Housing prices are expensive, affordable, stable, and boring
Stable house prices with low volatility isn’t very exciting, but it’s the best thing possible for residential real estate.
The norm in California housing over the last 40 years has been extreme volatility. We had one stretch in the mid 1990s when prices were closely tethered to rent, but other than that house prices were either in a bubble or over-correcting to the downside. For the most part, the rest of the US did not participate in the wild price swings characteristic of California, but starting in 2003, financial innovation in housing finance brewed up a toxic concoction of unstable mortgage products that inflated a massive housing bubble and a deep over-correcting crash.
Prior to the housing bubble, the normal state of affairs for the housing market was slowly but steadily rising prices that matched the growth in rents and incomes. From the early 1980s through the early 2000s, house prices rose a bit faster than incomes due to steadily falling interest rates, but generally the rate of appreciation was gentle and predictable.
The new normal in housing is very different from the old normal.
1. Low mortgage rates
The first unique characteristic of the new normal is very low mortgage rates largely because borrowers can’t afford current pricing at higher rates. The long-term average for mortgage rates dating back to 1971 is about 9%; only looking back 25 years brings this average down to between 6.5% and 7%. The current regime of 4% rates is very low by historic standards, but given the need for lenders to reflate the housing bubble to recover on their bad loans, it’s likely we will sustain below-average mortgage rates for a very long time. This is a feature of the new normal.
2. Low supply of for-sale homes on the MLS
The second unique characteristic of the new normal is unusually low MLS supply. In 2011 lenders embarked on an aggressive policy of loan modification can-kicking to get some income from their bad loans and get the distressed properties off the market, and they stopped approving short sales if the borrower had any assets.
The loan modifications and denied short sales kept borrowers in their homes and it kept the homes off the market; inventory plummeted, and by early 2012, there were so few homes available that even the tepid demand was enough to cause bidding wars and force the housing market to bottom.
The problems and solutions that lead to our current state of low MLS inventory is likely to persist for quite some time. Both lenders and underwater borrowers do not want to lose money on the bad deals they made nearly 10 years ago. Lenders can kick-the-can indefinitely, and they can force borrowers to play along. There are still millions of homeowners who are underwater, and the government loan modification programs and private-label loan modification programs delayed and deferred several million more distressed sales, so low MLS inventory will be an issue for a very long time. This is a feature of the new normal.
3. Low demand from owner-occupants
The third unique characteristic of the new normal is low demand from owner-occupants. When the housing bubble burst, several million people lost their homes in foreclosures, and several million more ruined their credit scores by defaulting on their loans to obtain loan modifications. This removed several million potential borrowers from the buyer pool, and despite hopes that these boomerang buyers would come back to the market in large numbers, they haven’t, and they won’t.
Further, first-time homebuyers, typically the largest demand cohort with an average 40% share, are not buying homes. Today, the share of first-time homebuyers is only 30%, and with the poor economy and excessive student loan debts, the Millennial generation won’t be major housing market participants until 2019. Owner-occupant demand will be weak; this is a feature of the new normal.
4. Home prices expensive but affordable
I create monthly market reports that carefully document rents and ownership costs for most cities and many zip codes in Southern California; this site displays the cost of ownership and comparable rental rates for every for-sale property on the MLS: between those two sources, it’s easy to determine market trends and gauge relative affordability from the county level all the way down to individual properties.
Relative to rents, house prices stabilized across Southern California at prices very similar to the stable equilibrium from the mid 1990s. In the past, toxic mortgage products would have restarted the Ponzi scheme, but since these products are effectively banned, rather than restart the Ponzi scheme, sales volumes declined, and buyers are giving up.
After almost of dozen years of volatility, the market has reached a stable equilibrium where prices are high but affordable. Since we aren’t likely to get an influx of supply, and since the weak economy means we aren’t likely to get a surge in demand, we will maintain this equilibrium for the foreseeable future. This is a feature of the new normal.
A decade ago the market was unquestionably too hot. Four years ago it was too cold. Now, by a wide range of measures, nationwide home prices look relatively normal when compared with incomes, rents and other fundamentals — and are rising at similar low, single-digit rates.
In contrast to the periods of irrational optimism and pessimism, the market is settling into a balance in which buyers are comfortable spending what they can afford given their income and savings, but aren’t willing (or able to persuade lenders) to stretch beyond that. Among buyers there is neither a sense of desperation to buy now on the assumption prices will rise rapidly, nor of fear they will plummet.
For a while in 2013 and early 2014, national home prices were rising at a double-digit percentage rate, which if sustained could have rapidly led housing back to its bubble-era extremes. But the reality — of caution on the part of home buyers and their lenders — soon set in. In the 12 months ended in March, the S.&P. Case-Shiller national home price index rose only 4.1 percent, not much higher than the rise in Americans’ incomes and broadly consistent with longer-term trends.
“The market is coming back, but we’re not having astronomical growth,” said Thomas O’Bryant Jr., the chief executive of the Greater Tampa Association of Realtors. “We’re having the kind of growth that is going to be sustainable, and any time you have steady growth it’s much better than having bubble growth.”
Does the shape of the above chart look familiar? It should because it’s very similar to the valuation method I use in my monthly reports.
When you consider the market manipulations of mortgage rates by the federal reserve and supply by lender policy, it’s a miracle the market stabilized at all. It’s an open question as to how stable these props are, but it seems very unlikely they will be unwound any time soon because the health of the banking sector depends on it.
Despite the overhanging issues, when you look carefully at where we are and how the market is reacting, the new normal looks much like the old. Prices will rise slowly from here always being expensive but attainable, not unlike they were in the 1990s.