A recovery is underway, but its not as robust as pact recoveries. Maybe that means it will last longer. —Nicolas Retsinas, Senior lecturer in real estate at Harvard Business School
WASHINGTON — As home prices rise, so are concerns that a new housing-market bubble may be appearing, particularly in cities with double-digit annual growth rates.
Are there red flags in recent data?
“I wouldn’t say that we have bubbles today. But if prices keep rising at these rates, pretty soon you will be in bubble territory,” said Dean Baker, co-director of the Center for Economic and Policy Research, a Washington think tank. “Generally, you don’t see situations with rapidly rising prices and they just stop.”
Before the bubble burst, year-over-year price growth reached above 17 percent. The current rebound has yet to reach such a frenzied pace, though home prices recently posted year-over-year growth of 12 percent, the fastest rate since 2006, according to the Case-Shiller index that tracks 20 cities.
Many of the cities with the largest price gains are where housing crashed hardest when the bubble burst. For example, Las Vegas home prices recently posted year-over-year growth of 22 percent, but remain more than 50 percent below a 2006 peak, according to the most recent S&P/Case-Shiller report. Prices in both Phoenix and Miami are also more than 40 percent below local peak levels in those cities, despite recent jumps higher.
“What’s important to keep in context is that those double-digit gains are off of very low prices. Even with those gains prices are still relatively low,” said Frank Nothaft, chief economist at federally controlled mortgage buyer Freddie Mac.
Tight inventory, pent-up demand and investors have supported price gains. Despite those gains, prices are 26 percent below peak levels, according to Case-Shiller’s 20-city composite index. Take San Francisco, for example, where inventory is lean and competition is fierce between would-be buyers. Among the 20 cities tracked by the Case-Shiller index, San Francisco recently posted the fastest year-over-year growth, hitting just under 24 percent. Yet even there, prices are 26 percent below peak.
Looking forward, such large price gains are unsustainable, especially as rising mortgage rates cut affordability and income growth plods along. At a certain point, rapidly rising prices mean investors looking for high rates of return will be less interested. With fewer investors, first-time buyers and others may have a better shot at participating in some of the hottest markets. Rising prices also encourage greater home construction, which expands inventory levels and eases some pressure off of prices, though builders have complained about a deteriorated infrastructure making it tough to ramp up work.
Jed Kolko, chief economist at real estate site Trulia, compared current prices with historical prices, incomes and rents, and found that home prices were 7 percent undervalued in the second quarter, compared with being overvalued by a peak of 39 percent, which was hit in the first quarter of 2006.
“Even with the recent price increases, home prices nationally remain undervalued relative to fundamentals and much lower than in the last bubble. That’s why today’s price gains are actually still a rebound, not a bubble,” Kolko said in a blog post.
But is housing affordable?
In a healthy market, owning a home should be within reach for a typical family, economists say.
A gauge from the National Association of Realtors, a trade group, indicates that affordability has declined 18 percent since January, hitting 172.7 in May, but is 17 percent above its average in the past decade. A reading of 100 means that a household with median income would have exactly enough income to qualify for buying a median-priced existing single-family home.
Separate analysis from CoreLogic recently found that Hawaii and the District of Columbia were unaffordable, while other pricey areas were near peak affordability.
In an alternative view of affordability, Trulia’s Kolko calculates the gap between the cost to buy versus rent, including items such as maintenance, insurance and mortgage payments. For June, he found that it was about 40 percent cheaper to buy a home than rent, compared with 46 percent cheaper in March 2012. Back in September 2006, it was 15 percent more expensive to buy than to rent.
“Because mortgage rates are still near long-term lows, and because prices fell so much after the housing bubble burst and remain low relative to rents even after recent price increases, buying is still much cheaper than renting,” Kolko said in a blog post. “Mortgage rates would have to rise a huge amount — to 10.5 percent — to tip the math in favor of renting.”
The presence of large numbers of troubled properties also differentiates the current housing market from those in the past. While shadow inventory, which includes properties with seriously delinquent mortgages, in foreclosure or held by mortgage servicers, has been declining, it remains relatively high.
Shadow inventory dropped to about 2 million homes in April from a peak of 3 million in early 2010, but far higher than 650,000 in early 2006, according to CoreLogic. Fewer distressed homes, which are sold at a discount to other properties, means that year-over-year price comparisons are skewed up. As distressed homes work their way out of the system, this effect will decline.
For those who are dubious about the housing market’s health, here’s one potential red flag: House flipping is back.
So far this year about 250,000 single-family homes have been sold that were also sold within the prior 12 months, according to RealtyTrac, an online foreclosure marketplace. If that pace is maintained, there could be about half a million flipped homes by the end of the year, up 4 percent from last year and almost double the total in 2005.
“Yes, there is a red flag. High levels of flipping are indicative a market that is speculative and at risk of becoming overheated,” said Daren Blomquist, vice president at RealtyTrac.
But Blomquist added that the high level of flipping is likely a short-term trend given recent drops in areas such as Southern California, Phoenix and Las Vegas.
“If that pattern is repeated in other parts of the country in the next six to 12 months, then it will be a sign the market is not getting overheated,” Blomquist said. “However, if flipping continues at a high level, then it could indicate another housing bubble forming in some markets.”
What’s behind the high flipping level? Blomquist cited a “rare combination” of lots of distressed homes and quickly rising prices.
“This gives flippers both a good source of inventory to purchase from at discounted prices and a favorable market to sell in,” Blomquist said. “The second half of that equation was in place during the previous real estate boom, but the first half of the equation was not, so flippers were limited in the number of homes they could buy at a discounted price.”
Indeed, the existing-home-sales market is seeing a large share of all-cash deals, many of which are backed by investors. According to the National Association of Realtors, all-cash deals represented 31 percent of existing-home sales in June, up from 29 percent during the same period in the prior year.
The bad loans that plunged the country into a deep recession slashed credit access. A key difference between the current housing-market rebound and prior run ups is how tough it is to obtain a mortgage.
“Credit seized up. Now access to credit isn’t as easy as it once was,” said Nicolas Retsinas, senior lecturer in real estate at Harvard Business School.
In a November speech, Federal Reserve Chairman Ben Bernanke said it’s likely that “the pendulum has swung too far the other way,” and some credit-worthy borrowers are unable to access mortgages.
Reports from Fannie Mae and Freddie Mac show that borrowers’ credit profiles have been trending higher. This year the average FICO score for loans acquired by Fannie Mae is 757, up from 719 in 2005. Over that same period, FICO scores for Freddie Mac-acquired loans rose to 752. Fannie and Freddie back almost seven-tenths of all refinance and purchase loans for one- to four-family residences.
Still, there are signs that consumers are finding it somewhat easier to access loans. A recent Fed report indicated that a few domestic banks have eased standards on prime residential mortgages. A separate gauge of mortgage credit signaled an increase in availability in June. According to the Mortgage Bankers Association, its gauge of mortgage-credit availability ticked up to 109.8 in June from 108.9 in May, compared with a benchmark level of 100 in March 2012. Despite last month’s gain, the index is far lower than readings of about 800 in 2007.
Looking forward, experts say it’s likely that credit standards will remain high as federal regulators creating mortgage rules.
When it comes to new homes, construction starts have been growing at a double-digit percentage pace since late 2011, but this rebound is relatively slow.
“A recovery is underway, but it’s not as robust as pact recoveries. Maybe that means it will last longer,” Harvard’s Retsinas said.
The seasonally adjusted annual rate of new home starts hit 836,000 in June, the lowest pace in almost a year, and down 63 percent from a peak annualized rate of almost 2.3 million, which was reached in January 2006.
“This was the worst housing crash since the Great Depression. Basically no one in the industry today has ever witnessed anything like this,” said David Crowe, chief economist of the National Association of Home Builders, a Washington-based trade association.
Among the three largest home-construction drops in the past four decades (before the last one), two had regained much, but not all, of their lost ground within six years. In the third case, construction started dropping from a 1984 peak, and didn’t fully recover until January 2006. But the drop was narrower, with starts eventually falling about 65 percent from peak, compared with the most recent bust, which saw starts plummet 79 percent from a peak.
This sharp drop in the most recent bust punched holes in the building market’s infrastructure, Crowe said.
“This was such a long and deep housing recession that we lost builders, we lost product manufacturers, we lost the process of developing lots and plans for buildings, and we lost financing infrastructure. And none of it has been rebuilt completely,” Crowe said. “Those builders that made it through made it through because they were careful, and they are still being careful.”
Builders are perking up, with a gauge of their confidence in the market for single-family homes recently hitting the highest level in more than seven years. Still, building remains slow going, and home-construction starts are far below levels that are typically associated with current builder-sentiment readings.
“Builders finally saw a light at the end of the tunnel. But as they approached the light, it turned about to be a 40-watt bulb, not a 100-watt bulb,” Crowe said.
Crowe estimates that about 1.7 million new homes are needed every year to accommodate new households, as well as replacement and vacation homes, and he thinks that level will be hit by 2016 or 2017.
More building is needed to help curb price growth as the inventory of existing homes is low. As prices rise, more sellers will be willing and able to place their homes on the market, but the process takes some time.
Shares of home builders have seen large gains in the past year. Stock of KB Home, for example, has almost doubled, while PulteGroup shares rose more than 75 percent. The S&P 500 Index has increased about 24 percent in the past year.
Looking at a basket for builders, the shares are pricing in growth of 20 percent to 25 percent in housing starts in the coming 12 months, said David Neil Williams, an analyst at Dallas-based financial services firm Williams Financial Group. Generally, shares are pricing in the recent expansion in interest rates, he added, though this factor remains a concern.
“There are so many variables. We got to a point where everyone was comfortable and knew that housing demand was there. Now people are concerned about what the impact of interest rates” could do to demand, Williams said.
Mortgage rates could rise to 6 percent before substantially cutting demand for new homes, said Jack Micenko, an analyst with Susquehanna International Group, a Bala Cynwyd, Pa.-based quantitative trading firm.
“The assumption that rates will hurt purchase demand suggests that everyone looking to buy a house right now is maxed out,” Micenko said. “What does happen is that maybe they buy a smaller house, maybe they put less options into a house, scaling back on granite and hardwood.”
But buyers choosing fewer pricey options, the kind that come with high margins, isn’t great for builders, he added.
Because rates have increased more than 1 percentage point since early May, some buyers will have to scale back their purchase plans. Also, the record low interest rates created an urgency to buy that will lose some power even though mortgages remain relatively inexpensive, said Robert Shiller, an economist at Yale University.
“When mortgage rates hit record lows that focuses people’s attention,” Shiller said. “It’s very salient when it’s a record low. People think, ‘I don’t want to miss this.’ ”
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