Friday, August 14, 2009

Unreal Estate

Much like the stories of economic recovery lately, I have been astounded by the bottom-calling that is going on in real estate.

Here's how the storyline goes: Median prices have ticked up, as have some pending sales, and the rate of change in decline has tempered. The problem with business journalists nowadays is that they know how to write, but not what they write about. Any random noise for a month or two in a longer-term data trend is weighted more heavily than it should be.

The reason that median prices have ticked up is because the sales have been so skewed to the lower-end, that any slight increase carries a heavier weighting in the data and elevates it. However, does anyone really believe housing has bottomed because some foreclosures have moved up temporarily from an average of $100k to $105k (example for illustrative purposes only)?

The middle and higher end are still falling substantially. And Google a chart of OptionARM and NegativeAM loan resets, and then reconcile them concurrently with current Notices Of Default (NODs) and foreclosures. The future of housing is indeed bleak.

Further, as Calculated Risk has noted "the increase in pending sales has been mostly from lower priced homes with demand from first time home buyers (taking advantage of the tax credit) and investors. As [Lawrence] Yun notes, the demand from first time buyers will probably fade in another month or two."

But I don't want to get to far into these details, because in this post, I am primarily concerned with one, which I'll address after this rosy article from my city's newspaper.

From the Dallas Morning News: It's a risk to say it, but it looks like the worst is over for real estate market

...All that being said, I'll go out on a limb and say that the North Texas home market has bottomed out. After some significant declines in sales and prices early this year, the numbers are showing a definite leveling.

This week, North Texas pre-owned home sales data showed that July had the lowest percentage decline in almost two years. And median prices last month were up 3 percent from a year ago, according to statistics prepared by Texas A&M University's Real Estate Center.

The National Association of Realtors reports that median home sales prices for the entire second quarter were basically flat in D-FW when compared with prices a year ago. That follows five consecutive quarters of falling prices in the Realtors' benchmark report.

Yet another home price measure, by Standard & Poor's Case-Shiller, recently found that the Dallas region was one of only two metropolitan areas in the country with three consecutive months of home price increases...

...Home inventories – new and pre-owned – are now at the lowest levels in several years. Tight lending restraints will make it hard for builders to put up a bunch of spec houses.

The only real wild card left is the foreclosure situation.

My focus is Interest Rates...unlike the author's view, they are the key real unobserved wild card (although I will be the first to admit there are many). I don't know why NO ONE will address them.

Well, maybe I do.

The recovery story loses its luster when you have to address interest rates. Not one person has been able to articulate to me - in a data-driven, historical context - how recovery built upon inflation expectations can be achieved without higher interest rates.

But, maybe they won't go higher, maybe this is the new norm.

Um, no.


The chart above is as far back as I could dig up (with limited time) for the 10-year Treasury yield, which most closely approximates a 30-year fixed mortgage because of its normal life (people do sell their house before the mortgage is paid off after all). It shows that we are at the bottom of a range stretching 50 years.

Further, average mortgage rates for the last 35+ years demonstrate the same. Doing some rough calculations off of rate approximations, I come up with an average rate of 9.125% for this time period.

It can be argued whether rates will go that high, but based on a legitimate recovery case - and with all of the monetizing of debt and printing that has gone on (getting those Excess Reserves at the Fed into circulation), I think it is reasonable.

Let's examine what happens to the bottomed housing market when stagnant incomes that can't lift the demand curve much beyond where it currently is are suddenly hit with higher interest rates:

$400,000 house @ 6% interest rate = $2,398 P&I

$400,000 house @ 9.125% interest rate = $3,254 P&I

Payments just went up 36%.

Looking at it another way, to maintain the same housing payment that could be afforded before, the house price must now drop to $294,750. The price just decreased by another $105,250, or 26%.

So, buyer beware. This is just one element of a housing collapse that I expect will continue for years to come based on fundamentals and not noise in data sets.

YOU CANNOT HAVE AN ECONOMIC RECOVERY AND A HOUSING BOTTOM AT THE POINT AT WHICH WE CURRENTLY STAND. It is simply not structurally possible.

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