The much anticipated second leg down in house prices is official. Will we hit bottom this winter?
Irvine Home Address … 8 INDIGO Irvine, CA 92618
Resale Home Price …… $1,049,000
Time is getting closer
I read it on a poster
on corners prophesized
I just come back to show you
all my words are golden
so have no gods before me
I'm the light
Alice Cooper — Second Coming
Back in July I wrote All Signs Point to Lower House Prices. Well, here we are….
By: Dirk van Dijk, CFA November 30, 2010
In September, home prices continued to slip, and the declines were very widespread. The Case-Schiller Composite 10 City index (C-10) fell 0.67% on a seasonally adjusted basis, and is up just 1.52% from a year ago. The broader Composite 20 City index (which includes the cities in the C-10) fell by 0.80% on the month and is up 0.55% from a year ago.
In August, the year-over-year gains were 2.50% for the C-10 and 1.61% for the C-20, so it looks like the year-over-year gains are rolling over. Of the 20 cities, only one (Washington DC, and it was only up 0.05%) posted a gain on the month, while 19 saw prices fall. Year over year, five metro areas saw gains and 15 suffered losses.
In August, there were also 19 down and just one up. It thus looks like a new downtrend in housing prices is under way.
It is difficult to argue with data. Prices are falling again — and not simply because they always drop a little bit at the end of the year — prices are falling all over the country on a seasonally adjusted basis.
Consider Seasonal Adjustments to Prices There is a seasonal pattern to home prices, and thus it is better to look at the seasonally adjusted numbers than the unadjusted numbers. Most of the press makes the mistake of focusing on the unadjusted numbers.
While the 0.55% rise in the C-20 year over year in isolation is not the end of the world, it hardly makes up for the damage that was done in the popping of the housing bubble, and it is also unlikely to last. From the April 2006 peak of the housing market, the C-10 is down 29.83%, while the C-20 is off by 29.56%.
Calculated Risk has created a great chart compiling house prices calculated by the Case-Shiller method back to the mid 1970s. It clearly illustrates the two previous bubbles largely concentrated on the coasts as well as the Great Housing Bubble.
As you can see from the chart, the Federal Reserve attempted to halt the house price decline before it reached its natural bottom. Perhaps they prevented an overshoot to the downside and saved many banks from going under. If they did, it was at an enormous cost that will ultimately be borne by taxpayers.
The Case-Schiller data is the gold standard for housing price information, but it comes with a very significant lag. This is September data we are talking about, after all, and it is actually a three-month moving average, so it still includes data from July and August.
Existing home sales have been weak since the home buyer tax credit expired (see "Used Home Sales Fall"). In the process, the inventory-to-sales ratio has been extremely high, at 10 months, although that is down from the June peak of 12.5 months. That is what we saw during the implosion of housing prices that took place in 2007 or 2008. Housing prices are going to fall again in the coming months.
I noted this in Home Price Drop Sudden and Dramatic.
Month-to-Month Data a Bitter Pill
It is hard to find much of a silver lining in the month to month data. Only Washington DC posted an increase, and that was anemic at just 0.05%. Only three other cities kept the decline to less than 0.5%: Las Vegas down 0.21%, Denver down 0.30% and L.A. down 0.43%.
On the other hand, there were five cities that posted month-to-month declines of over 1.5%. The Twin Cities were the hardest hit, plunging 2.21%, followed by Cleveland with a 2.00% decline. Portland was down 1.72%, Detroit fell 1.61% and Phoenix fell 1.55%. Those are similar in magnitude to the monthly declines we were seeing three years ago during the first wave of the housing price implosion.
I doubt the upcoming price declines will approach the depth of the previous drop, but it interesting that the decline is picking up speed and it now rivals the rate of decline from three years ago.
Results by Region
On a year-over-year basis, the strongest cities are in California, which was an early poster child for the housing bust. However, even there the year-over-year gains are starting to erode. San Francisco leads the way with a 5.43% rise, followed by San Diego, up 4.94%. LA was in fourth place with a 4.32% year-over-year increase.
DC was in third place with a 4.40% gain. Boston was the only other city with a year-over-year gain, and it was up just 0.39%. As recently as July, the year-over-year gains in California were 11.06% in SF, 9.26% in SD and 7.5% in LA.
There were nine metropolitan areas where the year over year declines were more than 2.5%. Chicago fared the worst with a 5.63% decline, followed by 4.36% in Tampa. It is not going to take global warming to put that entire city underwater — the housing market has already accomplished that.
Charlotte, which early on seemed relatively immune from the housing bust, is down 3.72% year over year. Portland is down 3.63%, and Detroit is off 3.15%. In other words, significant year-over-year declines are happening in just about every corner of the country.
Declines in the areas which did not rally during the bubble are most likely the result of deteriorating employment in the local economies in those areas. Without the bubble rally to facilitate over-borrowing and to create distressed loan owners, other factors must be driving the declines.
The graph below tracks the cumulative declines for each city over time. If the red bar is shorter to the downside than the yellow bar for a city, it indicates that prices in that city have risen since the start of this year.
In every city prices are below where they were in April 2006, but there is a huge variation. Las Vegas is the hardest hit, with prices down 57.57% from the peak, followed by Phoenix down 53.65%. Three more cities are down more than 40%, Miami (down 47.92%), Detroit (off 45.19%) and Tampa (with a 43.53% decline).
At the other end of the spectrum are Dallas (down only 6.26%), Charlotte (off 8.13%) and Denver (down 10.25%). (Note: the percentage declines I am quoting are from when the national peak was hit, the numbers in the graph are relative to that city’s individual peak, so there is a little bit of difference.)
No Support for Home Prices
The homebuyer tax credit was propping up home prices, but now with that support gone, prices are resuming their downtrend. People had until June 30 to close on their houses, and they had to agree to the transaction by April 30. That pulled sales into those months that might otherwise have happened in July or August. The credit was up to $8,000, so almost nobody would want to close their deal in early July and simply leave that money on the table.
The tax credit is a textbook example of a third party subsidizing a transaction. When that happens, both the buyer and the seller will get some of the benefit. The buyer gets his when he files his tax return next year, the seller gets hers in the form of a higher price for the house.
Since the tax credit is now over, that artificial prop to housing prices has been taken away. Sales of existing houses simply collapsed in July, after the credit expired, and have remained depressed ever since. The extremely high ratio of homes for sale to the current selling pace is sure to put significant downward pressure on prices.
There is still quite a bit of “shadow inventory” out there, as well. That is, homes where the owner is extremely delinquent in his mortgage payments and unlikely ever to make up the difference, but that the bank has not yet foreclosed on or foreclosed houses that have not yet been listed for sale.
Take a good hard look at the second graph (also from this source) and tell me what you think is going to happen to housing prices over the next few months. A normal market has about six months of supply available. During the bubble, the months of supply generally ran closer to four months, and prices were soaring. It was not until inventories climbed above the six month mark that prices started to fall.
The really collapsed as the months of supply moved into the double digits. The extensive government support for the housing market — including the tax credit, but also the Fed buying up $1.25 Trillion in mortgage paper to artificially depress mortgage rates — helped boost sales and bring the months of supply back down. Now that support is over, and the months of supply far exceed the worst we saw during the heart of the bust (Note: the graph is not updated to include the September data).
Calculated Risk created another interesting chart showing the relationship between months of supply and the monthly price change in the Case-Shiller. He inverted the price change data so the correlation is more obvious.
As you can see, when months of inventory goes up, prices go down. The only way prices hold up is if sales rates remain very low. If banks continue to hold out for top dollar, the inventory will never clear out.
The tax credit was not a very effective means of stimulus, but it did help prop up prices, and that is a pretty important accomplishment, even if it proves to be ephemeral.
Was it really? Why was it so important to temporarily prop up prices? Let's recap what was really accomplished:
- create false hope among debtors,
- prevent prices from bottoming,
- delay the recovery of prices and the economy,
- keep homebuilding in the doldrums,
- keep a few zombie banks in business,
- keep prices artificially high to price out would-be buyers,
- and add billions to the bill for taxpayers.
What about that list is positive?
The credit cost the government about $30 billion. A large part of that money went to people who would have bought anyway, but perhaps would have done so in July or August rather than May or June. To the extent it rewarded people for doing what they would have done anyway, it did nothing to stimulate the economy.
Also, turnover of existing houses really does not do a lot to improve the economy. It is the building of new houses that generates economic activity. And it is not just about the profits of D.R. Horton. A used house being sold does not generate more sales of lumber by International Paper or any of the building products produced by Berkshire Hathaway or Masco. It does not put carpenters and roofers to work. New homes do.
While housing prices are important to the economy, the level of turnover in used houses is not. Home equity is, or at least was, the most important store of wealth for the vast majority of families. Houses are generally a very leveraged asset, much more so than stocks. Using your full margin in the stock market still means you are putting 50% down. In housing, putting 20% down is considered conservative, and during the bubble was considered hopelessly old fashioned.
As a result, as housing prices declined, wealth declined by a lot more. For the most part, we are not talking vast fortunes here, but rather the sort of wealth that was going to finance kids' college educations and a comfortable retirement. With that wealth gone, people have to put away more of their income to rebuild their savings if they still want to be able to send the kids to college or to retire.
The decline in housing wealth is a very big reason why retail sales have been so weak. With everyone trying to save, aggregate demand from the private sector is way down. If customers are not going to spend and buy products, employers have no reason to invest to expand capacity. They have no reason to hire more workers.
The cycle of deflation is difficult to stop once it gets started. Bernanke is right to be concerned. However, he is foolishly optimistic in his belief that he can do something about it. He can print a lot of money — which he is doing right now — but he will have to print a lot more to get consumers to change their behavior.
Underwater Mortgages Lead to Foreclosures
Also, as housing prices fell, millions of homeowners found themselves owing more on their houses than the houses were worth. That greatly increases the risk of foreclosure. If the house is worth more than the mortgage, the rate of foreclosure should be zero. Regardless of how bad your cash flow situation is — due to job loss, divorce or health problems for example — you would always be better off selling the house and getting something, even if it is less than you paid for the house, then letting the bank take it and get nothing.
By propping up the price of houses, the tax credit did help slow the increase in the rate of foreclosures.
No it didn't. The rate of foreclosure is completely artificial as the banks are doing the amend-extend-pretend dance. Right now, it takes 492 days to process a foreclosure.
Still, 23% of all houses with mortgages are worth less than the value of the mortgage today. Another five percent or so are worth less than five percent more than the value of the mortgage. If prices start to fall again, those folks well be pushed underwater as well.
On the other hand, it is not obvious that propping up the prices of an asset class is really something that the government should be doing. After all, it is hurting those who don’t have homes and would like to buy one.
It pisses me off every day to see my government working against my best interest with my tax dollars, particularly in a blatant giveaway to greedy and stupid bankers and greedy and stupid loan owners.
Support for housing goes far beyond just the tax credit. The biggest single support is the deductibility of mortgage interest from taxes. Since homeowners are generally wealthier and have higher incomes than those that rent, this is a case of the lower middle class subsidizing the upper middle class. Also, even if they are homeowners, people with lower incomes are more likely to take the standard deduction rather than itemize their taxes. The mortgage interest deduction only applies if you itemize.
It is also worth keeping in mind in the current debate over extending the Bush tax cuts for just 97% of the population as Obama has proposed, or for 100% of the population as the GOP insists on, that the $250,000 per couple threshold is for adjusted gross income, not the top-line income. Thus, a couple with income of $274,000 (in wages) but who pay $2000 a month in mortgage interest, would not see an increase in their taxes at all.
Housing Prices to Find a Lower Floor
The real problem though is that, now that the tax credit is over, prices will find their more natural level. Fortunately, relative to the level of incomes and to the level of rents, housing prices are now in line with their long-term historical averages, not way above them as they were last year.
In other words, houses are fairly priced — not exactly cheap by historical standards, but not way overvalued, either. That will probably limit how much price fall over the next six months to a year to the 5 to 10% range, rather than the 30% decline we saw from the top of the bubble. That, however, is more than enough of a decline to do some serious damage.
This authors assessment is a good one. I concur with what he wrote above.
The Case-Schiller report was weaker than the consensus expected. The second leg down in housing prices is underway, but fortunately will probably be a much shorter leg than the first one.
Still, that is bad news for the economy. Used homes make very good substitutes for new homes, and with a massive glut of used homes on the market, there is little or no reason to build any new ones.
Residential investment is normally the main locomotive that pulls the economy out of recessions. It is derailed this time around, and there seems to be little the government can do to get it back on track.
There is nothing the government can do to increase residential investment, and they shouldn't try. If they simply let the market work without continuing manipulation, the problem will fix itself, and the economy will improve.
Unfortunately for California, what our economy needs is a huge home price rally and lenders stupid enough to give out HELOCs like drugs at a rave. The California Economy Is Dependent Upon Ponzi Borrowers like the one I am featuring today. How will we make up for the loss of hundreds of thousands of dollars in consumer spending per household?
High end Ponzi borrowing
HELOC abuse is not restricted to social class or income level. It is a common misconception that only the poor and subprime borrowers don't know how to manage their money. High wage earners are equally likely to go Ponzi, particularly if they are trying to keep up with the other Ponzis in the neighborhood or in their social circles. Since high end homes are more expensive, the Ponzi borrowing was more extreme there. No matter how much people make, if they are offered free money, they will take all they are given — even if it costs them their house.
- Today's featured property was purchased on 4/29/1999 for $528,000. The owners used a $422,000 first mortgage, a $52,750 second mortgage, and a $53,250 down payment.
- On 5/15/2000, after about 1 year of ownership, these owners refinanced with a $540,000 first mortgage, withdrew their $53,250 down payment, and got an extra $12,000 in spending money.
- On 3/2/2001 they got a private-party loan for $35,000.
- On 3/18/2003 they refinanced with a $650,000 first mortgage and obtained a $32,000 HELOC.
- On 8/31/2003 they refinanced with a $738,750 first mortgage.
- On 3/19/2004 they obtained a $150,000 HELOC.
- On 5/31/2005 they refinanced with a $847,000 Option ARM with a 1% teaser rate.
- On 5/31/2005 they obtained a $121,000 HELOC.
- On 10/25/2006 they got their final HELOC for $250,000.
- Total property debt is $1,097,000 plus negative amortization assuming they maxed out the HELOC.
- Total mortgage equity withdrawal is $622,250.
They spent the house, and now they are likely to be a short sale.
Irvine Home Address … 8 INDIGO Irvine, CA 92618
Resale Home Price … $1,049,000
Home Purchase Price … $528,000
Home Purchase Date …. 4/29/1999
Net Gain (Loss) ………. $458,060
Percent Change ………. 86.8%
Annual Appreciation … 5.9%
Cost of Ownership
$1,049,000 ………. Asking Price
$209,800 ………. 20% Down Conventional
4.55% …………… Mortgage Interest Rate
$839,200 ………. 30-Year Mortgage
$206,216 ………. Income Requirement
$4,277 ………. Monthly Mortgage Payment
$909 ………. Property Tax
$250 ………. Special Taxes and Levies (Mello Roos)
$175 ………. Homeowners Insurance
$139 ………. Homeowners Association Fees
$5,750 ………. Monthly Cash Outlays
-$1023 ………. Tax Savings (% of Interest and Property Tax)
-$1095 ………. Equity Hidden in Payment
$355 ………. Lost Income to Down Payment (net of taxes)
$131 ………. Maintenance and Replacement Reserves
$4,119 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$10,490 ………. Furnishing and Move In @1%
$10,490 ………. Closing Costs @1%
$8,392 ………… Interest Points @1% of Loan
$209,800 ………. Down Payment
$239,172 ………. Total Cash Costs
$63,100 ………… Emergency Cash Reserves
$302,272 ………. Total Savings Needed
Baths: 3 baths
Home size: 3,600 sq ft
($291 / sq ft)
Lot Size: 6,175 sq ft
Year Built: 1999
Days on Market: 104
Listing Updated: 40490
MLS Number: S629131
Property Type: Single Family, Residential
Community: Oak Creek
According to the listing agent, this listing may be a pre-foreclosure or short sale.
Gorgeous open concept luxury home nestled on quiet cul de sac in highly sought-after gated community. Huge kitchen opens to family room. Spacious master suite. Upstairs bonus/loft area. WOW!