up in economic growth that could allow the Federal Reserve to raise interest rates soon.
“Consumers are taking the leap and buying the biggest of big ticket items of their lives and this speaks to confidence. The Federal Reserve can raise rates at their June meeting without fear the economy is going to slow,” said Chris Rupkey, chief economist at MUFG Union Bank in New York.
New home sales jumped 16.6 percent to a seasonally adjusted annual rate of 619,000 units, the highest level since January 2008. The percent increase was the largest since January 1992.
Data for February and March were revised to show 39,000 more units sold than previously reported. Economists had forecast new home sales, which account for about 10.2 percent of the housing market, rising to only a 523,000 unit-rate last month.
New home sales increased broadly, with the exception of the Midwest. April’s increase, however, probably exaggerates the housing market strength given that homebuilders confidence has stagnated since rising in January.
New home sales are extremely volatile month-to-month and preliminary figures are subject to large revisions because they are mostly drawn from building permits data.
And new home sales could be much higher if more new homes were built in California.
It would also help if these new homes were priced under the conforming limit where they are built. The only market where I see a significant amount of the new home housing stock priced under the local conforming limit is in the Sacramento area. The builders are extremely active there, and sales are good. The houses are affordable, and FHA financing can be used to buy them. That’s a recipe for strong new home sales.
… and every single OC homeloanowner could be a millionaire if home prices ALWAYS went up.
MBA: Mortgage applications post another tepid week
It was another tepid week for mortgage applications despite the current low-mortgage rate environment, with applications increasing 2.3% from one week earlier, the latest data from the Mortgage Bankers Association’s Weekly Mortgage Applications Survey for the week ending May 20, 2016 posted.
The Refinance Index marginally increased 0.4% from the previous week, while the seasonally adjusted Purchase Index increased 5% from one week earlier.
Continuing to hover in the low 50s, the refinance share of mortgage activity decreased to 53.7% of total applications from 54.6% the previous week. The adjustable-rate mortgage share of activity ticked up to 5.7% of total applications.
Meanwhile, the average loan size for purchase applications reached a survey high of $307,700. This shouldn’t come as a surprise given home-price appreciation has steadily risen for roughly a year now, and it doesn’t look like it’s going to change anytime soon.
Rates have ticked up so refi’s are tepid, but purchase applications increased by 5% which is very good.
Coming up on Memorial Day week. I imagine we will get the huge drop followed by the “surge” the week following.
Expect to see more ads where the candidates own words are used against them. It’s brilliant politics.
Hillary Clinton ad uses housing crisis to smear Donald Trump
While former Secretary of State Hillary Clinton may be the frontrunner for the Democratic nomination for president, she’s not the official nominee yet, but that’s not stopping Clinton from attacking the presumptive Republican nominee and attempting to use his seemingly crass prediction against him.
In a new campaign ad posted online Tuesday by Clinton’s campaign, Clinton claims that Donald Trump “rooted for the real estate crash,” and uses Trump’s own words against him to supposedly prove that point.
The ad, which can be seen below, begins with various clips of news programs from 2008 with captions like “this is an economy that can’t find the bottom of bad news,” “ten years of saving completely gone, vanished,” “the biggest crash of household wealth that we’ve ever had in the United States,” and “5 million families lost their homes.”
Next, a smiling picture of Donald Trump appears with the caption, “And the man who could be our next president was rooting for it to happen.”
Then, a recording of Trump from 2006, reportedly taken from materials from his failed Trump University, states that he “sort of hopes (a crash) happens because then people like me would go in and buy…if there is a bubble burst, as they call it, you know, you could make a lot of money.”
That is followed by the caption, “If Donald wins, you lose.”
Is Hillary trying to get Trump elected?
As a former renter during the housing boom, I was also rooting for prices to crash. Not because I wanted a great deal, but because I wanted a fair price. Hillary comes off as supporting housing bubblenomics.
It’s an appeal to homeowners who were hurt by the bust. It goes to the core of Trump’s support with the working class. If Clinton can shake his supporters faith in him looking out for them, it will create problems for Trump he isn’t counting on.
Hillary is a failed real estate speculator in the Whitewater development. It will be interesting if Donald dredges that up as an example of her many failures, and also hammers her on the related corruption when Bill used his position as AG to broker a loan for his business partners.
I lived in Northwest Arkansas from 1977-1985. Arkansas politics was a small circle of people back when Bill Clinton was governor. Hillary made huge money as an attorney in Little Rock while Bill was governor because if you hired her firm, you had direct access to the governor’s bedroom. Needless to say, she was very well compensated.
New Home Sales Surge But Prices Getting Problematic
McLaughlin said the supply of new homes on the market “dropped sharply” after April’s blockbuster month of sales, which isn’t great news for home prices in the short term. Home prices have steadily climbed in recent years – a trend that if left unchecked inherently cuts off sales to lower-income Americans already on the fence about jumping into the homeownership market.
“A decreasing supply of new homes is sour news for homebuyers, who have also been stymied by low inventory of existing homes over the past four years,” he said. “The drop in supply means sales prices for new homes may rise quickly throughout the remainder of the home buying season.”
An existing home sales report published last week by the National Association of Realtors – which tracks the number of previously constructed and owned homes in the U.S. and represents a much bigger share of the overall domestic real estate market – showed such sales were up only 1.7 percent on the month in April and about 6 percent on the year. “Ongoing inventory shortages and faster price growth” were cited as complicating factors holding the market back.
“There’s growing concern a number of buyers will be unable to find homes at affordable prices if wages don’t rise and price growth doesn’t slow,” Lawrence Yun, the association’s chief economist, said in a statement last week. “Looking ahead, with demand holding steady and supply levels still far from sufficient, the market for entry-level and mid-priced homes will likely continue to be the most competitive heading into the summer months.”
Low supply plagues spring housing
The inventory of homes for sale nationally in April was 3.6 percent lower than in April 2015, according to the National Association of Realtors. Redfin, a real estate brokerage, also recently reported a drop in new listings.
The supply numbers are even tighter in certain local markets: Inventory is down 32 percent in Portland, Oregon, from a year ago; down 22 percent in Kansas City; down 21 percent in Dallas and Seattle; down 17 percent in Charlotte, North Carolina; down 12 percent in Atlanta; down nearly 10 percent in Chicago; and down 8 percent in Los Angeles, according to Zillow. Houston and Miami are seeing big gains in supply, due to economic issues specific to those markets.
“The struggle will continue for home shoppers this summer,” said Zillow chief economist Svenja Gudell. “New construction has been sluggish over the past year; we’re building about half as many homes as we should be in a normal market. There still aren’t enough homes on the market to keep up with the high demand from every type of homebuyer.”
The short supply is pushing home prices higher than expected this year. Zillow had predicted 2 percent growth in home values from April 2015 to April 2016, but its latest data show values currently soaring more than twice that, at 4.9 percent.
“In many markets, those looking to buy a home in the bottom or middle of the market will need to be prepared for bidding wars and homes selling for over the asking price. This summer’s selling season’s borders will most likely be blurred again, as many buyers are left without homes and will need to keep searching,” added Gudell.
The inventory drops are most severe in the lower-priced tier of the market. Homes in the top tier are seeing gains and therefore show more price cuts. Sixteen percent of top-tier homes had a price cut over the past year, compared with 11 percent of bottom-tier homes and 13 percent of middle-tier, according to Zillow.
The chinese bubble already popped, that’s old news
Market rents are absolutely affordable in SoCal and NorCal based on income for those setting the market.
This doesn’t mean long time renters will be able to afford future rents.
This has already occurred in SF and NYC where the only way long time renters can afford to live there is based on rent control programs.
Over time these rent controlled people are forced out… and the market always fills the void. Demand is just too high and the supply too low.
At least in SF, what you say is true today but it won’t be true tomorrow (whenever tomorrow breaks). The demand in SF is driven by very highly paid tech engineers (as IR says) but the growth engine is not profits or even revenue, it is venture investment. That can go away really quickly as it did in 2000. Many people have forgotten, but rents in SF and Silicon Valley went down pretty hard and fast in 2000 – 2002. My apartment went from $900 in 1998 to $1350 in 2000… to $1050 in 2002!
The rents in SF right now are not sustainable unless there will be an endless flow of capital into the City forever.
Recession always comes. Always.
Low interest rates are fueling it because PE investors are looking for anything that yields an acceptable return (sound familiar?.. ahem… subprime.. cough..cough).
In a normal rate environment, you wouldn’t see this level of risk taking but they have so much idle cash to invest, it needs to go towards something. Many know that it’s a ponzi scheme and are expecting to cash out to the greater fools (the stock market) before it all comes crashing down. Unfortunately, stocks have been stagnant for 18 months and tech startups in particular have not been treated kindly by the market.
So what is the exit strategy for the PE crowd? The answer to that could be entertaining to watch play out in real time. If new capital injections freeze up completely, there will be some major pain suffered by the existing investors.
Low FICO borrowers don’t even try
http://www.mortgagenewsdaily.com/cfs-file.ashx/__key/CommunityServer.Blogs.Components.WeblogFiles/jann.0000201605/2016_2D00_5_2D00_24-core3.jpg
CoreLogic has looked at an apparent contradiction in purchase loan originations that has emerged since the housing bubble burst. Why, CoreLogic economist Archana Pradhan asks in an article in the company’s Market Trends blog, if credit standards have tightened do we also see a drop in loan denial rates?
Single-family purchase loan applications numbered 4.6 million in 2014. While this is up from the 3.6 million that set a decade-long low in 2011, it is down 60 percent from the 11.7 million applications submitted in 2005. Similarly, there were 7.4 million single-family purchase loans originated in 2005 and that dropped to 3.2 million by 2014. The denial rate for purchase applications, peaked at 18.7 percent in 2007 but was at 13.2 percent in 2014. If credit standards are relatively tight today, Pradham asks, shouldn’t the denial rate be higher than it was in 2005 and 2006? Or is the industry seeing fewer applications from riskier borrowers?
Figure 3, shows how the credit score distributions have shifted from 2005 to 2015 for both applications and originations and indicates that the share of applications with lower credit scores has actually declined more sharply than originations. The share of credit scores below 700 for applications has declined and has been offset by a greater share of credit scores above 740.
The author says, that the similarity of distributions for both applications and originations in 2015 suggests that lenders are largely meeting the demand of applicants. “Thus, the observed decline in originations could be a result of potential applicants being either too cautious or discouraged from applying, more so than tight underwriting as the culprit in lower mortgage activity.”
She suggests that this caution results in “self-sidelining” that makes it appear that credit is tightening. This means that the policy solutions are quite different than if the cause was credit tightening and that more consumer education could be more successful in raising originations levels than introducing new lending products with lower credit standards.
[Consumer education is not the problem. Consumers know they won’t qualify, so they aren’t applying.]
There are companies going all the way down to 550 FICO to qualify for FHA, but the problem is low FICO borrowers also tend to have other problems. They may not have any money saved for a down payment or reserves, and their work history and income may be spotty, inconsistent, or non-existent. They may also have loads of other debt they are having trouble paying (which is why their FICO is so low), so their back end DTI is limiting what they can qualify for.
Irvine Co. gets $1.2 billion in loans on apartments
The Irvine Company, Orange County’s biggest landlord, recently took out $1.16 billion in mortgages on 19 apartment buildings it owns in the county, Silicon Valley and San Diego, a Freddie Mac apartment financing unit announced recently.
The loans are being rebundled into $1.04 billion in mortgage securities to be sold to investors.
Irvine Co. declined to comment about the deal. A Feddie Mac document indicated the loans are to refinance existing debt on the properties.
The interest rate for the 10-year loans is 4.31 percent. The loans were taken out on 15 complexes in Irvine, one in Tustin, two in San Diego and one in the San Francisco Peninsula town of Redwood City.
In all, the 19 complexes, ranging from 14- to 41-years-old, have a total appraised value of $1.8 billion, meaning he mortgages amount to 63 percent of the total value.
The 19 buildings have 5,242 of the company’s 57,000 total apartments, according to Freddie Mac.
The average vacancy rate for the 19 buildings is 4 percent; average rent is $2,097 a month, ranging from $1,581 a month for the San Paulo Apartment Homes in Irvine to $3,305 a month for the Franklin Street Apartments in Redwood City.
Irvine Co. investments total 115 million square feet, making the firm one of the largest owners and managers of commercial real estate in the nation, Freddie Mac’s filing said.
The Irvine Co. reports that it owns 130 apartment complexes in California, at least 82 of them in Orange County. And of the 57,000 apartments the company owns, about 40,000 are in Orange County.
In addition to apartments, the 152-year-old ranching firm-turned-land developer has 8.8 million square feet of retail space, plus 47.5 million square feet of offices in Orange County, San Diego, Silicon Valley, Chicago and New York.
With solar panels, O.C.’s buildings could be generating almost as much energy as they use, report says
To generate a lot of energy from rooftop solar panels, you need two things – a lot of sunshine and a lot of roof space.
Orange County, it turns out, has both, making it one of the most solar-ready regions in the country, according to a report from the National Renewable Energy Laboratory.
Mission Viejo topped a list of 47 cities studied, with rooftops capable of generating 88 percent of the city’s electricity consumption. Since apartments make up just 15 percent of the city’s housing, roughly half the state average, Mission Viejo has a very high proportion of rooftop per resident, and a lot of space for solar panels, according to the report.
But Mission Viejo isn’t unique in Orange County. It was just the local city that researchers happened to study. Researchers said the characteristics that make Mission Viejo a potential solar hub are found throughout the county.
“You guys have a fantastic place for solar – there’s no question about that,” said Pieter Gagnon, the report’s lead author who is based in Golden, Colo.
California, overall, fared well in the rooftop survey. The state could generate 74 percent of its 2013 electricity demand using rooftop solar panels – the highest percentage in the nation, according to the report. And a typical roof of a small building in the Los Angeles County/Orange County region has enough space for solar panels to generate more electricity than the building consumes, the report said.
The local solar market is strong for a couple of key reasons:
• Buildings here generally are more energy-efficient than buildings nationally.
• Also, compared with many other regions, there are fewer trees or other high objects that can block sunlight from solar panels.
The potential for solar energy already is translating into real-life production.
Southern California Edison, which provides electricity to most of Orange County, connected more solar panels to the grid last year than any utility in the country – 1,258 megawatts, roughly enough power for 943,000 households. San Diego Gas & Electric, which delivers energy to south Orange County, came in fourth, with 441 megawatts, or about 308,000 homes.
In all, about a quarter of the energy sold by Southern California Edison and more than one-third of the energy sold by San Diego Gas & Electric came from renewables, figures that don’t include residential rooftop solar, indicating the real percentage of renewables is higher. By 2030, half of the electricity sold by California utilities must come from renewable sources, such as solar, according to a state mandate.
The housing crisis is great news for America
There’s a part of the new housing crisis that tells us good news about the US economy.
Right now, inventory levels are not enough to service potential homebuyers in many markets.
This imbalance has contributed to a rise in home prices that is locking many out of homeownership. San Francisco is probably the poster child of this problem.
But the demand side of the equation is reason to remain bullish on the outlook for the housing market.
On Friday, the National Association of Realtors said that existing-home sales kept their momentum in April, rising 1.7% at a seasonally adjusted annual rate of 5.45 million.
NAR chief economist Lawrence Yun said that the biggest gains were in the most affordable Midwest — indicative of where the activity really is.
Still, the trend in the West, where low supply and high prices are hurting buyers the most, is not widespread enough to be bearish on the overall housing market.
“The good news is we’ve actually seen the number of new listings coming onto the market this year rise rather significantly from last year,” said Budge Huskey, CEO of Coldwell Banker Real Estate, which transacts in nearly 50 US cities.
“It’s just that whenever [listings] come on the market, they’re selling quickly ’cause the demand is there,” he told Business Insider.
What will cause the next housing bust? Good question. Another good question is what will cause the next housing boom. Before housing prices and sales fall, they have to rise first. Not only rise back to historic levels, but rise above historic levels by a substantial amount.
Sales volumes are still well below the last bubble (5.6M nationally vs. 7.5M during the boom). Millenials aren’t buying homes yet – I know this to be true because I hear it daily in the media and on this blog. Inventories are also low because of cloud inventory. Without demand or supply it’s hard to envision sales volume booming.
Housing sales prices are capped by a buyer’s ability to pay. Rents are capped by income, and prices are inline with rents. It seems like the assumption is that we are either in a bubble, or soon to be. Does the data support this assumption?
In order to have an economic recession, there has to first be an economic expansion. Despite low rates, massive borrowing, and government stimulus, the economy is still closer to imploding than exploding. With GDP growth averaging 1% over the last few years, it’s hard to imagine what the next recession would look like. Maybe we’ve been in a recession, and are about to exit it.
(1) repatriation of foreign investment
This is a local phenomenon, mostly isolated parts of California, Florida, New York, Vancouver, and Seattle. The rising dollar and rising housing prices have blunted the effect of Chinese capital flight already. The controls on capital flight resulted in even more capital flight. Repatriation efforts might do the same.
(2) rising mortgage rates
Rates rise in response to economic expansion. They rise rapidly during inflationary periods. Inflationary periods occur when consumer demand drives up prices. Rising prices also result in higher wages, further fueling demand. Capital is borrowed at higher rates to expand production capacity to meet rising consumer demand. This continues until production outpaces demand and prices fall. Inventories stack up and production demand craters. Layoffs happen and then housing prices fall. I don’t know of any evidence showing that rising rates in the past caused housing prices to fall.
(3) an economic recession.
Expansion first then recession. We have seen very little evidence that the economy has hit full production or even that demand is outpacing production (since we have low inflation). Household debt has been falling since 2009. Until the US consumer starts to fund purchases with rising debt, I don’t see a pending expansion, much less a recession.
https://research.stlouisfed.org/fred2/series/HDTGPDUSQ163N#
If prices are aligned with current incomes and rents and if a recession lowers incomes, it won’t fit the traditional definition of a bubble, but it would be a painful period of price decline all the same.
The recession of 1980 came less than two years after the recession of 1978, and there was no real expansion in between.
If the excesses of the previous expansion is not wiped out by the recession, a second recession may follow to finish the job. I would also argue that for as bad as the recession of 2008 was, it did not wring the excess out of the system, as evidenced by the bad debts still in the system.
In the past we had affordability products and no limits on DTIs, but this time around we don’t have toxic mortgages, and DTIs are capped.
Personally, I don’t see the likelihood of a price decline as being very high. I don’t believe we will see a recession, and I don’t believe mortgage rates will rise much. The Chinese repatriation may or may not happen. Each time things start to go awry in China, they apply more stimulus, so who knows what will happen there.
“If prices are aligned with current incomes and rents and if a recession lowers incomes, it won’t fit the traditional definition of a bubble, but it would be a painful period of price decline all the same.”
Agreed. Recessions are bad for incomes and home prices, but not as bad as when bubbles pop. Recessions also tend to be short-lived (less than 18 months). Not all incomes fall in recessions, and only a small percentage of workers lose their jobs (less than 3% typically). Foreclosures rise but not nearly as high as when bubbles pop. Recessions are a necessary part of the business cycle.
“The recession of 1980 came less than two years after the recession of 1978, and there was no real expansion in between.”
I have to disagree here. GDP grew more or less unabated between 1978 and 1980 (13% in 1978, 11.7% in 1979). Even in 1980, GDP grew 8.8%, despite a bad second quarter 0.1%. In 1981, GDP grew 12.2% and then it fell off a cliff in 1982 – only rising 4.2% (thanks to a bad first quarter of -.3%). GDP then resumed it’s upward trajectory with an 8.8% gain in 1983, 11.1% in 1984, and 7.6% in 1985.
Compare that with the last three years of GDP growth: 3.1% in 2013, 4.1% in 2014, and 3.4% in 2015. The lowest quarter in 1978 was 1.8% (1st), later rising to 5.8% (4th). That’s QOQ not YOY.
“I would also argue that for as bad as the recession of 2008 was, it did not wring the excess out of the system, as evidenced by the bad debts still in the system.”
Household debt to GDP has fallen from 98.2% in 2009 to 79.5% today, as shown in the above link.
“In the past we had affordability products and no limits on DTIs, but this time around we don’t have toxic mortgages, and DTIs are capped.”
I would say this is true in the recent past (1970s onward). If you go back into the 50s and 60s, where use of affordability products was very limited, the dynamic changes. Rates didn’t rise rapidly, and prices didn’t rise or fall rapidly. When affordability products aren’t available, affordability caps both prices and rates. Affordability growth is driven then by real wage growth – which has been stagnant for the last decade.
BTW, Russ, I always appreciate your long and thoughtful comments.
This graph is mind boggling, 30 years of declining value of the cost of money:
https://research.stlouisfed.org/fred2/graph/?s%5B1%5D%5Bid%5D=DGS10
Interest rates will have to go to 0% by 2020 to maintain the status quo.
Its over, the jig is up.
Actually, it was over/jig was up back in 08.
To learn more about the latest jig (since then) just google ‘Potemkin Village’
Ah nevermind.
Potemkin village
noun
a. an impressive facade or show designed to hide an undesirable fact or condition.
b. something that appears elaborate and impressive but in actual fact lacks substance.
Interest rates already fell below zero in Europe and Japan. It could happen, but at some point, it has to stop.
Everyone is family with the inflationary spiral, but can we also have a deflationary spiral? If bad loans are continually made to stimulate the economy, the deflation from those bad loans would counteract any inflationary expansion from the initial underwriting. The cycle of bad loans would feed the deflation, and the spiral gets out of control.
For as much as people have criticized the Japanese prime minister, I think his policy of printing lots of money is the only real solution to break out of their 30-year cycle of deflation.
Supply constraints in LA may be overblown. It could be the constantly increasing availability of money causing the increasing competition when we have had stable housing unit/population ratios. No more increase in money supply and declining home owner age population is a hell of a hill for income gains to push housing prices up.