Existing Home Sales Rise Across the Board

While the overall level of existing home sales is still well below the bubble peak (4.62 million vs. 7+ million in mid-2005), the trend is positive across housing markets and prices.

Source: Realtor

When Leverage Attacks

The real estate market is certainly heating up in the San Francisco, my new city, despite the broader Case Shiller Home Index still hovering near cyclical lows.

How soon we forget.

I will admit, real estate does sound like close to a sure thing with mortgage rates at record lows, potential inflation on the horizon, negative real rates in savings accounts (i.e. zero opportunity cost), and prices as much as 50% or more off. And it may be, but not necessarily when leverage is introduced.

But, first, let's take a look at housing without leverage.

Case Shiller Index (without Leverage)

As last week's post The Power of Momentum outlined, the broad Case Shiller Composite-10 index was stagnant from 1987 to 1997, rocketed between 1997 and 2006, and has tumbled since. However, over this entire period we have seen a healthy increase in the price (a bit more than the rate of inflation... assuming growth using the composite-10 index, a house worth $100,000 in 1987 is now worth a bit less than $250,000)

Case Shiller Index w/ Introduction of Leverage

As James Montier of GMO has pointed out:

Real risk is the risk of permanent loss of capital.

Investments made with borrowed money reduces the range that the investment can move without causing a permanent impairment of capital.

Using the same Case Shiller Composite-10 index data as in the above chart, we introduce leverage using the following rules:

• 5x leverage (i.e. a 20% down payment... pretty standard, though not so much during the bubble)
• If prices rise, sell your investment property each year and with the equity gains, buy a more expensive property at 5x leverage

Simplifying Assumptions:

• Mortgage payments = rental receipts
• No taxes / transaction fees

Using the same $100,000 house as an example (this time with 20% down), we get the following:

Returns were actually okay from 1987 to 1997, but were dwarfed by the boom seen from 1997 to 2006 as property values, debt to go along with it, and equity SOARED, taking the original $20,000 investment to $3.7 million.

BUT, it all came crashing down. As property values declined, the new outsized level of debt remained, which resulted in all that hard earned equity flipping negative (in the above example) by early 2008. 5x leverage means that when the value of the property turned down just 20%, the entire equity stake was gone.

Takeaways....

• Real estate investment is not riskless, especially when leverage is introduced
• Down payments of 20% do not prevent bubbles (as the chart above shows, asset appreciation allows an investor to put gains back in the market)

A case can be made (specifically within real estate) that negative equity does not equal permanent impairment. As long as payments continue to be made, an investor is still alive. While this is true, it does completely reduce liquidity (i.e. you can't sell without making the loss permanent) and it require an investor to make mortgage payments that are higher than the current market clearing price for similar properties.

Source: S&P

What Goes Up...

Source: S&P

Existing Home Sales Rise

Bloomberg details:

Sales of previously owned U.S. homes rose for a third month in December to the highest level since January 2011, a sign the housing market ended last year with momentum.

Purchases increased 5 percent to a 4.61 million annual rate, the National Association of Realtors said today in Washington. The pace was less than the 4.65 million median forecast of economists surveyed by Bloomberg News. The gain helped push down the inventory of homes for sale last month to the lowest level since 2005. Purchases in 2011 climbed 1.7 percent from a year earlier as prices fell.

Historically low mortgage rates and a pickup in employment may be giving Americans the confidence to purchase homes that have fallen in value. At the same time, another wave of foreclosures may inhibit a faster recovery in real estate as more distressed properties are put on the market.

Looking at the data, it appears sales are on the rise as prices are creeping lower (to a level where demand is finally meeting supply). My guess is the reason higher priced home sales are less is two-fold... they don't qualify for conforming loans and prices are being reduced (i.e. houses formally in the $500k-$750k "bucket" are now in the $250k-$500k bucket).

Source: Realtor.org

Even More Perspective on Housing

In response to my post Some Perspective on Housing, reader Tom Lindmark commented:

It would be interesting if you could take the time series back far enough to account for the rise of the Boomer generation. My guess is that if it were at all possible to normalize the data for their outsize impact we might see a far lower number of new home starts than what economists predict would occur in a "healthy market".

The chart below normalizes housing starts by the 16+ year old population (not perfect as it does not account for family size... the smaller the family size, the more housing units needed). What we see is that the most recent spike in housing units during this bubble was not as outsized as I would have thought (at least relative to the baby boom when household formations spiked), while the drop off remains severe. For reference, 0.5% roughly equates to 1.2 million homes (i.e. the number of homes economists referenced in a healthy market).



Source: Census / BLS

Are Home Prices Inexpensive Relative to History?

It depends on the time frame you are looking at. The below charts show real appreciation (after inflation), by city where available, going back 5, 10, and 15 years.

5 Years (Home Prices Appear VERY Cheap)

10 Years (Home Prices Appear Quite Cheap)

15 Years (Regions Impacted Most by the Recent Recession Appear Cheap... Others Quite Expensive)

Source: S&P

Generation Vexed... Housing Edition

Source: Census via Calculated Risk

New Home Sales Flatlines

Reuters details:

The Commerce Department said May new home sales fell 2.1 percent to a seasonally adjusted annual rate of 319,000. Analysts polled by Reuters were expecting a slightly slower pace of 310,000 for the month.

The decline ended two straight months of strong gains, with sales rising 6.5 percent in April and 8.9 percent in March. May's new home sales were 13.5 percent above the May 2010 level.

Lets take a look at those recent "strong gains" by sale price.

And relative to the longer term by region (note that "strong gains" in percent terms are easy when the base is 80% below previous peaks).

As GYSC noted in a previous post:

I cannot believe how many run thier game under "The FED is behind us no matter what!". 

While that is a great trade when the market simply needs liquidity, as seen above it doesn't help so much when the asset has fundamental issues.

Source: Census

Case Shiller Index Points to Housing Double Dip

Source: S&P

Housing Starts Quite Low

Housing market optimists will blame this partially on December weather. Broader optimists will point out that low levels of new construction will help clear the existing inventory. Those looking for the housing market to contribute towards the economic recovery (outside of addition by the elimination of subtraction) will be disappointed.

Source: Census

Housing: Another Leg Down

Biz Journals with the bearish view:

One of the nation’s leading real estate indexes showed home prices are on the decline across the country, raising fears of a double-dip recession in the housing market.

Home prices in the Case-Shiller 20-City Composite fell by .8 percent in October, compared to the 4.6 percent gain it saw in May before the federal housing tax credit expired.

“The double-dip is almost here, as six cities set new lows for the period since the 2006 peaks,” David M. Blitzer, chairman of the Index Committee at Standard & Poor’s, said in a statement. “There is no good news in October’s report. Home prices across the country continue to fall.”

Below is the year over year change by city through October, which appears to show that we are entering another leg down in a large portion of the nation's housing markets.



Source: S&P

New Home "Pipeline" Lowest Since 1961

Marketwatch reports:

Construction of new U.S. homes rose 3.9% to a seasonally adjusted annualized rate of 555,000 in November, the Commerce Department reported Thursday. The November rate matched forecasts from analysts polled by MarketWatch. Housing starts for October were revised higher to a rate of 534,000 from a prior estimate of 519,000. Permits for new construction fell 4% to an annualized rate of 530,000 in November, reaching the lowest level since April of 2009. With persistent weakness in the housing market, homebuilders have been cautious.

Not detailed above is the number of permits issued that have not yet been started (i.e. the new starts "pipeline", which is now at the lowest level since December 1961 (i.e. before the New York Mets were a franchise).

While still years away, I think when the market turns and inventory finally falls we may actually see a housing shortage.

Source: Census

Housing and Inflation

Bill Ackman (via Paul at Infectious Greed and pulled from a Beracha and Johnson white paper) shows the following chart comparing the rate of appreciation required for housing to breakeven with an equivalent rental (adjusted in some concocted manner to adjust risk to match the opportunity cost for a homeowner that plans to change the quality of their residence... don't ask).

While not Bill Ackman's only rationale, the claim with the above chart seems to be that with required appreciation only ~4% (down from 9%+ in the early 1980's), the rental equivalent value hasn't been this cheap since the 1970's.

My problem?

Well for one, I am questioning Bill Ackman (not typically the best move).

But ignoring that, my problem is this does not compare the "real" appreciation needed now to "real" appreciation needed in the early 1980's, but only nominal. Nominal appreciation was easy in the early 1980's when inflation was running at 10%+, but not so much with current inflation thus far non-existent.

Want proof that inflation matters to home values? Here you go.



Is housing a good hedge against potential inflation? Sure. But it may not be so cheap should inflation not show itself.

Source: Irrational Exuberance

New Home Starts Dive in October

CNN Money details:

New home construction fell to an 18-month low in October, the government said Wednesday. Housing starts, or the number of new homes being built, fell 11.7% to a seasonally adjusted annual rate of 519,000 in October, down from a revised 588,000 in September, the Commerce Department said. The annual rate is the lowest since the 477,000 starts reported for April 2009.

The west's 91,000 annualized figure is the second lowest total in more than 50 years.

Source: Census

Case Shiller: Home Prices Stagnant

FT details:

US house prices slipped in July in a sign that the residential real estate market continues to face challenging headwinds.

Prices in the biggest US cities fell by a seasonally adjusted 0.1 per cent from June to July, according to the S&P/Case-Shiller home price index. That was in line with Wall Street analysts’ predictions and left house prices up 3.2 per cent from the same month a year ago.

The figures show that home price growth on an annual basis is decelerating as the effects of government stimulus measures to support the market fade.

Going forward, expect continued pressure on the index.

Case-Shiller’s index uses a three-month moving average, so the impact of the first-time homebuyer tax credit was still reflected in the data. Without seasonal adjustments, prices ticked up by 0.6 per cent from June to July.

Source: S&P

Housing Off Lows... Slightly

The AP details:

Home construction increased last month and applications for building permits also grew. But the gains were driven mainly by apartment and condominium construction, not the much larger single-family homes sector.

Construction of new homes and apartments rose 10.5 percent in August from a month earlier to a seasonally adjusted annual rate of 598,000, the Commerce Department said Tuesday. That's the highest level since April.

Pulling the figures up was a 32 percent monthly increase in the condominium and apartment market, a small portion of the market. Single-family homes, which represent about 80 percent of the market, grew more than 4 percent.

Below we see that "jump".



And now... a little perspective.

Housing starts are up 25 percent from their bottom in April 2009, but are still down 74 percent from their peak in January 2006.

New Home Starts Over the LONG Term



What's this all mean? Calculated Risk sums it up best:

As I've mentioned many times - this low level of starts is good news for the housing market longer term (there are too many housing units already), but bad news for the economy and employment short term.

Source: Census

Housing over the LONG Term

Below is a chart of housing prices in a number of regions over the long term (i.e. 10, 15, and 20 year periods). As can be seen, changes in the price have been widely varied by city and a number actually appear "cheap" relative to the 20 year inflation rate of 2.5%. Interesting (to me) is that while a lot of markets still appear to be extended over 10 and 15 year periods, prices look quite reasonable over a 20 year period.



Source: S&P / BLS

Mortgage Rates and Housing Prices

David Leonhardt at NY Times Economix (hat tip Calculated Risk) discusses the relationship between mortgage rates and housing prices:

Anyone who argues that home prices do not seem headed for another big decline will probably hear some version of this question. Interest rates are historically low right now. They will surely rise at some point. All else equal, higher rates should push home prices down.

Yet compare the national median home price to 30-year fixed mortgage rates over the last three decades (with both indexed to 1 in 1971)

And shows the following chart:



And concludes:

It’s not easy to see much of a relationship. The fall in rates appears to have helped the housing boom of the last decade. On the other hand, the spike in rates in the 1980s had little apparent effect on prices.

My best guess for why the two don’t correlate more closely is the role that psychology plays in housing markets. Prices just don’t move as quickly as economic theory suggests they should.

My immediate thought... why are you comparing REAL price levels with NOMINAL rates?

Lets see the relationship of real housing prices (in this case Case Shiller discounted by CPI) vs. real mortgage rates less year over year CPI (note that the right y-axis is flipped to show the inverse relationship between the two).



A much stronger relationship appears when viewed on a real to real basis.

Note that the relationship appears to be non-existent from around 1972 to 1980 (pre-Case Shiller index data), which can be explained in part that government agency mortgages (i.e. subsidized financing rates that made housing affordable on a monthly payment rather than price level basis) jumped from just 10% of the market in 1980 to almost 50% by 2000 (see page 5 of the Fed's paper Securitization and the Efficacy of Monetary Policy for more).

Calculated Risk seems to vehemently disagree with my view that there is in fact a relationship between rates and price:

I've tried to explain this several times in several different ways. Price is what you pay for something. Interest rates are related to how the item is financed. Some people pay cash for a house. Would they pay more because interest rates are low? Nope.

My disagreement to his disagreement can be found in last month's post The Importance of Mortgage Rates, but his argument is in a nutshell the following question:

Would people pay more for a car if interests rates are low?

My simple answer to that question... OF COURSE (and I did for my first car from a sleazy used car dealer).

Why? Because I could not afford to pay cash for the full price of a car at the time, thus I paid with credit, rather than fiat money (we live in a credit, not a fiat economy - see Steve Keen's epic piece that changed my understanding of the economic collapse here for more).

Details of my first car purchase:

• 1990 Dodge Shadow (yikes)
  
• Cost: ~$3200
• Savings available for a car = ~$0
• Monthly disposable income available for a car = ~$100 / month

Without financing, I could not afford the car I ended up with. With financing, I was able to afford it across a range of sticker prices, depending on financing rates, all at the same $100 / month payment. And unlike case-by-case deals on auto rates, anyone with decent credit and 20% down (harder to come by these days, but not limited) can access the subsidized mortgage rate.



Which brings me back to my conclusion in my post on rates and housing:

Since the key contributor to housing affordability is not the current list price, but rather the mortgage rate, anyone looking to buy should seriously consider the alternative (i.e. renting) if they don't plan to use that contributing factor (again... the mortgage rate) for the life of the loan (i.e. to keep their house for 15-30 years).

If you do plan to buy a house for a smaller window of time (i.e. 1-10 years) with the idea of flipping it into a larger house, be careful. That per month clearing price may mean a much lower home value when you are trying to sell...

Source: S&P, BLS

Housing (Greed - Fear - Bottom) Cycle

Irvine Housing Blog (hat tip The Big Picture) shows the below chart and details that:

It is a sign that people are clinging to the hope of a real estate recovery. We are not yet at the bottom.

While I understand the above chart is meant to make a high level point (rather than show exactly where we are), I thought it would be interesting to overlay the Case Shiller home price index on top.



We are not as early in the process as the chart would indicate (i.e. we've already fallen much further), it appears we still have plenty of risk remaining to the downside.

Another way to view this is Case Shiller 10 vs. inflation (CPI) over this time.



Closer, but still about 20% "too high" and during "despair", it tends to break through.

Source: S&P / BLS

Housing Prices Continue Rebound Due to Tax Credits... Now What?

S&P details:

Data through June 2010, released today by Standard & Poor’s for its S&P/Case-Shiller1 Home Price Indices, the leading measure of U.S. home prices, show that the U.S. National Home Price Index rose 4.4% in the second quarter of 2010, after having fallen 2.8% in the first quarter. Nationally, home prices are 3.6% above their year-earlier levels.

In June, 17 of the 20 MSAs covered by S&P/Case-Shiller Home Price Indices and both monthly composites were up; and the two composites and 15 MSAs showed year-over-year gains. Housing prices have rebounded from crisis lows, but other recent housing indicators point to more ominous signals as tax incentives have ended and foreclosures continue.

Strength was widespread, but note this data is two months old and importantly, during a period before the tax incentive ended.

Update:

Calculated Risk with a beautiful chart showing the cumulative change by market here.

Source: S&P