More than Just Curb Appeal Factors that affect the Housing Market

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1 Insight. Education. Analysis. M a r c h More than Just Curb Appeal Factors that affect the Housing Market By Kevin Chambers Not only is buying a house usually the largest purchase anyone will make, housing expenses are a large percentage of a homeowner s personal budget. Housing prices are regularly discussed on the news and used as an indicator for the health of the economy. For over 30 years, housing prices steadily increased, ballooning over 530% from 1975 to The 2008 crisis popped the housing bubble; from 2007 to 2012, we saw falling house prices. In the last couple years, housing prices as a whole have rebounded, climbing back to the pre-recession peak. Today, the housing market is still fighting to gain stability. There are many skeptical investors that still do not trust housing prices after To get a better picture of the housing market as a whole, here are some supply and demand factors that affect housing prices. Housing Market Data Points: Housing markets are an important contributor to the US economy. The housing market contributes to GDP in two ways, direct investment and related consumption. Direct investment includes construction of new properties, remodels, and production of manufactured homes. Related consumption includes all of the housing services that surround the housing market, but do not include construction. These services include things such as rent and mortgage payments, landscaping, and utility payments. Direct investment in housing represents 5% of GDP and related services average about 12% of GDP. Since the housing market contributes about 17% of the total US economy (National Association of Home Builders, 2014), watching the key indicators and indexes will help investors understand and project where the market is moving. New Housing Construction: The New Residential Construction Report, released monthly by the US Commerce Department, is commonly referred to as the Housing Starts Report. This report is watched closely by investors and analysts because housing starts are considered an indicator of both economic growth and a supply factor. Because construction is an industry that is affected by weather, the numbers are seasonally adjusted. 1 FRED, All Transactions House Price Index USA Terms to Understand: Since it usually takes about 6 months to complete the construction on a single family home and 12 months for a multifamily structure, Housing Starts is a data point that refers to the number of new residential homes that are started in a given month. Supply factor relates to the economic theory of supply and demand. It is a gauge of the amount producers, home builders in this instance, are willing to produce in the market at a given price. A leading indicator is a data point that tends to change before the economy as a whole follows. 408 SE 1 st Street, McMinnville, OR T: F:

2 During the crisis, housing starts fell to the lowest point in over 50 years. Recently housing starts have been trending upward, but they are nowhere near pre-recession highs. The large increase in building starts from 1991 to 2006 was led by single family homes. Multifamily housing starts did not see the dramatic increase, making them more insulated in the collapse. As the housing market has commenced its recovery, multifamily housing starts are now above pre-recession levels. This is headlined by a demographic shift from single family to multifamily living situations. Most projections predict that multifamily housing growth will outpace single family homes over the medium to long term, a shift that can have significant effects on the US economy as a whole (Rappaport, 2014). Multifamily homes makeup about 40% of the total housing starts, compared with about 20% in early Number of Sales: The second key indicator to watch is the sales volume of new and previously owned homes. Home sales are a marker of the current demand of houses and are considered an indicator of economic strength in the economy. The data is seasonally adjusted and reported at an annual rate. Home sales are affected by current interest rates. As a general rule, as mortgage rates rise, home sales will fall. Most investors look at the sales volume number in conjunction with the housing starts data. Housing sales volume is usually considered a leading indicator (Barnes, 2014). Although most leading indicators are fairly unreliable in the short term, in Page 2

3 longer terms you can see how they act. Housing sales peaked in the summer of 2005, a full two years or more before the recession started. New houses were hit harder in the recession, falling 80% from peak to trough. Existing home sales fared better, falling approximately 50%. Existing home sales are sold at significantly higher volume then new homes; however, new home sales are considered to be a better indicator of a growing economy. Prices: Pricing for existing homes is another key indicator for the health of the housing market. The most well-known and most widely used index for tracking housing prices is called the Case-Shiller Index. Developed in the 1980s by three economists (Allen Weiss, Karl Case, and Robert Shiller), the index is now administered by the S&P. The headlines usually report the composite of 20 city-specific indexes 2. The Case-Shiller only tracks single family, detached housing units. The index tracks changes in the prices of houses over time using a method called repeat-sales. Essentially, it compares sales prices of the same property over time, as it passes from owner to owner. New houses are excluded (Fontinelle, 2014). The index lags by 2 or 3 months, so although it is a good tool for observing prices over time, the index doesn t give the most up-to-date data. Housing prices are considered to be a less volatile then the last two indicators, and tends to move slower. Housing prices peaked in early 2006 and didn t hit the bottom until early Over those 6 years, housing prices fell about 34%. The housing market has slowly started to rebound since Prices are up 27% since the trough. Some markets (Denver and Dallas) were more insulated from the recession and prices are now above 2006 peaks; however, the majority of cities are still seeing lower prices versus 8 years ago. Mortgages: Another meaningful data point related to housing is mortgage rates and volume. Mortgage rates are tied closely to interest rates overall, therefore they have been decreasing since the late 70s early 80s. The current average interest rate on a 30-year fixed rate 2 Boston, Chicago, Denver, Las Vegas, LA, Miami, New York, San Diego, San Francisco, DC, Atlanta, Charlotte, Cleveland, Dallas, Detroit, Minneapolis, Phoenix, Portland (OR), Seattle, and Tampa Page 3

4 mortgages in the United States is about 3.7%. As investors flocked to US treasury bonds in 2014, the yields on treasury bonds fell. Accordingly, mortgage rates fell almost 18% over the course of Action from the Federal Reserve on interest rates will affect mortgage prices. Currently the market is predicting interest rate action from the Fed at their June or September meeting. If the Fed decides to increase the Federal Funds rate, this will increase mortgage rates nationally. Since the 1980s, there had been a large increase in the volume of mortgage debt in the United States. Presidents Carter and Regan signed laws that restructured the mortgage industry significantly to encourage inter-bank competition. The outcome was a large increase in mortgages. Then, with the repeal of the Glass- Steagall Act in 1999, banks were given more leeway to combine traditional banking practices (taking deposits and giving mortgages) with their investment operations. This created the large investment banks that dominate the banking landscape today. It also lead to predatory lending and the further increase in mortgages in the early 2000s as investment banks demanded more mortgages to turn into investment products. This was one of the main contributors to the 2008 crisis. Mortgages make up the majority of debt in the US. The total amount of mortgage debt peaked in 2007 at $10.6 trillion. Since the recession, that rate has been on a slight downward trend. Now the total mortgage debt in the US stands at about $9.4 trillion. As a percentage of total household debt, mortgages have remained steady at about 70%. However, with the increase in mortgage debt as a whole, the ratio of mortgage debt to income has increased, peaking in 2007 at just over 100%. That has fallen since the crisis to about 75%. Page 4

5 Mortgage Refinancing: A distinct aspect of mortgages to analyze is the rate of refinancing. This is a very volatile data point that is subject to booms and busts. Homeowners go through waves of refinancing that usually ends as soon as talk of increasing interest rates hits the news. Coinciding with the financial crisis and the crash in interest rates, refinancing rates went up to their highest levels in 20 years. Refinancing levels peaked at the end of 2010 with 85% of mortgage applications being for refinance. Through 2013 and 2014, the media threatened pending increases in interest rates. Now about 50% of all mortgage applications are for refinancing. Outlook: Going forward, most analysts anticipate modest growth in the housing market over the next few years. After the recession, the housing market was in the rebound phase, reacting to the dramatic fall in prices through 2007 and This rebound effect is likely to fade and a more stable, slower paced housing market is going to take over. Continued job and income growth are expected to help drive the market (Kolko, 2014). Housing starts have begun recovering at a faster rate. January 2015 saw orders for new homes increase by 32% from a year earlier (Hudson, 2015). Freddie Mac predicts that housing starts will increase by 20% in 2015, and home sales to increase by 5% (Nothaft, 2014). Zillow predicts that home prices will rise 1.9% in 2015 to an average house value in January 2016 of $181,000 (Zillow, 2015). Freddie Mac is a little more optimistic with gains of about 3% (Nothaft, 2014). It appears the housing market is settling into equilibrium, with a less volatile market (Carlyle, Page 5

6 2014). Most experts agree that mortgage rates are going to increase in While the Mortgage Bankers Association predicts a 5% rise in rates by the end of 2015 (Carlyle, 2014), Freddie Mac foresees a 4.5% increase in rates (Nothaft, 2014). The x-factor in the housing market is the entry of the Millennials into the market. People under 35 in the US have delayed home purchases more than any previous generation. Higher student loans, delaying of marriage and family building, and difficulty starting careers amid the recession have all been factors in their decision not to buy homes. As this generation matures and the economy recovers, their home buying is expected to increase. In the 1990s and 2000s, the mantra was that real estate always goes up. A homebuyer could always sell their house for more than they bought it for, making homes a great investment. Post 2008, the landscape is different. Although the housing market is currently trending up, it is growing at a far less rapid pace then before the recession. It will be interesting to watch the housing market in the coming years, and see how it reacts to the new road that has been laid before it. Works Cited: Barnes, R. (2014). Economic Indicators: Existing Home Sales. Investopedia. Carlyle, E. (2014, December 18). Housing Outlook 2015: 11 Predictions From The Experts. Forbes. Fontinelle, A. (2014). Understanding The Case-Shiller Housing Index. Investopedia. Hudson, K. (2015, February 17). Strength in January New-Home Sales Bodes Well for Spring. Wall Street Journal. Kolko, J. (2014, December 29). What to Expect From the Housing Market in Time. National Association of Home Builders. (2014). Housing's Contribution to GDP. National Association of Home Builders. Nothaft, F. (2014). 2015: The Purchase Market Strengthens. Freddie Mac. Rappaport, J. (2014). The Demographic Shift From Single-Family to Multifamily Housing. Kansas City Federal Reserve. Zillow. (2015). Zillow Home Value Index. Zillow. Page 6