Are We Headed for Another Housing Cliff?

Posted: Dec 15, 2015 12:01 AM
Are We Headed for Another Housing Cliff?

The Housing Market has been in the unfettered hands of the Fed since 2008.  And, the looming Fed rate-increase may be the end of the recovery.  

If you bought a home in the last four years, you’ve likely seen your equity grow. And that has created blind-optimism about the future of housing.  But if you look at those same values a year from now, it’s not likely to be that optimistic.

With the imminent fed-rate increase, mortgage rates are due to rise by at least 1% over the coming year.  When this happens, the payments on a home may rise by 15-20%, creating downward pressure on housing prices.  

Living near the best schools is already out of reach for most Americans.  Rent is still rising in most cities -- a shocking 40% of leaseholders can’t afford their monthly rent.  It might seem that this would indicate a positive forecast for housing sales. However, the credit damage overhang -- courtesy of the 2008-2012 housing crash – has left many borrowers on the sidelines, unable to purchase a home and thus hampering the housing economy.

Many homeowners are beginning to beg for help with selling their homes, which prompted me to investigate the cause of this apparent shift in the housing landscape. How is it possible that demand is rising, sales are increasing and median price is growing in most cities, yet I see signs of a correction is in our near-future?

First, the fundamentals tell us that interest rates, presently lower than at almost any point in the last forty years, have created a short-term housing stimulus that has increased demand and allowed buyers to purchase homes that, historically, would have been out of their price range.  Second, builders are building spec-homes again (homes where there is no buyer yet). This skews the numbers, and therefore the perception of the housing market, because these properties in builder-communities are not included in the homes listed for sale. Third, as many as a million homes have been purchased by institutional investment-companies for the sake of generating short-term rental income.  Their intention, however, is to sell these homes once the market has recovered (likely, they will be too late).  In other words, we still have to clear that inventory through the market in the near future.  

This means that the numbers being reported by Realtors are missing hundreds of thousands of unlisted spec-homes and lots, as well as shadow-inventory that will reappear in the future (when it’s needed the least).  

This excessive and hidden inventory is beginning to put downward pressure on resale home-prices in many cities across America (absent most in California). And, because of extremely low mortgage interest-rates, the exciting 2015 sales numbers are misleading. Median home-price is rising (while transaction volume is rising), but actual home-price appreciation is stalling or even declining. The main reason that median-price is rising is that interest rates are low, which affords most buyers more purchasing power. That is to say, they are buying more home today than they were two years ago, but not necessarily paying a higher payment for the same home.  Realtors reports of median-price appreciation is a result of reduced-interest rates, and not that of an appreciating real estate market.

Additionally, the inconvenient fact remains that housing has not appreciated in most cities in the last decade.  It fell by 20-50% in these cities between 2007-2011, and has somewhat recovered. In other words, we’ve been making up lost ground, not gaining new ground.  If a home’s market-value fell by 50% during the crash, it would take 100% appreciation for it to return to its pre-crash value.  That is not appreciation. It is recovery. If record low interest rates, combined with 4 trillion dollars printed by the Fed (mainly to purchase mortgage bonds), couldn’t stimulate new housing appreciation in the past decade, then a rise in interest rates will certainly create depreciation in many cities’ housing markets.  

On my housing radio show, we talk about how home-buyers seem to be buying the maximum of what they can afford (part of a growing trend of irresponsible consumer decisions).  They’re generally putting as little down as possible, to such an extent where the following holds true: a 1% rise in mortgage interest rates would reduce the home-buyer’s purchasing power by 11%.  

The overwhelming majority of all new mortgages are backed by the Federal Government through HUD/FHA, VA, Fannie Mae or Freddie Mac.  Unlike previous eras, where we saw volatile mortgage-interest rates, we have new and unprecedented control by the Government.  Combine this with the Dodd-Frank legislation (and QRM, Qualified Residential Mortgage), requiring much stricter scrutiny on lenders, and the housing-industry is simply not capable of enduring much of a rise in rates.

If mortgage rates rise to 5.125% (roughly a one point rise), housing will experience an immediate increase in sales as buyers rush to lock lower interest-rates and purchase homes while the mortgage is more affordable.  This will, in effect, borrow sales from the future and, in most housing markets, create a downward pressure of 3-5% on home values for each 1% rise in rates.  Put in different terms:  Depreciation to follow a mini-boom of purchasing at the onset of rate increases.

We’re about to learn that this “housing recovery” has really been nothing more than a Government-sponsored stimulus of ridiculously low interest rates and trillions of dollars in Fed-printed money.