There has been an odd shift when it comes to US sentiment toward home ownership: while in the past, the higher home prices rose the greater the demand was for housing (leading ultimately to the housing debt bubble of 2006), this time around we are getting increasingly more frequent indications of just the opposite.
Some have started to notice: as we noted one week ago, in its traditionally cheerful assessment of the US housing market, the NAR’s Larry Yun snuck in an unexpected warning:
“Home prices ascending near or above double-digit appreciation aren’t healthy – especially considering the fact that household income and wages are barely rising.”
He did it again just a few days later:
“The overall demand for buying is still solid entering the busy spring season, but home prices and rents outpacing wages and anxiety about the health of the economy are holding back a segment of would-be buyers.”
This is about as close to a warning that the US housing market is back into bubble territory as one can hope to get from the NAR. To be sure, we noted this surprising development one week ago in “For The Average American, Owning A Home Is Increasingly Unaffordable.”
Recently MarketWatch came to the same conclusion noting that “there’s a paradox in Monday’s existing-home-sales data. Sales slid 7.1% to the lowest pace since November, the National Association of Realtors said. NAR has warned for many months that low levels of supply, which are pushing prices ever higher, will eventually cripple the market.”
February’s decline may be a sign that the Realtors’ fears are coming true, although it may still turn out to be a temporary blip caused by weather, new closing regulations, and the difficulties of adjusting data to account for all those anomalies. Still, as NAR Chief Economist Lawrence Yun said in a statement, “the main issue continues to be a supply and affordability problem. Finding the right property at an affordable price is burdening many potential buyers.”
That may sound obvious: if you can’t afford the few limited options available on the market, you’d probably give up too. It also tracks with a survey NAR published last week, which found that the share of current renters who say now is a good time to buy fell in the most recent quarter.
But it’s worth remembering, as Yun pointed out in a press conference Monday morning, that it wasn’t too long ago that higher prices drew more buyers in, rather than shutting them out.
It goes on to observe that this phenomenon was documented by Robert Shiller. In a 2007 paper, Shiller described the bubble mentality as “a feedback mechanism operating through public observations of price increases and public expectations of future price increases. The feedback can also be described as a social epidemic, where certain public conceptions and ideas lead to emotional speculative interest in the markets and, therefore, to prices increase.” A few paragraphs later, Shiller wrote, “That the recent speculative boom has generated high expectations for future home price increases is indisputable.”
In other words, a buying scramble driven by manic euphoria to jump on the latest rising-price bandwagon.
But that is no longer the case: “In the February Fannie Mae Home Purchase Sentiment Index, survey respondents said they expect home prices to rise 1.7%. One year ago, respondents forecast prices would rise 2.5%. In the 12 months to February, the actual price gain was 4.4%, NAR said Monday, but in recent months the yearly increase has been as high as 8.2%.”
Additionally, homeowners have become less confident about the value of the equity they have in their homes. That means they’re no longer cashing out to finance other spending, as they did in the bubble years. It also means they may not understand how much their homes could command on the market, making them less likely to list and worsening the supply problem.
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But ultimately it all come down to what is the fair value of housing. And according to a Bank of America research report, the recent trends in which ordinary Americans are left behind from the “American Dream” will persist for one simple reason: “home prices are currently overvalued by 14% on the national level.”
This is what BofA’s chief economist Michelle Meyer says:
In order to gauge the ‘fair value” of home prices, we typically compare prices to the trend in income. The logic is simple – the more income one earns, the more housing he/she can access. However, prices will occasionally diverge from income, as we are experiencing now and clearly did during the early 2000s. As we have been arguing, home prices are currently overvalued – by our estimates 14% on a national level.
It is useful to explore the reasons for overvaluation to understand the likelihood of a correction. During the early 2000s, the strong appreciation in home prices reflected the combination of greater availability of credit and unanchored expectations for future home prices. Today, the gain seems to be more a function of the price of credit – in other words, the level of rates. It is not an environment of high leverage in the mortgage market.
According to IMF research, this is an important distinction. In recent research under the Global Housing Watch umbrella, IMF economists argue that a distinguishing feature of real estate busts is the “coincidence between the housing boom and the rapid increase in leverage and exposure of households and financial intermediaries.” During this past crisis, of the 23 countries with “twin booms” in real estate and credit, they found that 21 of those countries had a severe downturn in housing and the economy. The 7 countries that just had a housing boom without excess leverage, only 2 went through a systemic crisis.
The US is not alone in returning to a housing market where prices appear overvalued. The IMF identifies a number of other major economies with prices in excess of income (Chart 5). The worst offender is New Zealand followed by Germany. Indeed, over the past year, 33 out of the 51 countries in their global housing price index showed an increase in home prices. The IMF’s aggregate for global home prices shows that prices are up 1.7% yoy as of 3Q15, assuming equal weights for countries (Chart 6).
Bottom line: lessons have been learned regarding household leverage. However, there has still been an impressive recovery in home prices in many countries.
There is another, simpler explanation: perhaps it is not concerns about future home appreciation, perhaps American incomes are simply not growing anywhere as fast to give them comfort that there will be other greater fools to whom the newly purchased house can be flipped. Couple with the ongoing lack of easy credit for most Americans to fill the purchase price gap, and it becomes very clear why the US housing market continues to be driven higher mostly by all-cash foreign buyers spluring on ultraluxury properties in hopes of parking cash indefinitely now that the Swiss banking model is defunct.
The good news, if only for the Fed, rent inflation will continue to soar in the coming months and years as the best households can hope for is to pay month to month for a roof above their heads, which is troubling because as we noted back in January, “Rental Rates Have Reached Apocalyptic Levels.” With the Fed’s ongoing easy money policies, rents will only keep rising and soaking up even more of US disposable income. And then the Fed’s economists will wonder why spending on non-core items continues to decling with every passing year.