Current Residential Real Estate Outlook
We have seen the media and the news is out—developed countries such as the United States are providing engines for the world economy for the first time in five years as opposed to emerging markets. The question now is how soon will the U.S. make a full recovery to housing levels pre-debacle. Progressing into a slower winter buying season won’t help housing prices, and neither will the rapidly increasing mortgage rates. Moving forward into Q1 of 2014, although the Federal Reserve’s QE tapering begins January 2014, MIAC expects the strong momentum that has built up during the past year to continue propelling home prices at a modest pace.
Review of Home Price Movements
We look at price momentum, macroeconomic environment, credit conditions, and the supply of distressed assets as key determinants of home price growth. Each of these factors helps analyze recent developments and sheds light on what the first quarter of 2014 bodes for us. Below are brief descriptions of each factor.
Price momentum– Home prices are auto-correlated, and in a market that depends so much on “comparables,” price momentum is a big driver of future home values.
Macroeconomic environment– Economic conditions are intricately linked with housing prices. Increased employment has likely boosted demand for distressed properties, decreasing the inventory and leading to rising prices.
Credit Conditions–While historically very low, the new rate environment is higher compared to the last few years. It is suppressing homeowners’ demand for mortgages and refinancing. Through HARPs extension, and possibly a revised QRM definition, more people can finance a home, increasing the demand for homeownership, but not enough to outweigh the results of increasing rates and adjusting to new QM rules.
Supply of distressed assets – With supply of foreclosed homes decreasing, demand shifts towards new and existing homes, pushing home prices up, helping the overall housing market.
With current mortgage interest rates breaking through 4.47%, home buyers are not as incentivized, leading to further diminished price increases. The price momentum through September 2013 gave us reason to be optimistic. Prices continue to increase, as the S&P/Case-Shiller National Home Price Index indicates a 3.2% and 11.2% increase over 3Q and year over year, respectively. The 10-city and 20-city composites rose 0.7% for September, as well as 13.2% year over year for both composites. These are the highest annual increases for the composites since February 2006, when the boom peaked. While 19 of the 20 cities posted monthly and annual gains, 19 of the 20 cities have experienced month over month dampened price increases since May 2013. Despite the decelerating growth, September 2013 prices have reached mid-2004 levels, which was a great period economically.
The Bureau of Economic Analysis (BEA) announced a 4.1% increase in real GDP for Q3, blowing past their forecasted gain of 3.6%. New home construction accounts for a large chunk, as it rose 14.6%. However, some of that increase can be attributed to the new GDP accounting methodology that changed starting in Q2 2013. Other factors such as R&D are accounted for now, and are expected to boost annual GDP by 3%. Providing some background, from 1948 to present, the real GDP’s average percentage change from preceding quarter is 6.03%. Despite being below the historical average, real GDP printed 2.5% in Q2 and is now 4.1%.
Following GDP, the positive employment situation should favorably impact the housing market. In October, the national unemployment rate fell to 7.0%. The rate hasn’t been that low since November 2008. Put into perspective, from 1948 to present, the US unemployment rate averaged 5.8%. Despite being worse than historical average, percentages are slowly improving, and November 2013 represented a 0.3%, 0.8%, and 3.0% decrease since October 2013, November 2012, and October 2009, the peak of the crisis, respectively. However, employment may be increasing due to a shrinking labor force participation rate. In November, the participation rate increased to 63.0%, just .2% away from being the lowest since March 1978. With an average of 62.9%, and a high of 67.3% in 2000, it has been on a sharp decline since June 2008, and has shown little sign of recovery since the recession. A rosier picture in the unemployment front should help home valuations, but the Fed has stated that signs of a strengthening economy will lead to a shifting monetary policy environment. The Fed’s $85 billion in monthly purchases of mortgage-backed securities (MBS) and U.S. government bonds has reduced borrowing costs, helping a recovery in the nation’s housing market. However, mortgage rates have been driven higher since May, when the Fed stated they could trim their purchasing by as early as September 2013. Now, with the $10 billion taper beginning in January 2014, rates will continue to rise, but at a slower pace than if the Fed cut purchases even more.
Freddie Mac reported the 30 year fixed rate loan was 4.47% in December, an increase of 112 bps when compared to the average rate of 3.35% in May. There are two ways for a lender to view the rapid rise in mortgage rates. On one hand, rising rates may encourage prospective buyers to enter the market with fears that they have missed peak affordability, catching the current rate before they climb higher. As seen in the Freddie Mac 30 Year Mortgage Rate Chart below, a rate of 4.47% is low compared to its historical average of 8.62% going back to 1976. On the other hand, the rate rise may be seen as a payment shock, as increasing rates lowers affordability to a new buyer. While homebuyers are seeking a lower price, housing activity is dampened. If the rates were increasing gradually, homebuyers would have time to adjust buying plans, but the sharp increases gives reason to believe the homebuyer will wait for a sharp decrease, building a better case for the payment shock environment.
Single-family housing starts surged 20.8% from October to November, increasing 26.2% since November 2012. Similarly, building permits for single family homes rose 2.1% from October to November, and have increased 10.5% since November 2012. It’s possible the surge came from fear of rates shooting up if the Fed announced they would begin the taper. Despite a higher mortgage rate environment, homebuilding seems to be holding its own, likely due to small inventories and steady household formation. With November 2011, 2012, and 2013 starts at 465, 576, and 727 thousand respectively, it is clear that starts have improved as we move further from the recession.
According to the National Association of Realtors’ profile for 2012, 39% of recent home buyers are first-time owners, a slight rise from 37% in 2011, and closer to the historic average of 40%. This indicates an increasing availability of credit. As seen in the results of the Federal Reserve’s Senior Loan Officer Opinion survey (Figure 6), standards for getting a residential mortgage are loosening for prime and nontraditional borrowers, while tightening for sub-prime borrowers, leading to an increase in first-time home buyers. Also, a report from the Federal Housing Finance Agency indicates the volume of Home Affordable Refinance Program (HARP) refinances remain strong (Figure 5). With 574,238 HARP refinances through 2Q13, the program is more than halfway to the 1,074,769 HARP refinances in 2012. Market permitting, HARP could stay in force for a while since it has been extended to December 31, 2015.
On the regulation front, Qualified Mortgages (QM) and Ability-to-Repay rules are beginning in January 2014. The Fed and five other US financial regulators proposed a revision to align QM with the Qualified Residential Mortgages (QRMs) definition, making mortgages more affordable and increasing credit availability while discouraging relaxed underwriting that fueled the sub-prime crisis. To achieve that, they recommended QMs to include loans with a 10% down payment, a 43% debt-to-income ratio, and force banks to retain a slice of mortgages when borrowers are spending more than 43% of their income on debt. The previous definition required at least a 20% down payment and a 36% DTI ratio. Additionally, previous versions would have increased the origination costs for lenders who would most likely pass it to borrowers in order to maintain margins.
If the revision isn’t passed, first time home buyers, who generally, and historically, have created the updraft that churns momentum for moving housing stock, may have a hard time coming up with the 20% down payment. There are non-QM mortgages available for them, but lenders will take greater caution for the first several months, as they observe how both the market and court reacts to QM, and adjust internally with staff training and new software systems. Also, non-QM loans will likely be more expensive for consumers, as they will have no other option. Since 80% of current borrowers qualify for QMs, the market won’t suffer too much, but since those who don’t qualify will likely fall back on the rental marketplace, the housing market will at best accelerate, but at a decreasing rate.
Supply of Distressed Assets
The declining supply of distressed assets has been a positive for many housing markets, naturally boosting prices. As illustrated by Figure 7, the national foreclosure concentration has been steadily decreasing, following a plateau from 2009-2012. When using the percentage of outstanding residential mortgages that are in foreclosure as a measure of distressed assets, the supply has decreased to 3.08% in September 2013 from a high of 4.64% in December 2010. While this number is about three times greater than the levels seen from 2004 to 2006, the concentration of loans in foreclosure has followed a relatively steep downward trend. According to CoreLogic, there were 51,000 completed foreclosures in September, down from 83,000 in September of 2012, a 39% decrease. Before the downturn of the housing market in 2007, there was an average of 21,000 completed foreclosures a month between 2000 and 2006. However, foreclosure inventory has declined year-over-year for 23 straight months, with nine consecutive months of year-over-year declines of at least 20 percent. Additionally, RealtyTrac Inc. reported lenders initiating the foreclosure process on 174,366 homes in Q3, the lowest level for any quarter in over seven years. With fewer initiated foreclosures, housing prices are increasing due to the demand exceeding the supply.
Q4 2013 Housing Price Outlook
All four of the areas described above are currently exhibiting positive trends. In our Perspectives from Q4 2012, mortgage rates were near or at all-time lows, and we correctly projected positive year-over-year and month-over-month change in housing prices. Looking ahead, with mortgage rates over a point higher than Q42012, we envision a moderate jog rather than a sprint towards a fully recovered economy. As the economy transitions away from quantitative easing, mortgage rates will continue to increase. Although employment is at a five year high, the distressed property supply is decreasing, and HARP has been extended–adjusting to new QM rules and rising interest rates contrast and may dominate them, indicating that the recovery path may be rocky. In the near future, MIAC expects the housing market to continue its recovery at a more moderate rate than in 2013.
By: Eli Clark-Davis, Capital Markets Group
MIAC Perspectives – Winter 2014
Q4 2013 – Residential Housing Market Update