In recent months, a slew of new data from several major indices suggests home prices have found a floor nationally and are now slowly rising. While that may be welcome news to homeowners and a real estate industry battered by years of lost equity and sluggish sales, they might want to keep the champagne on ice for now. This is not to suggest the data is wrong and house prices aren’t going up, it’s just worth taking a closer look at the fundamentals behind the recent price trends and asking if there is a corresponding “housing recovery.”
Here are four reasons to temper optimism with caution:
- Investors drive a significant share of home buying. Many former homeowners and new households have chosen the safety of renting over the risks (and potential benefits) associated with homeownership. This increased rental demand, combined with home prices that are only now getting back up to 2004 levels, have driven residential rental rates to all-time highs.
Naturally, this combination has attracted the attention of investors. These include seniors looking for income opportunities at a time when near-zero interest rates are punishing savers, to large investment funds and international speculators that see an attractive real estate opportunity.
As of May 2012, investor purchases made up 25.3% of all real estate transactions. That’s simply unsustainable.As prices continue to rise, the opportunity for investors to reap sweet returns begins to fall. In fact, we’re already seeing signs of diminished demand as investor purchases fell to 21.9 percent of all real estate transactions in July, down from 23.5 percent in June and 25.3 percent in May.
- Refinancing accounts for most new loans. New bank loans are expected to reach $1.28 trillion in 2012, up from $1.26 trillion in 2011, according to the Mortgage Bankers Association. While this is welcome news for bankers and homeowners refinancing to take advantage of low interest rates, demand for owner- occupied housing remains too weak, with refinances constituting 80% of total applications.# The percentage of first-time homebuyers, 34% in July, 2012, and 31% in August# is still far below the 40% of a normal housing market. And while rates continue to remain at historic lows, at some point we will simply run out of households to refinance.
- Too many homeowners are being forced out of the market.In addition to those who choose to rent rather than buy, and those who would like to buy but can’t meet tough credit requirements, there is a third category of people forced out of home ownership by economic adversity. These include millions scarred by foreclosures and “short sales”.
Recently, the FHFA announced it was standardizing and streamlining guidelines for “short sales.” A short sale is when banks allow distressed homeowners to sell their house for less than they owe on the current loan. The banks eat the loss, and the homeowners get rid of underwater mortgages. So far so good, but the seller is not a candidate for moving up to a more expensive home, as normally happens in a healthy housing market. As these sellers head to the rental market or move in with their families, housing demand slackens.
- There’s still too much political risk and uncertainty.It’s fashionable to blame Washington for creating uncertainty in all manner of markets. But in the case of housing, it’s a fair criticism. For example, the federal government is working on regulations that will have a big impact on housing markets when they are finalized next year. The Qualified Mortgage (QM), Qualified Residential Mortgage (QRM) and Basel III capital requirements, will all shape how banks lend, to whom and at what price.
In addition, the federal government currently guarantees over 90% of the mortgage lending market. That won’t change until Congress finally addresses how and to what degree Washington should be involved in mortgage lending.Reforming the two mortgage giants, Fannie Mae and Freddie Mac (GSEs) and clarifying the role of the Federal Housing Administration (FHA) is essential for striking a healthy balance of government support and private capital in the residential mortgage capital markets.
The Fed’s QEIII Initiative
The stock market surged last week after Federal Reserve Chairman Ben Bernanke announced a third round of quantitative easing. Under QEIII, the Fed will indefinitely purchase mortgage backed securities to the tune of $40 billion a month. Its goal is to drive down mortgage interest rates, but they already are at historically low levels. People enticed by low rates already have entered housing markets. Lowering those rates further won’t address the other structural impediments to home ownership, namely tough credit standards and large down payments. If the low rates available now haven’t stimulated new buyers, it’s hard to see why further rate reductions will. And we need to get more first-time buyers on the home ownership ladder, which will allow current owners either to move up to more expensive homes or build new ones, putting contractors back to work.
Finally, rising housing prices have been concentrated in large coastal metro areas. A notable exception is Phoenix which has seen a 19% YoY increase, but there the rise is largely driven by supply constraints and juiced demand from investors. That dynamic and corresponding appreciation is simply unsustainable. In vast stretches of interior America, there’s little sign of a housing recovery.
All in all, it’s too early for policy makers to conclude that U.S. housing markets are firmly on the road to revival. Until they confront the structural obstacles detailed above, housing will continue to lag rather than lead the recovery.