For the first time since September of 2010, nearly two years ago, has the Case Shiller 20 City Index realized a year-over-year gain. Does this signify a sustainable turning point for the market? At this point it is too hard to tell for a couple of reasons. The first has to do with the composition of homes being sold but also, at a more profound level, household income has fallen for well over a decade. Much of the sustained gains have come from astoundingly low interest rates offering buyers more leverage, low available inventory for sale, and a continuation of low down payment mortgages. You will notice that none of these reasons include household incomes rising to meet current prices. It really is unsustainable unless incomes can follow in conjunction. This year, according to the Case Shiller Index home values are now up 3.86 percent. Household incomes are not up. So what justifies this significant move? The CPI is up 1.3 percent so why are overall home values moving up at a rate 3 times higher than the overall index? You also see Millennials taking the brunt of the negative equity situation.
Young and underwater
Zillow recently came out with data showing that a whopping 48% of homeowners under 40 are in a negative equity position. This rate would look even worse if we considered how many of these homeowners actually bought with say FHA insured 3.5 percent down loans and have a razor thin level of equity. The reality is, we have two groups in the US right now when it comes to housing. You have younger Americans confronting a very tough employment market and purchasing homes during the manic 2000s and you have many older Americans that bought pre-2000s and enjoyed the multi-decade long bull market of the US, including steady rising incomes and home values:
Income is absolutely important and as we discussed previously, younger Americans that are in a deeper underwater state also saw the biggest decline in their earnings potential:
Source: The Washington Post, Sentier Research
So how is it possible that home prices are rising so strongly in spite of weak income growth? First, there is an unusual mix of buying going on. You first have investors competing for a lower amount of distressed inventory. Take a market like Las Vegas were over 50 percent of all sales last month went to all cash buyers, a continuing multi-year trend except inventory is lower now. Cash buyers in Las Vegas are now paying 19 percent more for their summer 2012 purchases versus the purchases made in summer of 2011. For Phoenix 41 percent of buyers paid all cash last month. The vast majority are investors as noted by their absentee status. Nationwide investor buying is a big segment of the market and with falling distressed inventory and people chasing yield, prices have been pushed up as many investors are likely opting to purchase non-distressed homes that carry a higher price tag.
The other segment is coming from the low down payment FHA first time buyers. Rates are at incredibly low levels. Interest rates have fallen substantially in the last year. The 30 year fixed rate mortgage has fallen by 28 percent in the last year alone from an already very low level. So even with stalled out incomes, many Americans found that they could afford more house with the same or even lower household income. With slim pickings for inventory, many bid prices up. Think inventory isn’t low? Take a look at this:
Source: ISI Group
Inventory is at a 30 year low and probably even lower if we had data going further back. Yet as we noted earlier, half of those under 40 are underwater. We discussed that there might be a bounce and slog market as we move along since rising prices will bring more people to the table to unload properties. Banks are methodically dumping distressed real estate.
What is concerning overall is the price rise has come from artificial factors. The low interest rates are already having hidden leakage costs in other sectors of the economy. You also condition the market to low down payment loans that are defaulting in mass in spite of rising home values. And of course the low inventory pushes prices higher given access to more leverage via lower interest rates and also investors competing for a smaller pool of properties in a tight market. It would be one thing if household incomes were moving up in tandem with home values. But even this year, home values measured by the Case Shiller are moving at a clip 3 times higher than that of the overall inflation rate.
Household income absolutely matters and has been a good metric to use for multiple decades. Only recently have we seen such artificial stimulus in the market where it has the ability to push home values up in spite of slow income growth (i.e., Alt-A or lower quality loans during the mania, low down payment FHA loans and massive levels of investor buying in the current market). The interesting point of rising home values is that it will likely drag out some of the underwater inventory and thus add more supply to the market.