Has an Unavoidable Decline in Home Prices Begun?

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1 Has an Unavoidable Decline in Home Prices Begun? October 6, 2014 by Keith Jurow In late September, the former head of Goldman Sachs housing research team sent a lengthy report to President Obama. In it, he predicted that home prices would fall by at least 15% in the next three years. He warned that this could push the country back into a recession. With this blunt warning in mind, let s look at the state of housing markets around the country. Revisiting the trade-up housing market At the center of the housing collapse was the disappearance of the trade-up market. As home prices rose for 50 years until 2006, the first-time buyer was the foundation of the housing market boom. These younger buyers purchased homes that were smaller and less expensive than most houses. The homeowners then traded up to larger, nicer homes, enabling other trade-up buyers to do the same. Trading up was possible because the seller almost always posted a profit on the sale of the house and could plow that into a more expensive home. That worked beautifully as long as prices were rising. When the bubble finally burst in late 2006, speculators dumped their properties on the market in one metropolitan area after another, and prices no longer rose. Listings soared and sales slowed down even in the hottest markets. Then prices began a precipitous decline. That posed a serious problem for the trade-up buyer. Many found they had little or no profit with which to buy another home. Worse yet, a growing number found themselves underwater. Because many had put little or nothing down, the value of their homes were less than the mortgages on the properties. Exacerbating the problem was that lenders finally tightened up their underwriting standards after the sub-prime market collapsed in spring They began to demand down payments of 20% or even more. With little or no profit garnered from selling, would-be buyers could not come up with such steep down payments. Nor could first-time buyers. Given these radical changes, the trading-up game came to a screeching halt. It has not returned and won t for a long time. The decline in home prices ended because a horde of all-cash buyers raced in over the last three years to replace trade-up buyers. Even more important, servicing banks around the nation made a concerted effort to substantially reduce foreclosures as well as the sale of repossessed properties. This graph shows how this occurred in California. Page 1, 2016 Advisor Perspectives, Inc. All rights reserved.

2 You can see how much distressed sales (in red) plunged from their peak in the summer of This totally artificial restriction of homes on the market leveled off prices. Here is another key chart showing the tremendous decline in repossessed homes sold on the market in Phoenix. Page 2, 2016 Advisor Perspectives, Inc. All rights reserved.

3 At the height of the price collapse in early 2009, two-thirds of all houses sold in Phoenix were repossessed homes (REOs). Then the servicing banks decided they had to reduce the sale of foreclosed properties to stem the decline of prices. They have been doing this for five years. What is the status of these seriously delinquent homes? The servicing banks have put some into formal default (an NOD ), but most just sit there, as the banks take no action. Many have been delinquent for three to four years with owners who have made few or no payments still living in the house. The departure of all-cash buyers As I stated earlier, all-cash buyers primarily investors replaced trade-up buyers. At their peak in early 2013, all-cash buyers comprised one-third or more of all homebuyers in numerous major metro areas. Take a very good look at this important table from Redfin, the online brokerage firm. It covers January through April of this year. Page 3, 2016 Advisor Perspectives, Inc. All rights reserved.

4 Metro areas such as Miami, Las Vegas, Chicago and Phoenix have become extremely dependent on all-cash homebuyers. This was most true for the least-expensive distressed properties as well as the high-end homes. Without these buyers, median home prices would not have risen the last two years. Over the last year, cash buyers have significantly pulled back from home purchases around the nation. This chart from PropertyRadar.com shows clearly what has occurred in California. Page 4, 2016 Advisor Perspectives, Inc. All rights reserved.

5 This decline in all-cash buying is critically important for understanding the weakening in housing markets that has occurred in On Sept. 22, Inside Mortgage Finance issued its monthly Housing Pulse release, which announced that investor share of the home-purchase market dropped to 15.5% in August. That was down from 19.5% as recently as April and well below the all-time high of 23.2% in March This is truly ominous. The decline in home sales For many months, I have been reporting on the dramatic weakening of home sales throughout the nation. It has continued in August. Take a look at this table showing the slowdown in cities and towns of Connecticut, where I live. Page 5, 2016 Advisor Perspectives, Inc. All rights reserved.

6 Housing Markets in Connecticut August 2014 Statistics TOWN Y-O-Y SALES Y-O-Y PRICE PSF HOMES FOR SALE Stamford down 13.5% up 5.1% up 24.8% Hamden down 22.4% up 2.8% up 36.8% Branford down 48% up 0.6% up 34.4% Orange down 15.8% up 0.6% up 51.4% Glastonbury down 4.4% up 5.9% up 25.8% Hartford County down 12.3% down 0.7% up 20.7% Shelton up 9.7% down 1.6% up 15.4% Stratford down 44.4% down 3.6% up 20.9% Bridgeport down 21.7% down 12% down 7.7% West Haven down 11.8% down 3.9% up 12.2% Source: raveis.com, graphics by A.J. Kaps Group Year-over-year sales declines, based on the number of homes sold, are occurring in the majority of Connecticut towns. For those of you who think that this might apply only to small New England states, take a look at this table from DataQuick for southern California sales. Page 6, 2016 Advisor Perspectives, Inc. All rights reserved.

7 Throughout southern California, sales volume based on the number of homes sold is down by nearly 20% from a year earlier. Does this portend further trouble ahead? Other key factors pointing toward price declines By itself, slowing home sales would not necessarily presage a decline in prices. However, other important factors must be considered. Weakening markets are often signaled by a large number of home sellers who are compelled to reduce their asking prices. Take a good look at this chart from Redfin. Page 7, 2016 Advisor Perspectives, Inc. All rights reserved.

8 There are 12 major metro areas in which the owners of more than 30% of all the homes for sale have had to reduce their asking prices. Among them is Phoenix, which was one of the hottest markets in the country a little more than a year ago. What about the number of homes for sale? Go back and take another look at the table with Connecticut statistics for August. You will see that listings of homes for sale have risen by double digits year-over-year in every town and city in the table except one. Listings are up by more than 20% yearover-year in Hartford County, where the capital of Connecticut is located. In three towns, the number of homes for sale has soared by more than 30%. Is this just a Connecticut phenomenon? Not at all. Take a good look at these Redfin figures for major metro areas around the country. Page 8, 2016 Advisor Perspectives, Inc. All rights reserved.

9 Major Metros Around the Nation August 2014 Statistics MAJOR METRO Listings for Sale Y-O-Y Change Home Sales Y-O-Y Change Chicago Up 25.8% Down 12.9% Atlanta Up 7.3% Up 2.6% Boston Up 25.7% Down 9.4% Riverside, CA Up 29% Down 16.1% Phoenix Up 23.8% Down 8.8% Orange County, CA Up 18.3% Down 10.6% Sacramento Up 15% Down 11.9% Washington, DC Up 24.4% Down 10.7% San Diego Up 11.2% Down 23.4% Los Angeles Up 11.3% Down 15.1% Source: redfin.com, graphics by A.J. Kaps Group These figures show a similar pattern listings are up substantially, and home sales have declined. Soaring listings and slowing sales are a deadly combination. Together, they indicate that prices will weaken in all of these metro areas as well as in Connecticut. Recommendations to investment advisors In late August, Barron s published an article in which Tad Rivelle, TCW s chief investment officer for fixed income and his co-director, Laird Landmann, were interviewed about their assessment of the fixed-income space. Landmann made it clear that he views non-agency mortgage-backed securities (RMBS) as undervalued. This was especially true in those metro areas in which the fundamentals are improving, he said. What are those improving fundamentals? He did not say. But he was quite confident that we will see some house price appreciation in those areas. Page 9, 2016 Advisor Perspectives, Inc. All rights reserved.

10 As an adviser whose clients depend on the soundness of your recommendations, are you prepared to follow money managers who give this kind of investment advice? Given my in-depth analysis of why housing markets are showing worrisome signs of tanking now, caution your clients to assume the worst and consider a prudent course of action. Here is my specific advice to you for your clients with real-estate investments: Disregard pundits who are confident of a continued housing recovery. Do not make the assumption that an underwater house will rebuild positive equity over the next few years. Clients thinking of moving should put their house on the market now at a price based on a professional appraisal. Clients with underwater investment properties should consider selling some or all of their investment real-estate holdings while markets are still liquid. Keith Jurow is a real estate analyst and former author of Minyanville s Housing Market Report. His new subscription report Capital Preservation Real Estate Report launched a little more than a year ago. Page 10, 2016 Advisor Perspectives, Inc. All rights reserved.