Front Running the Fed
John Burns
Working with a great team to solve today to help you navigate to a better tomorrow.
We are very bullish on housing, and already thinking through the impact that 3.5% mortgage rates can have if prices rise substantially due to the interest rate stimulus. The Fed has put 34% more purchasing power into the pockets of homeowners, and investors are taking advantage.
Predicting the Future
We think home prices are poised to rise significantly, and we aren’t the only ones. Investors of all sorts are piling into the housing industry. Here is some of the evidence:
- Stocks. Home building industry stock prices have risen to late 2003 levels (see below) while new home sales are still near historic lows and less than half of normal levels.
- Land. Our finished lot value index is showing near peak pricing in Phoenix, Dallas, and Orlando.
- Speculators. Investors and speculators are different. Investors buy homes at a great value and rent them out cash flow positive. Speculators buy homes with the intent of flipping out at a significant profit. Speculators are now emerging. While bank loans do not seem to be playing a role in the speculator boom, we won’t be surprised to see high LTV loans reemerge later this year, probably by non-banks. In the last cycle, the banks eventually bought the non-banks or purchased their securities.
Fed Stimulus
The Fed is buying $45 billion per month in mortgage-backed securities in a clear attempt to raise home prices. They are succeeding. We are already having conversations with numerous clients about the bubble that can easily be created if home prices appreciate rapidly.
The Power of Mortgage Rates
A family who can afford a mortgage payment of $1,000 per month could have gotten a $165,000 mortgage in November 2008, when mortgage rates were 6.05% and the Fed stimulus known as QE1 began. That same family’s $1,000 per month payment now qualifies them for a $222,000 mortgage. They can afford a 34% more expensive home!
Price/Income versus Payment/Income
A simple comparison of current price/income and payment/income ratios shows that:
- 133 of 134 markets are underpriced from a payment/income status.
- 69 of 134 (only half) are underpriced from a price/income status.
The five most undervalued housing metro areas are:
- Vallejo-Fairfield, CA
- Yuba-Sutter, CA
- Detroit, MI
- Las Vegas, NV
- Stockton, CA
The five least undervalued housing metro areas are:
- Honolulu, HI
- Boulder, CO
- Louisville, KY
- Portland, OR
- Orange County, CA
While 3 of the 5 most undervalued markets are dealing with significant municipal distress, and 4 of the 5 least undervalued markets have become permanently more expensive due to supply constraints, the point is that low mortgage rates have created a tremendous distortion in the market that could easily result in tremendous price appreciation and overpriced homes someday in the future—if/when mortgage rates return to normal. The 124 markets not shown in the list above are the ones where housing is most susceptible to bubble pricing.
The Future
Who knows what future mortgage rates will be? Here is some perspective. The median 30-year, fixed rate conforming mortgage rate over the last:
- 42 years is 8.15%
- 30 years is 7.45%
- 20 years is 6.52%
- 10 years is 5.72%
With rates currently at 3.53%, prices can go up 28% nationally just to equal normal affordability over the last 10 years. If that happens, that will create price/income ratios that are 27% above their historical norms. What happens if mortgage rates then go up?
Unprecedented Recovery
Investors of all types are assuming that the Fed’s unprecedented intervention in the mortgage market will keep mortgage rates low for a very long time, resulting in tremendous price appreciation. This is going to be an interesting housing recovery!
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Independent Real Estate Market Analyst | Mostly-Retired Real Estate Agent
11y"the point is that low mortgage rates have created a tremendous distortion in the market that could easily result in tremendous price appreciation and overpriced homes someday in the future" Huh? Yeah, "created a tremendous distortion" but rising rates will make it harder for real home prices to increase in the longer term. We'll see a rush in sales and prices, however, when rates first start to increase due to the rational expectation of further increases.
Registered Representative with Nylife Securities LLC., helping families and business owners develop a sound financial strategy
11yAssuming normal economic conditions return (after 5 years, a big if, I know) In the mid term, we'll look back at this period as the coiled spring in housing that got wrenched even further by a Fed desperate to restore consumer confidence. The inevitable inflation from all the money printing will make those piling their money into treasuries and other fixed income instruments regret their decision to avoid risk assets that are more likely to float upwards with inflation. I'm looking forward to my jumbo mortgage in the northeast costing less in real dollars while that 30 year fixed mortgage keeps my interest payments even lower. Those who saw a similar effect from 1977-1982 will get to see a repeat. The wild card is the oil and gas creation boom that is pushing us towards energy independence by 2020, and allowing us to pay much less than our global competitors, which should help rebuild our manufacturing base, assuming we can either educate our kids properly or liberalize our immigration policies to fill those highly skilled positions properly. Should be interesting either way assuming DC doesn't intentionally grind things to a halt with poor or nonexistent fiscal policy.
Owner, Radii Construction And Development
11yAnalysts and industry insiders are always extrapolating linearly (past performance does not guarantee future performance), hence they are always looking at the rear view mirror. To look into the future for housing, simply look at the job market. No one will encumber themselves with a 30 years loan if they are not confident upon their job situation even if they are employed now. We forget that we cannot force someone to go out and get a loan if they don't want it (no matter how low the interest rate is). Bernanke is trying to do this as he had said in his interviews and testimonies before congress, but he is tingling with a theory that has no proof or may I say "just guess". In 2006, he said there was no bubble in the housing market, what happened? The Fed chief and his cronies don't know anything except that they are mostly academics who presumed they all knowing. 80+ years of credit expansion cannot continue forever, this is similar to Madoff ponsi scheme where debts are passed on to your grand children and so on as long as the older generations are willing and able to do so. Look at Southern Europe, we will be heading there soon, if this stupidity don't stop. The youth unemployment in Spain is over 30%, Italy 27% and last but not least Greece over 50%. Wake up people!!!! The party is over, deflation is the name of the game. Do not buy anything for the long term (real estate, stocks, even gold). For more proof, look to the 1929 to 1937 period for a guide. Good luck.