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7-27-18: What is primary factor that could slow the housing market and cause a drop in prices?

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Question of the week:  What do you see as primary factor that could slow the housing market and cause a drop in prices?

 

Answer:  In addressing this question I will be using the Southern California market as the “housing market” since that is where the majority of the Weekly Rate & Market Update live.

 

The most basic principle of economics is that of supply and demand determine price. If supply is greater than demand prices drop, if demand is greater than supply prices rise.

 

The past several years we have seen demand greater than supply and as a result prices have risen. During this period the number of sales has also increased. With prices and transactions increasing we have seen increasing inventory hitting the market but demand increasing faster than the inventory available for sale.

 

The most recent data show home prices continuing to grow, but the number of transactions decreasing. Demand still is higher than supply, but supply is shrinking. Will this lead to even higher prices, or is it an indicator that the market will slow and the total number of sales and prices will decline? This is the multi-billion dollar question, literally.

 

Over the past several weeks I have been in several discussions with professionals in the real estate, mortgage, accounting, commercial lending and financial services industries with the primary topic being, what is the threat to housing markets, what will cause the market to slow and put downward pressure on rates.

 

Demand will remain high for some time, which puts a nice floor under the market to absorb supply. Supply will remain tight for some time absent some major economic event, such as very high unemployment. With these factors prices should be strong. So where is the threat.

 

There is a difference between demand for a product and ability to purchase a product. Instead of demand we will say “desire.” There will remain a high desire to purchase homes by families, this becomes demand when their ability matches their desire.

 

There are two ways to purchase a home, with a loan or without a loan. Those able to purchase homes in Southern California without a loan are not overly prevalent, much more so in the very high end of the market, but those transactions have limited, if any, impact on the overall market. Therefore, the real estate market for the overwhelming majority of buyers and sellers is dependent on home buyers being able to obtain a mortgage for their purchase.

 

Qualifying for a mortgage has three main components, known as the three C’s: Credit, Capacity, and Cash. Credit is how much you owe, what your payments are and your history of making those payments. Capacity is your ability to repay the mortgage, i.e. income. Cash is how much money you have for down payment which determines the loan amount.

 

Every borrower is limited by one of these factors when determining the maximum sales price and mortgage for which they qualify.

 

While there are those who desire to purchase a home who have less than good credit, there are not enough of them to impact the housing market.

 

With increasing prices, which means higher loan amounts, and higher rates it takes more income today to qualify for the median priced home than it did last year, or the year before, or the year before, or… However, we have found that most of our clients have incomes sufficient to qualify for the home price they feel comfortable purchasing. While necessary income to qualify is a damper on the housing market due to prices and rates increasing, we have not seen it as a strong barrier for most families entering the market.

 

This brings us to cash. It is my feeling, and supported by many in my conversations, that cash for down payment is becoming the primary barrier to home ownership for many families. Further, part of this barrier is self-imposed.  What does that mean?

 

There has always been, and likely will always be, a very negative sentiment about mortgage insurance. For those not aware of mortgage insurance, it is a cost added to mortgages that are greater than 80% loan to value. As a result of this sentiment most families feel they need to have 20% of the purchase price to purchase a home. While they are working to save the 20% prices are increasing on homes they could have purchased with mortgage insurance.

 

Two families, the Bakers and the Fryerrs, each make $100,000 a year in 2016.  The median priced home in LA County is about $500,000 so $100,000 is needed for 20% down payment. Both families worked hard to save and both had saved $50,000. The Bakers decide they want to continue to save until they get to the 20% down number and figure by really cutting their expenses they could do this by June 2018.

 

The Fryers decides to purchase a home, and because they have only 10% down pay mortgage insurance. They purchase the median priced home for $500,000, get a $450,000 mortgage with an interest rate of 3.375% and pay $1990 for the mortgage $110 per month in mortgage insurance for a total of $2100.

 

Even with rising income and rising prices the Bakers meet their savings objective of 20% down payment and purchase the median priced home in June 2018. They pay $585,000 for the home put $117,000 down and get a $468,000 mortgage at 4.5% with a payment $2370 per month for their mortgage.

 

Due to the rising prices and their declining mortgage balance and that they have made twenty-four consecutive mortgage payments on time the Fryers are eligible to remove their mortgage insurance payment and lower their monthly payment by $110 per month to $1990.

 

By not waiting until they saved 20% for the down payment the Fryers have almost tripled their initial down payment in equity and have a house payment that is almost $400 per month lower than the Bakers and paying about $1000 less per year in property taxes.

 

So, what is the issue with mortgage insurance?

 

It takes a lot of money to purchase a home in California, especially in most Southern California areas. Even 10% down can be a very large percentage of your total gross income, 20% down may exceed your gross income. Because of this cash is the biggest barrier to homeownership in the region. However, those willing to pay some form of mortgage insurance can get in with as low as 3.5% down for FHA mortgages, or depending on the price 5% or 10% down for non-FHA mortgages (if you are a Vet you can purchase with zero down).

 

Those who have been waiting for to save higher down payments have lost tens, hundreds of thousands of dollars in equity while chasing higher prices.

 

While I see cash to close as the biggest barrier to home ownership, I know there are options to lower that barrier. As well, I do not see the housing market undergoing an extreme correction due to this barrier, but it could slow down the number of sales and cause home prices to slow or decline slightly in the medium to long term.

 

Do you, a family or friend have savings in your bank, investment or retirement accounts and want to purchase a home but feel you do not have enough money saved to do so? Call me to go through your options for purchasing your new home.

 

 

Have a question? Ask me!

 

It’s summer, it’s hot and so was the economy in the second quarter. Today the Gross Domestic Product for April through June was released and while it was lower than expectations it still showed 4.1% growth, almost double the 1st quarter growth. Leading the way was the consumer as spending jumped 4% in the quarter, mostly on services. Shrinking inventories kept the growth under 5%, however the low inventories are a positive for 3rd quarter growth as those inventories will need to be replaced causing economic activity. This is the first quarter with over 4% growth in the third quarter of 2014. In the report this morning was a 3% growth in the price index, which was above expectations. The report is negative for mortgage rates due to the combined strong economic growth and increase in prices. While the mortgage markets have built in rate hikes of 0.25% by the Federal Reserve in September and December, more reports showing economic growth and prices similar to today’s reports will push mortgage rates even higher.

 

Rates for Friday July 27, 2018:  While mortgage markets had no impact to today’s GDP numbers since they had been anticipated, the same cannot be said for Japanese credit markets. Earlier in the week speculation was out that the Japanese central bank was going to alter its policy and push up interest rates in Japan. If true this would impact U.S. credit markets and to get ahead of the actual news investors sold off American long term debt, like mortgages. The sell-off resulted in rates jumping on the speculation. The Japanese central bank meets on Monday and Tuesday and investors have held their position on long term debt to see what, if any, policy changes will be made. Should the speculation be true most of the impact has already been priced into our markets, if the announcement is no change we could see rates dip back down next week. For this Friday rates are up for the week, more so on the high-balance products than the conforming products, rates are at five week highs.

 

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            4.50%                         Up 0.125%

30 year high-balance conforming                      4.75%               Up 0.25%

 

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

 

On Sunday we visited the King Tut exhibit at the California Science Center. I highly recommend the exhibit, especially if you are a bit of a history geek like I am (okay, I’m more than a bit). We went early and it was not very crowded, though it did become more so towards the end as Leslie and I read everything, much to the chagrin of the 18 year old, and those mostly walking through caught up to us. The detail and workmanship on many of the pieces from 3,000 years ago is fantastic. Another bonus is the air conditioning!

 

Making the day even better was a short drive to Phillipes, the Original in its 110th year for some French dipped beef sandwiches—they invented it you have to have it!

 

Have a great week,

 

Dennis

2-23-18: Do you think we are in a real estate price bubble that is coming to an end soon?

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Question of the week: Do you think we are in a real estate price bubble that is coming to an end soon?

 

Answer: This question, or some variation, has been asked by several different people in several different settings in the past few weeks. From clients, to real estate professionals, to friends, to attorneys and accounts asking in my office, on the phone, at dinner and in networking meetings, everyone wants to know, will housing markets drop precipitously in the near future?

 

My short answer: No. No, I do  not think we are in a real estate price bubble that is ending soon.

 

My long answer: why I feel this way.

 

One underlying facet to the question is everyone’s experience from the 2007-8 market crash, and the expectation that it will be duplicated because we have experienced a very large increase in real estate prices in the past 5-6 years, similar to the home price increases in the early 2000’s.

 

Comparing our current market to the market at the beginning of the century is not comparing similar actions and motivations of the buyers in the markets.

 

The pre-recession housing bubble was created by several factors. First, was the ease of financing. Following the lead of hard money, then soft money, lenders, Fannie and Freddie were purchasing mortgages from lenders that required no verification of income or assets and in many instances required no appraisal. Further, they were buying loans that were secured by homes with no equity—borrowers were also obtaining second mortgages, usually HELOCs, that took their total loan to value to 100% of the property value.  This easy money enabled many people to purchase homes, or refinance current homes and pull out equity, well above the prices and mortgages they would normally be able to qualify for, which often resulted in borrowers choosing adjustable rate mortgages for lower payments.

 

Second, were the motivations for much of the purchasing activity. Prices go up based on purchases not on refinances, the closed sales become comparable sales used for the next sales in a neighborhood. As prices rose many people felt that had to buy right away or miss out, not just on buying a piece of property but also on the money that could be made as the market went up. The shift in purpose that we saw was people buying investments they would live in instead of buying homes. They were motivated by trying to capitalize on a market, which resulting in highly leveraged and risky purchases, with the intention of selling or somehow cashing out—which was done with refinancing, pulling out equity and using this equity for consumption of goods and services.

 

Third, once the market softened homeowners who were highly leveraged, in mortgages they could not afford once they adjusted, and had little to no money in their home from their savings, found it easier to walk away or sell at a loss than homeowners who purchased in conventional markets.

 

Today, there is a healthy foundation to the housing market. Changes in underwriting policies have ensured that borrowers have the income to debt ratios and credit history to afford their mortgages. When purchasing they have down payment into the property, i.e. “skin in the game.” One more solid piece of this foundation, the overwhelming majority of homeowners who have mortgages that are long term low fixed rates.

In one market you had speculative purchasing, made with little to no down payments, financed with non-qualifying mortgages, many of which were non-fixed rate products. In the other market you have buyers purchasing homes for the long term, purchasing with down payments and financed with long term fixed rate mortgages with low interest rates.

 

If/when there is a turn in the housing market and we see prices flatten, or even dip, there will not be the resulting sharp drop in prices across regions because of the solid foundation that has been built with qualified, well-motivated homeowners. Bubbles pop and created market downfalls not because of a slight correction, but because that correction snowballs as owners panic and sell their product, thereby creating significant over-supply and exponential price declines. With families owning homes they can afford to retain and having purchased with their hard earned savings, a dip in the market will not create a panic-selling environment for any significant portion of the market to create a crash.

 

The most significant threats I see to housing in California, particularly along the coastal markets (which I define as any county that touches the Pacific) are cash for purchasing homes and interest rates. Both of these factors can limit buyers ability to qualify as home prices climb.

 

At some point prices will flatten, and possibly decline, I do not see this happening in the near future, but when this occurs it will not be long lived nor a deep decline in housing prices across several markets in the region, state or nation.

 

Have a question? Ask me!

 

Overreaction? On Wednesday the minutes were released from the January Federal Open Market Committee (FOMC), the group at the Federal Reserve that determines the federal funds rate. Almost immediately after the minutes were released, well immediately after investors had time to read them and then take action in the market, rates jumped as investors sold off bonds and mortgages. Why? Because the Fed has adjusted its economic outlook since its December meeting, forecasting stronger economic growth than previously thought and achieving the 2% inflation target sooner than previously thought. The minutes also showed that the FOMC members still feel that the economic outlook supports further “gradual increases” in the federal funds rate. Many investors trying to read the tea-leaves felt the Fed maintaining its stance was instead a signal that it will raise rates more than previously estimated (three times this year). This created a sell-off that became more pronounced as the day progressed spiking rates.

 

Rates for Friday February 23, 2018: After Wednesday’s big sell off investors returned to market with cooler heads on Thursday and Friday as investors bought back into the bond markets and over the two days scratched back almost all the losses. We see a slight bump in high-balance rates, but conforming holds on for the second straight Friday with no change. As we have been saying for over a month, rates are volatile so lock when you can.

 

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            4.25%       Flat

30 year high-balance conforming                       4.50%      Up 0.125%

 

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

Busy weekend for the Smith household as we host about 20 fifteen and sixteen year old’s for our daughter’s Sweet Sixteen party. Hopefully the weather cooperates and is not too chilly since we are setting up for an outdoor formal event. It is fun watching our little ones become young adults and see their friends grow and mature right alongside them. Sunday will be having family over for another celebration, and then perhaps a nap!

 

Have a great week,

 

Dennis