Tuesday, June 17, 2014

Housing Market, Already Slowing Economy, Appears Unsustainable

The U.S. housing market was at the heart of the financial crisis that led to the Great Recession. Yet, most of the hopes for our economic recovery have been pinned to a housing recovery.

While there has been some semblance of a recovery (home prices have increased 20 percent nationally over the past two years), it has been uneven, differing greatly from market to market.

The S&P/Case-Shiller 20-City Composite Home Price Index shows that in February prices were back around the same levels as in 2004, though still down from their peak in 2006.

Home prices nationwide, including distressed sales, increased 12.2 percent from February 2013 to February 2014, according to CoreLogic. This change represented 24 months of consecutive year-over-year increases in home prices nationally.

However, the housing recovery has been driven largely by investors, not typical buyers.

Sensing an opportunity, institutional buyers have accounted for a large percentage of home purchases, which has boosted prices. This is not a market driven by normal consumer demand.

All-cash purchases accounted for almost 43 percent of all sales of residential property in the first quarter of 2014, up from almost 38 percent in the previous quarter and 19 percent in the first quarter of 2013, according to data released in May by RealtyTrac.

These investors are eager to make a profit by buying low and renting these properties — or flipping them — which is driving up the number of all-cash deals. Wealthy Americans and downsizing empty nesters also account for some of these all-cash deals.

According to the National Association of Realtors' annual study of consumers, the 2014 Investment and Vacation Home Buyers Survey, investors accounted for 20 percent of market share in 2013, down from 24 percent in 2012.

As a result, the median price of a new home rose to $290,000 in March, the highest level on record, according to the Commerce Department.

This is pricing out many first-time and lower-income buyers. When you look at incomes, it's little wonder.

In April, for example, weekly wages for the average American worker were just 0.2 percent higher compared to a year earlier, adjusted for inflation. And real hourly wages were actually down 0.1 percent in the same one-year span.

In real dollar terms, the median annual income is 7.5 percent lower ($4,309) than its January 2008 high.

This makes the 20 percent increase in home prices over the past two years tough to reconcile. It's even more confounding when you look at the broader inflation rate.

The latest annual inflation rate for the United States is 2.1 percent through the 12 months ended May, as published by the US government on June 17, 2014.

So the rise in home prices is wildly out of line with general rise in prices throughout the economy.

As previously noted, this is hurting first-time buyers, many of whom tend to be younger.

The Millennial generation, in particular, is being squeezed out of the housing market. This group is not only contending with rising home prices, but also tighter lending standards, tight supplies and high student loan debts.

Some graduates end up paying off student loans well into their 30s and even 40s. As a result, many Millennials simply can't come up with hefty 20 percent down payments. Others don't have good enough credit to qualify for loans.

Consequently, just 36 percent of Americans under the age of 35 own a home, according to the Census Bureau. That's down from 42 percent in 2007 and it's the lowest level since 1982, when the agency began tracking homeownership by age.

Yet, it's not just Millennials. Home ownership, in general, is on the decline.

Just 74.4 million American households — less than 65 percent of the country — owned the homes they lived in during the first quarter of this year, according to a recent U.S. Census Bureau report.

That was the lowest level since 1995 and a big drop from 2006, when a peak of 76.5 million households, or 68.9 percent, were owner-occupied.

The price of homes, the lack of sufficient down payments, and stricter lending standards have killed any hope of ownership for millions of Americans. What was long considered the "American dream" is no longer the dream for a huge percentage of people.

According to a May poll by the National Endowment for Financial Education, only 13% of Americans considered home ownership as their “top long term financial goal,” down from 17% in 2011.

Lending standards should indeed remain strict. Lax standards helped to drive the housing bubble in the first place. But the stagnation in wages has thwarted the ability of millions of Americans to save for a down payment, or service a mortgage.

The rise in home prices is a two-sided coin. It's been great for owners that have been underwater, and for those seeking to sell their homes. But it's hurt millions of other would-be buyers.

The question is whether the increases in home prices can be sustained. It doesn't seem likely, since it is so out of line with precedents.

Historically, home prices have appreciated nationally at an average annual rate between 3 and 5 percent, according to Zillow, though different metro areas can appreciate at markedly different rates than the national average.

This historical average is important to consider as we look for signs of another housing bubble.

Again, home prices nationwide, including distressed sales, increased 12.2 percent in February 2014 compared to February 2013, according to CoreLogic.

So, price increases over the past year are anywhere from 244 percent to 406 percent above the historical national average.

Cause for concern? Perhaps. This certainly isn't normal appreciation.

Additionally, as interest rates have slowly risen, institutional investors — people or companies that have purchased at least 10 properties in a calendar year — have been gradually leaving the market.

Investors accounted for 5.6 percent of all U.S. residential sales in the first quarter, down from 6.8 percent in the fourth quarter of 2013 and 7 percent in the first quarter of 2013.

One way or anther, this market looks quite tenuous. Incomes don't match home prices, and mortgage rates will only tend to rise.

As it is, the housing market is already slowing down.

New-home construction fell 6.5 percent in May.

Meanwhile, existing home sales saw a 3.4 percent increase in March. However, that was the first gain in nine months. And in April, existing home sales increased just 0.4 percent.

The housing market was a drag on the economy in each of the last two quarters.

Housing cut economic growth in the first quarter, as it did in the fourth quarter of 2013, resulting in the sector’s first back-to-back subtraction since the first half of 2009.

That trend could continue into the second quarter, and beyond.

Clearly, this is something we should watch closely in the months ahead.

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