Mar282014
Rental parity establishes the value of residential real estate
Rental parity is the price of real estate where the monthly cost of ownership equals the cost of rent. It is the best benchmark for establishing residential property value.
The importance of rental parity
Rental parity represents a crossover point where renting and owning have an equal monthly cost. When prices are above rental parity, it costs more to own than to rent, so owning is often not a wise financial decision. Owning may still be right for people, and many are willing to pay the premium to own to obtain the emotional benefits of ownership; however, on a purely financial basis, paying more than rental parity creates a negative cashflow situation where owners pay more to enjoy a house than they have to. Over time fixed-rate financing and rising rents may tip the balance the other way, but depending on how much more than rental parity an owner paid, it may take many years to realize this benefit.
When prices are below rental parity, it costs less to own than to rent, so owning under these circumstances is generally a wise choice. Since a buyer who pays less than rental parity for a house is saving money, there is a clear financial benefit obtained irrespective of fluctuations in resale price.
When the cost of ownership is less than rental parity, an owner is far less likely to be forced to sell at a loss. The property can always be rented to cover costs rather than sell for a loss. Further, this ability to rent and at least break even provides the owner with flexibility to move if necessary. Mobility to take a new job or buy a different house is denied to those who overpaid and who are stuck paying more in the cost of ownership than they can obtain in rent.
With these advantages, buying at a price below rental parity using fixed-rate financing is critical. Every buyer should consider rental parity in their buying decision, which is why the new upgrade to the OC Housing News shows the cost of ownership and the cost of a comparable rental for every property on the MLS.
Rental parity as the basis of value
When considering housing market valuation, I use rental parity as a basis. Valuation is the least understood, yet most important, aspect of a housing market. Economists look at various ratios including price-to-income, price-to-rent, and other aggregate measures to attempt to establish valuation metrics. Each of these has strengths and weaknesses, but each of them fails because they don’t directly connect the actions of an individual buyer to the activity in the broader market. 
For this reason, I strongly favor rental parity as the best measure of valuation. Rental parity ties together income, rent, interest rates, and financing terms in a way that matches the activities of individual buyers to the overall price activity in the market.
Premiums or discounts to rental parity
Rental parity does not capture the complete picture. Some neighborhoods are very desirable, so move-up buyers take the profits from previous sales and bid up prices, and motivated buyers often stretch to the limit of their borrowing power to acquire homes in these neighborhoods; therefore, the most desirable neighborhoods often carry a premium to rental parity. The inverse is also true. Some neighborhoods are not as desirable, or may contain high concentrations of condos and other first-time homebuyer products. These neighborhoods generally trade at a discount to rental parity.
Benchmark value of stable market
To value of any asset or market, it’s necessary to establish a standard of measure considered “normal” for the asset. To achieve this end, historic data must be obtained and analyzed to establish a period of time within the specified geographic area when the asset was considered fairly valued under normal market conditions.
Real estate markets generally exhibit long periods of stability and normalcy; however, there have been a number of distortions to market value over the last forty years. It is imperative for accuracy to identify and exclude periods when the data is distorted and does not represent a normal condition. There were a real estate bubbles in California from 1976 to 1982, from 1987 to 1992, and from 2003 to 2009.
For these calculations, I am using the period from 1993 to 1999 (the last period of stable prices with good available data) to measure the neighborhood premiums and discounts. I adjust the rental parity valuations accordingly to establish the baseline valuation for each neighborhood. When my report shows a neighborhood is overvalued or undervalued, it is not simply measuring against rental parity, it is adjusting for historical differences in value those markets typically experience.
House prices typically rise about 3.5% per year to match wage inflation. If someone pays 10% more than rental parity, they must wait 3 years for appreciation to catch up with their purchase price. Overpaying may not cost them nominal dollars, but it may cost them time, which is costly when considering inflation-adjusted dollars. Underpaying is also a significant advantage because this creates an opportunity for rebound appreciation back to historic norms. Valuation is critical in identifying the best opportunities for financial gain.
OC Housing News monthly market report
OC Housing News monthly market report and newsletter provides a clear picture of the health of the housing market. Both buyers and sellers find the information on location, valuation, and price trends, timely and relevant to their decision to buy or sell a home. The OC Housing News report answers the most important questions to buyers and sellers: (1) Where should I look for bargains, (2) Are current prices over or under valued in my area, and (3) what direction are prices headed, up or down in my area? Armed with better information, people make better decisions.
There is too much information about housing floating around the Internet, and most of it is bad. It is easy to take data and create pretty charts and graphs that don’t provide any useful information someone might use to make a good decision. The OC Housing News has eliminated the useless information and distilled the market down to three key pieces of information: (1) value relative to rental parity, (2) yearly change in resale prices, and (3) yearly changes in rental rates.
Using the OCHN monthly report
When most people are considering renting or buying a home, they already have narrowed their choices for location. Most want to be near work, but they may also want to be near family, friends, or a particular school district. The table of contents on the front page of the OCHN monthly report organizes the reports by county so people can narrow their search to the area they are most interested in. I suggest searchers start with the overview of the county as this provides important data on the broader real estate market.
For registered site users, the SoCal overview report is available in the Member’s Lounge, along with all the guides produced by the OCHN.
Also for registered site users, the OCHN monthly reports on Orange, Los Angeles, Ventura, Riverside, and San Bernardino Counties are available in the Subscriber’s Reports.
Interpreting an OCHN monthly market report
The first page of a county report breaks down into four parts: The news overview, Median Home Price and Rental Parity trailing twelve months, Resale $/SF and year-over-year percentage change trailing twelve months, Rental rate and year-over-year percentage change trailing twelve months.
NEWS OVERVIEW
The news overview provides concise descriptions of the facts and conditions in the market. It states whether the market trades at a premium or a discount to rental parity and provides a measure of it. A market trading at a premium to rental parity is more desirable, so buyers are willing to pay more than rental parity to live there. A market trading at a discount is less desirable, and people must be motivated to live there by savings over renting. The news overview measures the current premium or discount, compares it to the historic premium or discount, and states whether the market is currently overvalued or undervalued. This is an important measure of future financial performance.
MEDIAN HOME PRICE AND RENTAL PARITY TRAILING TWELVE MONTHS
For those who want the bottom line without all the analysis and detail, the market rating is the first row of the first section of data. The rating encapsulates all the conditions of the market into one figure. Suffice to say that a rating of 10 is good and a rating of 1 is bad.
The chart displays three lines that reveal much about the market. The first two lines to note are the parallel green and orange lines. These are rental parity and historic value. As mentioned previously, some markets trade at a discount and some at a premium to rental parity. If the orange line (historic value) is above the green line (rental parity), the market is a premium market. If the orange line (historic value) is below the green line (rental parity), the market is a discount market. The larger the gap, the greater the premium or discount is.
The third line plotted against these two parallel lines is the median resale price for the area. This line reveals whether the market is currently trading at a premium or discount to rental parity and historic value. The more important of these relationships is between median resale price and historic value. Over time, the market has shown a tendency toward trading at historic value. If it trades above for a while, over time it will revert back to this value. That may happen either by an extended period of little or no appreciation or an outright decline in prices. If the market trades below its historic value, it’s likely to see a rebound back to this value in the future. The best markets are those trading at a steep discount to its historic value.
RESALE $/SF AND YEAR-OVER-YEAR PERCENTAGE CHANGE TRAILING TWELVE MONTHS
Since the value is so important, the first column in next section displays the premium or discount from historic value over the last year. The second column and the chart shows the dollars-per-square-foot resale price in the market. The line on the chart visually shows the general direction of prices, and the third column shows the actual percentage change.
RENTAL RATE AND YEAR-OVER-YEAR PERCENTAGE CHANGE TRAILING TWELVE MONTHS
The final table and chart on the page is similar to the first grouping; it displays three lines, two of which are parallel and show current rent and the historic cost of ownership relative to rent, and the third line is the current cost of ownership. The relationships are similar, the charts will look similar, and the interpretations are the same.
This method of looking at the data is more revealing to those who like to focus on monthly costs rather than purchase price. It reveals how affordable properties are relative to monthly rent, which is what rental parity analysis is all about. The first column of data shows the rate of rent growth over the last year, and the next two columns show the cost of renting and the cost of owning during the same period.
The OCHN is your resource for finding property
Some of you may have noticed the changes at the site. I haven’t written about the new features because I am still working out some of the bugs (the calculations are all correct, but some search functions don’t work yet, and we are in the middle of an update, so the rents are in flux). When it’s all ready to go, I will write daily on specific improvements and features of the site. My intention is to create a comprehensive property search resource: I created a number of useful guides to educate homebuyers, I provide detailed market reports designed to help homebuyers identify good market conditions and good places to search within the market, and I designed a custom property search system to help people find specific properties within their search area. It’s these new features to find specific properties I am most excited about, probably because I spent the last 10 months of my life working with programmers to get the calculations right. It’s been no small task.
Since I first started writing about real estate seven years ago, I envisioned a site with the resources available here. When the programmer first displayed the cost of ownership information breakdown for each property on the MLS, I stopped and stared; it was the realization of a dream nearly seven years in the making. For the last five years or more, my daily posts have included the cost of ownership calculations for the featured property. Now, those calculations are available for every property. Take a look for yourself; explore a little. I’ll be telling you much more about it in coming posts. Thank you for your patience during the construction.
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“Quantitative easing was supposed to spur the economy and put ordinary citizens back to work.”
Really? Because the media says it? Because Bernanke said it? The largest result of quantitative easing was the hiding of TBTF bank insolvency. So why isn’t the result the intention? Doesn’t every other corporation in the world work for it’s shareholders?
Putting people back to work was the public relations front put on the quantitative easing bank bailout. I never believed it would do anything other than bail out the financial elites, but it was sold to Joe Six-Pack as a job creation measure.
That also makes me wonder how they expect everyone who is still struggling to react to withdrawing support.
The Federal Reserve is poised to decrease its interest in the mortgage bond market, according to a report on Bloomberg.
Fed-purchased securities, which helped to spur the housing recovery, are poised to fall below growth as soon as May, the report says.
One of the greatest delusions in the world is the hope that the evils in this world are to be cured by legislation.
– Thomas B. Reed (1839-1902) Speaker of the U.S. House of Representatives
this blog is chock full of those who feel if we could only vote in a few angels, legislation/regulation would be perfected.
It’s full of Utopian idealist gold bugs too, eh? Just a poke, not an insult…
5 perspectives on getting private capital back into mortgage markets
CoreLogic (CLGX) partnered this week with the Urban Institute to host an interactive Capitol Hill panel focused on bringing private capital back to the mortgage market.
The focus of the discussion was on pricing, governance and servicing.
“Though the housing market is well on its way to recovery with foreclosures at their lowest point since before the crisis, government-related exemptions from new regulations, including temporary exemptions under the qualified mortgage rule and government securitization exemptions under the re-proposed qualified residential mortgage rule, have led to a lot of private sector uncertainty and an industry-wide question of how to get back to a more balanced system,” said moderator
Faith Schwartz, senior vice president of government solutions for CoreLogic.
Panelists Paul Leonard, senior vice president of government affairs for the Financial Services Roundtable; Laurie Goodman, director of the Housing Finance Policy Center at the Urban Institute; Eric Kaplan managing director of mortgage finance for Shellpoint Partners; Trez Moore, managing director of markets for Royal Bank of Scotland, and John Vibert, managing director and portfolio manager for Blackrock Advisors raised a number of points on what must happen.
1) Paul Leonard
Leonard said there is concern that uncertainty around representations and warranties, particularly with the GSEs, is one of the biggest obstacles in the current market, leaving a gray area, despite the end of the low-documentation or no documentation era.
With the GSEs exempt from the proposed QRM rule, there is no incentive to securitize non-QRM loans, which is a barrier to bringing in private capital, he said.
The framework has already been laid, but lenders and originators want to see what the GSEs will do to add clarity around representations and warranties, which will influence the private securitization market, Leonard said. He added that the market needs to see housing finance reform move forward, transitional issues addressed and more industry regulations worked out.
2) Laurie Goodman
Goodman said that the GSE-plus-FHA/VA share of the mortgage market is around 80%, which strongly suggests the need to attract more private capital moving forward. She said there are two alternative strategies that can accomplish this.
“The first option is to contract the government footprint, and incite more movement through private channels, by increasing guarantee fees and lowering loan limits to encourage banks to retain more loans in their portfolios and, hopefully, to generate more volume in private-label securities,” Goodman said. “The second approach is to maintain the current level of engagement with the GSEs but lay off more of the credit risk through front- and back-end risk-sharing transactions or reinsurance.”
3) Eric Kaplan
Kaplan said that one of the biggest, but most important challenges is setting guidelines and protections to make sure the investor is buying what he thinks he’s buying, reestablishing an element of trust to the market.
This has to be something issuers, investors, rating agencies, due diligence firms, trustees and brokers can all agree to, with solid best practices and user-friendly benchmarks, Kaplan said. Progress is being made through collaborations like the Structured Finance Industry Group, he said.
4) Trez Moore
Moore said that pricing is a primary driving force for the private label securities market, and that currently, commercial banks are originating loans that could be held in their portfolio or placed into a private label securities deal. However, holding loans in their portfolio is far more economic, given where the price at which a private label securities deal can be executed.
“The return of the private label securities market is dependent on price execution that is comparable to the bank portfolio bid,” Moore said.
5) John Vibert
Vibert said the role of trustees is too unclear and there is no one effectively serving as the investor’s advocate. This makes it difficult to commit investors’ capital.
There is still no transparency in reporting on deals; documentation to investors has not really seen improvement; there continues to be inadequate accounting for fees or where the money goes; and the language around representations and warranties remains unclear.
He concluded that it is difficult to put capital back into a structure where you have undefined points that are so important.
A new populist hero in the making…
Is Benjamin Lawsky only going to get more aggressive?
In a note to clients, Ballard Spahr warns that the head of the New York State Department of Financial Services is only going to get more aggressive in his crusade against perceived wrong-doers.
“(Benjamin) Lawsky decried the ‘accountability gap’ on Wall Street,” the Mortgage Banking Update from Keith Fisher reads. “That gap fuels public outrage, he said, even as a proliferation of post-crisis scandals—money laundering, LIBOR, tax evasion, and currency manipulation—suggest that lessons from the crisis have not adequately been learned.“
Lawsky told guests at the Exchequer Club in Washington last week that a “culture on Wall Street” and only penalizing the institutions themselves plays into an “everyone was doing it” defense for individuals who engage in misconduct.
Lawsky says that real deterrence cannot be accomplished solely by corporate accountability, regardless of the size of the fines and penalties, and can only succeed if regulators and prosecutors change that focus to individual accountability.
Lawsky also turned his sights on the mortgage servicing business, where banks have been fleeing the MSR business in favor of nonbanks, arising from an unintended consequence of Basel III.
Lawsky is worried that nonbank servicers have become so large so fast that he apprehends harm to consumers, particularly in the foreclosure context. He indicated that DFS is cooperating closely with the Consumer Financial Protection Bureau on this and other matters.
Lawsky, notably, is the “zealous” regulator who put the brakes on Ocwen Financial Corp.(OCN) and Wells Fargo (WFC) in their $2.7 billion MSR deal.
“It is appropriate for regulators, where warranted, to halt the explosive growth in the nonbank mortgage servicing industry before more homeowners get hurt,” Lawskey told the New York Bankers Association Annual Meeting and Economic Forum in February.
Lawsky said companies like Nationstar Mortgage Holdings (NSM) and Walter Investment Management (WAC) are in his sights and drawing his scrutiny.
His crusade is misguided because non-bank servicers are the only alternative to the incompetent bank servicers. The reality is that most of the affected borrowers will be getting better service by going to Ocwen or Nationstar. I say that as somebody who is not much of a fan of either company, but when you compare them to BofA, Citi, and JPMorgan, they are much better run and provide a better customer experience.
Lawsky is clearly gunning for higher office.
The Attorney General position has historically been a steppingstone to the governor’s office. Kamala Harris will run soon as well.
Lawsky’s timing couldn’t be better though. With daily headlines about settlements and lawsuits regarding lenders, running a very public campaign to clean up Wall Street has a tremendous populist appeal.
Folks were talking about fairness in income taxes yesterday. My idea of fair is either of two methods.
1) Everybody pays the same amount, not the same percentage, but the same amount.
2) Each person pays for what they use.
“1) Everybody pays the same amount, not the same percentage, but the same amount.”
So you consider it fair that a person making $1,000,000 per year should pay the same income tax as a farm worker making $10,000 per year?
I imagine high wage earners would agree with your definition of fairness, but I also imagine low wage earners would not.
It sounds like a step toward feudalism to me.
“2) Each person pays for what they use.”
How would you measure this? How much of the roads or our national defense did you use last year?
I don’t see how why taxes are tied to the amount of one’s income other than that is the status quo, so nobody questions it. I see equality as fair. Equality is equal amounts. Everybody treated the same. Everybody having the same responsibility. I don’t understand why the person earing $1,000,000 is responsible to pay somebody else’s way in life. How is that fair? People shout inequality at everything. And no one thinks twice about equality in taxes. They go on forever about fairness, but what about equality? Why are fairness and equality the same idea except for when calculating fairness in taxes.
If feudalism is the same as equality, then I guess that is what it is. Or maybe calling it feudalism is just a convenient way to label rather than think.
I don’t know how it would be measured. I can’t imagine that it could be any more convoluted and ridiculous than now. At least fiuguring out what someone uses would be more objective than voting for the politician who promises the most tax benefit to the voter. On defense, that one is easy. Everybody uses an equal amount of defense. Take the total defense budget and divide by the total population. Use of roads would be based on miles driven and vehicle weight. See, much simpler and more objective than the mob’s perception of fair, or what is really just whatever is better for them.
Think about it. Isn’t fairness in everything else described as equal for all or, you use something, you pay for it. And there would be nothing stopping those claiming that the burden on the poor is too great from voluntarily contributing to the poor’s tax burden, as they can now. I guess I don’t understand why Buffett does not pay more when he says that he has an “unfair” advantage. Paying his fair share, by his judgement, is quite simple.
If everybody had to pay the same amount, my guess is that people would demand that the government spend a whole lot less, or they would demand some Congressperson’s heads. My guess is that defense spending would decrease to a level that would entail defending our country rather than empire building, policing the world, and murdering civilians. My guess is that corporate welfare, and corporate subsidies would halt quickly and maybe even go to chargeback. And with no deductions or different types of income, the IRS would be useless and that would save millions of hours of accounting and tax preparation time. ( Don’t you find it ironic that I mind not a twit for sparing my own income? )
Personally I find equality more fair than mob rule.
If every American were born into an equal/fair situation, then your proposal might have some merit; but we aren’t. Most people are born into situations combining unfair “luck of birth” factors:
1) physical characteristics: a historically discriminated against ethnicity, short, unattractive, propensity to fatness, etc.
2) good parents: prepared for child, well educated, interested in the child’s education, etc.
3) decent income parents
4) decent wealthy parents
and on and on…
Eliminate those inequities, and we can start talking about how fair life is…
Ironic that small government fans love use taxes. This is an extremely inefficient way to fund services, because the mechanisms for collection are endlessly duplicated, IOW, this doesn’t scale, and too much of what is collected is lost to administrative overheads.
This would be a good formula for doubling the number of government employees, though. Given our current labor participation rates, maybe this is a genius idea!!!
I think a flat percentage with no credits or deductions is the best. Your income X percentage = tax. But the CPA’s and tax preparation business to lobby to prevent that.
If you want to really get radical, how about no payroll deductions. You have to write a check to IRS 4 times year to pay your taxes.
2) Each person pays for what they use
What I like about that plan, it will hit the ponzi’s the most. Not the savers.
I like the flat percentage with a high standard deduction. You need the standard deduction to take the regressiveness out of the tax. The poor already pay high taxes because they can’t avoid sales taxes, gas taxes, and other expenditure related fees and costs. A high standard deduction compensates for that. Also, to make a flat tax work, you need to eliminate all deductions. Nobody itemizes.
>>>I like the flat percentage with a high standard deduction.
Me Too … looking something like this …
Tax 15% beyond these deductions:
Single = $15,000
Married = $32,000
Married w/1 or more children under 18 = $40,000
Extend Social Security Tax to income up to $1,000,000.
Eliminate the MID, and only allow business to deduct on legit expenses.
Yes. I’ve seen similar versions, and I believe that structure would be very fair to everyone. Of course, as awgee has pointed out, the tax code isn’t designed to be fair. It’s designed to get politicians reelected and preserve the power and wealth of the elite.
Half of the people who file income tax returns each year, have no federal tax liability. And many of them vote … hmmm …
People with little to no skin in the game get to select representation for the people that support this country.
If I were to rewrite the tax code, I’d make sure that the teacher making $55,000 a year was paying the same percentage as the business owner making $450,000 a year. At that point, they share the same financial burden and the same political motives.
Under the equal taxes system, there is no obstacle for those who claim that the poor are unfairly burdened from helping the poor to pay their equal share. I guess we would find out who really cares and who is just shooting off their mouth and making themselves feel good. Have you ever read,
“Who Really Cares”, by Arthur C. Brooks?
Progressive? Regressive? As far as I can tell, those are just two words that hide the concepts of “what is best for me”, or “how can I make my self feel good, without paying more”.
Refer to the quote in the second post today. In the end, tax code, will always benefit the wealthy. I did not say high income earners. I said wealthy. Oddly enough, get rid of tax code and the poor will benefit.
Mike, I worked in the business for quite awhile. Whatever lobby CPAs and the tax preparation business has, has absolutely no effect on tax code. None. Aip. Nada. They don’t lobby for complicated tax code because it is unecessary.
Tax code is superficially driven by votes and in reality driven by campaign contributions.
“They don’t lobby for complicated tax code because it is unecessary.”
Sorry. That does not read right. I need to clarify.
It is unecessary to lobby for complicated tax code that demands millions of hours of accounting, planning, return preparation, and unprofitable allocation of resources, because they don’t have to. The mob already demands specific provisions for fairness and more tax legislation and more tax legislation and more tax legislation.
Apparently I’m the Leftist here. I support a no deduction, exemption, exception income tax code, at low progressive rates with brackets in the million dollar income levels.
I just finalized our 2013 taxes, and we paid the following percentages of AGI:
21.63% Federal Income Tax
6.77% California State Income Tax
4.76% Social Security Tax
1.52% Medicare Tax
0.67% California SDI Tax
35.35% Total Income + Payroll Tax
That’s a whole lotta money, but I accept that a lot of this was the result of “luck,” for lack of a better word.
Why the need for an income tax? Treasury income tax receivables are ~$1 trillion per year, yet the fed has been printing out of thin air in excess of that amount annually for several years now. And, according to the fed itself, .gov and the MSM, without any supposed negative consequences. Just ask’n.
That thought had occurred to me as well. Why not just print all the money to run the government and let people keep everything they make? If the federal reserve and print money and buy unlimited government bonds with no inflationary effects, why not?
Seriously, why not? Or more specifically, why is the government taxing income? Why?
Why did the Fed buy mortgage securities from the TBTF banks instead of just paying off mortgages?
Like I said the other day, to determine motivation, look at the results.
the irony in this “there is no inflation” is people generally have short memories and are unable to link cause and effect over time periods greater than 3-6 months.
Blame holiday season, snow, drought, global warming, investors.
matt138 – I was schooled yesterday, and you may care to take note:
Inflation is increasing wages.
Forget money supply, debt, rising prices, etc. There is no inflation because wages have not risen and inflation is rising wages.
Or maybe it was rising incomes? I dunno.
The money supply & debt decline when the economy goes into depression like it did in 2008. All the inflation in commodities and energy (and even housing) got whacked in half. The ONLY thing that brought it back (temporarily) was this madness at the Federal Reserve to bailout these gawd damn banks, insurance co’s & Wall Street. But this time they have gone too far … too far. They have painted themselves into a corner, and now the more QE/Easy Money they do, the less impact it has. Japan has printed trillions in ponzi finance for 20+ years … and they get spikes and collapses in energy, food, etc, etc, etc, is that inflation???? HELL NO! They still have ZERO inflation.
America is NOT going this route. Get over it! The Fed is forced to continue the taper … right into another financial debt crisis … DEFLATION!
There’s ONE answer now … America needs NEW EQUITY OWNERS! Period.
Employment and New Construction Drag on Housing Market
growth … is dragging disproportionally weaker growth in young adult employment and stagnation in the new home construction sector in its wake, and worsening conditions for borrowers and investors keeps the road to overall recovery bumpy.
The strongest growth is in the value of homes being sold, according to Trulia’s chief economist, Jed Kolko. Though homes nationally were—by Trulia’s measure—5 percent undervalued in the first quarter of 2014, this is a vaulting improvement over the 15 percent undervaluation at the bust’s 2011 low point and the 10 percent undervaluation just a year ago.
Similarly encouraging is the fact that rising home prices and an improving economy are shrinking delinquency and foreclosure rates. According to Kolko, the delinquency/foreclosure rate was 63 percent back to normal in February, up from 42 percent one year earlier. More foreclosures are also being completed and sold, particularly in Florida, New York and New Jersey, where a judicial-foreclosure process can take years.
Holding up total recovery, however, is the steady-but-agonizingly-slow growth of employment among adults age 25 to 34, who are key to creating new households. Nearly 76 percent of these adults work, which is up not even one full percentage point from last year, Trulia reported.
Similar stagnation plagues the new construction sector, which Trulia found to be only 44 percent of the way to where it should be—a 1 percentage point drop from last year.
Further complicating recovery is a tri-level worsening of conditions for buyers and investors. First, though it remains cheaper to buy a home than to rent in the 100 largest metros, rising home prices mean declining affordability and, thus, a bigger challenge for first-time buyers.
Second, investors looking to flip or rent properties are stepping back as home prices rise, meaning fewer existing homes are being sold.
Third, potential buyers are leery of rising mortgage rates and the new rules that accompany them, and mortgage purchase applications and mortgage-based home sales are declining as a result.
Kolko, however, expects this last factor may be a temporary hurdle. “Rates remain low by historical standards, and the new mortgage rules offer longer-term clarity that should encourage banks to make more loans that are within the new rules,” he said.
Overall, Kolko puts the keys to recovery in the hands of the young. “The boost to young-adult employment is especially important right now,” he said. “The less the recovery can depend on the engine of investors, the more the housing market will need to rely on young adults entering the housing market, first as renters and eventually as buyers.”
Job Growth Ramps Back Up in California
After losing 32,000 jobs in January, nonfarm employment rebounded in February, adding 58,800 jobs in February, according to the Wells Fargo Economics Group. February’s increase reflected a 2.3 percent growth over the past year, creating a net gain of 345,600 jobs.
Three industries led the way in job creation, according to the Group’s report. Construction employment increased 2.2 percent during the month, with a net gain of 14,100 jobs. Residential and commercial construction, particularly in the Bay Area and Los Angeles, helped fuel the spike in job growth.
Construction payrolls increased by 6.1 percent.
The tech sector in California remains strong, with professional, scientific, and technical services adding 10,300 jobs in February, pushing employment up 4.1 percent from last year. “Hiring also continues to ramp up in wholesale trade, reflecting growth in international trade and online retailing,” the report said.
Retail, however, did not improve for the month of February, losing another 200 jobs to add to the 14,400 lost jobs in January. The Wells Fargo Economics Group attributes the loss of retail jobs to a disappointing holiday shopping season.
Overall, California’s unemployment rate continues to trend lower, reported at 8.0 percent for the month. The rate has fallen for seven consecutive months, narrowing the gap relative to the nation from 1.7 point to just 1.3 points for February.
The report found, “Because the drop in the unemployment rate nationally and in California has been accompanied by a decline in the labor force participation rate, the sharp drop in the unemployment rate has been met with a great deal of skepticism.”
Regardless, the group believes there are encouraging signs for California. The civilian labor force has picked up considerably, rising by 35,700 people in February, outpacing a 23,700 gain in civilian employment. The group notes, “We suspect that the improvement in the construction sector is pulling some folks back into the labor market that were discouraged when fewer high-paying job opportunities were available.”
Blame it on the weather.
The weather was beautiful in February. I played a lot of golf.
Believe it or not, el O and I were supposed to play golf and get a cerveza years ago before we started commenting on this blog. Sadly, it never materialized.
Pending Home Sales Down to Lowest Level Since 2011
The National Association of Realtors (NAR) reported yet another monthly decline in its measure of pending home sales, indicating continued softness in future sales figures.
According to the latest monthly report, the group’s Pending Home Sales Index (PHSI)—a metric based on contract signings—dipped 0.8 percent in February to a reading of 93.9, its lowest point since October 2011. It was the eighth decline in as many months.
Year-over-year, the index was down 10.5 percent, NAR reported.
Despite the ongoing decline in sales activity, NAR chief economist Lawrence Yun is holding on to hope that the situation will soon improve.
“Contract signings for the past three months have been little changed, implying the market appears to be stabilizing,” Yun said. “Moreover, buyer traffic information from our monthly Realtor survey shows a modest turnaround, and some weather delayed transactions should close in the spring.”
NAR projections call for existing-home sales to total approximately 5.0 million this year, a slight decline from 2013.
Pending sales rose modestly in the Midwest and West, whose regional indexes were up to 95.3 and 86.1, respectively. Those gains were offset by bigger declines in the Northeast (down to 77.1) and the South (down to 106.3).
Year-over-year, all four regions reported declines in pending home sales.
Yellen Projections Drive Up Interest Rates
Mortgage rates jumped up this week, propelled by remarks made at Janet Yellen’s first press conference at Federal Reserve chair.
In its weekly Primary Mortgage Market Survey, Freddie Mac reported an increase of 8 basis points in the 30-year fixed average rate, bringing up to 4.40 percent (0.6 point) for the week ending March 27. A year ago at this time, the 30-year fixed-rate mortgage (FRM) averaged 3.57 percent.
The 15-year FRM also climbed, moving up a tenth of a percentage point to an average 3.42 percent (0.6 point).
Frank Nothaft, VP and chief economist for Freddie Mac, explained the increase: “Mortgage rates rose following the uptick on the 10-year Treasury note after comments by the Federal Reserve Board Chair Janet Yellen indicated a possible increase in interest rates as soon as early 2015.”
Nothaft also pointed to relative strength in the S&P/Case-Shiller 20-city composite home price index, which saw an increase of 13.2 percent year-over-year.
Whatever the cause, the effect means “additional pressure for those local markets that are already feeling an affordability pinch,” Freddie Mac says.
Switching to adjustable-rate mortgages (ARMs), the 5-year Treasury-indexed hybrid ARM averaged 3.10 percent (0.5 point) this week, up from 3.02 percent in the last survey. On the other hand, the 1-year ARM moved down 5 basis points to 2.44 percent (0.4 point).
Meanwhile, finance website Bankrate.com measured the 30-year fixed average at 4.51 percent and the 15-year fixed at 3.56 percent, both up over the week. Also increasing was the 5/1 ARM, which climbed a tenth of a point to 3.36 percent.
All due respect, but demand has been heavily subsidized to bridge inflated price to deflated income gaps for quite some time, so what really establishes price is the $amount of largesse being administered by central planners.
I can’t argue with that. Rental parity measures based on a prevailing interest rate, and if that rate is artificially low because the federal reserve is pumping money into the economy, then like any computation, garbage in, garbage out.
First of all, that was great analysis and I think it really works for 90% of Orange County especially in zip codes where homes are very similar. In higher end markets, however the information in almost always incorrect. Take into consideration zip code 92663(Newport Beach). Here are the stats:
29 active rentals
10 are single family rentals (6 of these 10 are thrown out as they are vacation rentals)
19 condos/townhomes, etc (4 more thrown out due to vacation rentals)
The 4 single family homes are priced at:
$4650, $7900, $8300, and $4650. They are averaging $3.94 sq/ft
and $6275 per property.
The townhomes and condos have a median price of $875k. Here is a good rental example for this zip code.
Kamalli ct townhome 3/2 1600 square feet in escrow at list price $659k. 2 model matches have leased in the last 30 days for $3000. Here is the new breakdown:
Purchase price – $659,000
20% down payment – $131,800
4.25% $527,200 = $2593.51
1st year monthly principle $740/per month
Interest = $1853/month
HOA = $359
Property tax at 1.1 = $604
total out of pocket cost = $3556.51
monthly cost after principle reduction = $2816.51
potential rent: $3000
This is not ideal as an investment, but certainly not a $3460 ownership premium. I suspect, that this will be the case in many beach cities as condominiums dominate the rental market and figures are further skewed by weekly vacation rental listings.
Those weekly listings really mess up the data because there is no way to sort these out of the system. My algorithm for pulling comps can sort through differences in attached and detached and different sizes and ages, but when you start factoring in weekly rentals as comps for monthly rentals, things go bad quickly.
How does your rent parity analysis account for the fact that mortgages are for limited terms, but rent is forever? The longer you own the house the better it is financially. If you buy a house with a 30yrFRM, and own it for 60 years, then I imagine rent parity more or less sucks the first year, and is astronomically better the last year. After you pay off a home, then you still have to pay property taxes, insurance and maintenance, but this is a fraction of the mortgage amount.
Sure, there is the argument that people don’t stay in one home that long. But, that doesn’t mean you have to sell it either. And, besides, not all renters save the mortgage differential, and those that do may invest it poorly, or invest it wisely and the market performs poorly.
Rental parity is a point-in-time analysis. Since most people sell within 7 years of buying, it’s an important consideration. Sure, if someone knows they are going to own a specific home longer than seven years, there are long-term benefits to home ownership. Realistically, most of the people who sell within seven years believed they would be there longer when they bought. People are not good at considering all the potential life events that could prompt them to move.
I favor point-in-time analysis because it isn’t swayed by unrealistic projections into the future. Most buyers believe houses appreciate annually at rates more than double what they really do. If you set up a buy-versus-rent calculator and allow people to put in appreciation rates, it will always return an answer that says it’s better to buy. In fact, that’s why realtors create and use those bogus rent-versus-own calculators you can find on the internet.
People who pay more than rental parity then need to move often do have to sell, or they have to endure long-term negative cashflow to sustain an investment with returns that may take a very long time to materialize.
“Realistically, most of the people who sell within seven years believed they would be there longer when they bought. People are not good at considering all the potential life events that could prompt them to move.”
Good point. We bought our home with the intention on living in it for the rest of our lives, but it has appreciated 41% in two years, and if it appreciates another 41% in the next two years without a concurrent increase in the price of consumer items, I am going to put on some kevlar and approach my wife about selling and renting for awhile.
I like to model it as a perpetual annuity that begins paying in 30 years. Your downpayment + amortization is paying for the annuity. Discount everything to present value. A bit academic though, as this assumes you have some idea of what rent will be in 30 years’ time. However, at normal rates of inflation, the present value of a cashflow in 30 years begins to approach zero, so maybe it’s not a big deal either way. The other approach is to charge yourself the cost (pick a rate) of the sunk capital as it becomes invested (again, the downpayment + amort) and forget about the “free rent”. I find this approach less speculative.
Q: when I am doing a valuation, I only count the benefit of the MID which exceeds the standard deduction, because I would have to perform some other operation which has nothing to do with the purchase to have already exceeded the standard deduction, and this is not always guaranteed to occur every year. What do you think?
Yes, that’s the way you should calculate the tax benefit.
I think that model is fair, but only if your loan’s term is 15 years or less. That’s how a house should be financed.
I always find it odd here that people mention the Standard Deduction’s value as it’s related to the MID. Nice homes in nice areas are $750k+ around here. That conservatively requires an income approaching $200k, no? When incomes get into these levels, the state income tax always exceeds the Standard Deduction.
“The other approach is to charge yourself the cost (pick a rate) of the sunk capital as it becomes invested (again, the downpayment + amort) and forget about the “free rent”. I find this approach less speculative.”
I factor this into the cost of ownership calculation. I have a line item in there called opportunity cost. I calculate this as an expense, but what it really measures is the lost income on the down payment.
For the rate, I take the mortgage interest rate, divide it by 3, then add 1% to it. This usually closely approximates the yield on CDs or Treasuries, which is a safe investment with a consistent return.
“Q: when I am doing a valuation, I only count the benefit of the MID which exceeds the standard deduction, because I would have to perform some other operation which has nothing to do with the purchase to have already exceeded the standard deduction, and this is not always guaranteed to occur every year. What do you think?”
My calculation of the tax benefits is one of the most complex in my system. It uses the income requirement established by the price of the house to determine a marginal tax rate, which it gets from a table of tax rates I have to update yearly.
I then multiply the mortgage interest of the first year’s payment by the marginal tax rate (I have to repeat this for both State and Federal).
Then I multiply the standard deduction by the marginal tax rate to subtract from the tax savings.
After all that number crunching, I come up with what I believe to be an accurate measure of tax savings.
I agree with you that you must subtract off the loss of the standard deduction. Perhaps people who consistently tithe 10% of their income to a church can claim they will always itemize, but for most people, itemizing isn’t a given.
Apparently, I published this post a day early. The rental comp values are updating, and it’s temporarily making everything a zero.
We discovered yesterday that agents were mistakenly putting closed sales on inexpensive properties down as leases. This was making some properties out in the high desert that sell for $50,000 look like they rent for $16,000 per month! I wish they did. I would buy them all.
We put in an error correction algorithm last night, but we are having problems with it. Hopefully, by early this afternoon everything will be fixed.
I’ve been playing around with the property search tool and having the cap rate and cash-on-cash return pre-calculated is really handy. (My assumptions vary slightly from IR’s but it’s still ballpark.) This is going to be a real time saver compared to searching on any of the other property websites and then calculating the rate of return ratios manually in Excel.
That’s exactly why I put those into the system. You can only review so many properties manually. Automating the entire process is not only a time saver, but then you know you’ve left no stone unturned.
Real Price of Gold Since 1791
http://visualizingeconomics.com/blog/2014/3/25/real-price-of-gold-since-1791-updated-to-2013
Only another $1,000 drop to get back to the historical norm.
Note that the prior cycle took just under 20 years to fully deflate. That means the 2nd inning is just beginning! Enjoy!
Ok, time to nerd-out:
In calculating parity, I don’t count the PR, as paying down a debt is savings. Someone told me to use the initial IR portion of a P+I, but due to amort, that doesn’t make any sense to me. So I use an IR only mortgage payment, but use the interest rate that I could have had on a P+I. What does everyone think?
I back the amortization out of the calculation of cost of ownership. It’s one of the adjustments to PITI. I needed to calculate PITI accurately in order to get the income requirement, but I also needed to back out the amortization to more accurately measure the cost of ownership.
While rental parity is one of many metrics to look at, it has many flaws. The biggest flaw is the false signal it always gives to beach close real estate. In better zip codes near the beach, the rent has always been and continues to be far less than the payment at time of purchase. For example, if you used this analysis to pass on beach close homes in Manhattan Beach or Corona Del Mar, you would have missed out on 500%+ appreciation. I remember when I purchased a home a little more than 20 years ago with a 400K mortgage at in interest rate of about 7 or 8 percent … my payment was twice the rent. Now, that house is worth at least 2M, and the rent is massively higher than the mortgage payment. So much for rental parity … using it would have resulted in missing a massive investment opportunity. Then, there is the property I just purchased in a premier Newport Heights location recently. I paid all cash, but if financed, the payment would be double of what my renter pays. But, the property jumped in value approx. 400K which dwarfs any rental parity calc.
Jimmy, I would be very curious to know what criteria you have found useful.
I think that in order for rental parity to be useful, you have to overlay it with some other information:
1) historical relationship with rental parity for the area (as IR does in his reports). Even this requires some massaging IMHO, as neighborhoods rise and decline in terms of desirability
2) Macro-level: to what extent is money flowing in? I’d venture to guess that your luck in MB was a once-in-a lifetime opportunity springing from money flowing in to LA / macro wealth creation
3) Local knowledge: for example, when you spot an area which has a large price differential to a neighboring area and then you begin to see a hint of gentrification, new shops, community outsiders moving in, etc
4) psychology and ability to afford: how desperate is everyone to “get in”? What can they actually pony up for? Where I live in LA, I think there are a lot of people who, while still dependent on earned income, are not dependent on traditional “jobs”, so its almost impossible to assume anything about a large component of the would-be buyers
In addition, (and here I think IR and I might differ – not sure on this), I believe that every decision requires an assumed time horizon, even if it turns out to be incorrect. Therefore, the price to rent ratio on day one is not as relevant as the assumed *average* price to rent ratio between day one and year X. I can only speculate, but I wonder what the result would have been had you calculated this over a 10, 15, 20 year horizon.
I’m here to learn, so I would really hear more about what criteria you think works as a buy-trigger.
1) Metro area must be seeing population growth
2) New home supply must be restricted to land issues and regulation
3) Must identify demographic, and the zip code they reside, that have substantial income growth
4) New real estate acquisitions must occur during periods of dovish Fed policy
5) Long term horizons only … 12+ years min, 15+ years better
6) Older homes being torn down and replaced with new construction
7) Quiet grid of streets
8) Bars and restaurants that are within walking distance
This gets to the core of the disagreement we have over what makes a better real estate investment.
Your arguments about growth have merit, but the negative cashflow you endure greatly reduces your return on investment, and I suspect you simply ignore this cost, most people who buy in those zip codes do.
[…] recently wrote that Rental parity establishes the value of residential real estate, but others use different metrics to measure value and affordability. If the metric is […]
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[…] Rental parity establishes the value of residential real estate, both for entire housing markets and individual homes. For each property on the MLS, this website measures the cost of ownership and pulls comps to measure comparable rents. Rental parity is the point where these two values meet, and it’s displayed on every property. However, rental parity alone only gives part of the picture. To get a complete picture of affordability, rental parity must be compared to historic norms. […]
[…] once wrote that Rental parity establishes the value of residential real estate, but others use different metrics to measure value and affordability. If the metric is […]