Chris Tiller: June 2013

Thursday, June 20, 2013

The New Market Talking Point.....(hint) This one is actually true.

For some time we have been hearing some really goofy ideas about what is happening in the housing market, such as these old chestnuts:

Banks are holding onto their foreclosed REOs and only releasing them slowly (Shadow Inventory).
Institutional investors are dominating the market (REIT's, Mutual Funds).
First time home buyers are not participating in the market.

All of these are widely reported in the media but in Greater Phoenix they are certainly fabrications and can easily be proven untrue

But now we are hearing another idea that sounds goofy but may very well be true:.

Builders are deliberately slowing production to capitalize on rising prices.

The housing starts released this morning from the Commerce Department came in at an annualized rate of only 914,000 versus expectations of 950,000. Most of the increase of 6.8% was attributable to multi-family starts. Even 950,000 would be a low number by historic standards. If we have such a low supply of homes for sale, why are so few homes getting started? There are lots of reasons:

There is not enough skilled labor to build at a much higher rate
The supply chain is not geared up to deliver at a much higher rate
Some builders are short of land to build on
The price of desirable land is rising to unaffordable levels relative to today's home prices.
New land deals will only pencil out if you allow for a substantial rise in home prices
If you build a lot of additional homes the price of materials sky rockets and trims builders' gross margins
Builders are applying the brakes to production to sustain the low inventory and capitalize on rising prices

Some people would question the last point as merely silly; why would a developer prefer two birds in the bush to one in the hand? I think the idea deserves more than a second thought. Demand is really not a problem for builders in most of their subdivisions. Why sell out now for today's prices when you can sell much more slowly and keep raising prices by 1% to 2% each month. Gross margins are going to be much better in the latter case. What would you do if you were the CEO of a large developer?

This strategy would not work if we had a lot of builders competing for business. But remember it is very much a seller's market and developers like it that way. Why would they want to see the market return to balance?

Some people have said this undermines the robustness of the recovery. On the contrary, it will tend to make prices rise faster.

Most people have not got their head around the fact that there is a chronic lack of supply. They keep thinking it must be artificial in some way. No it is real, and unless the developers start to ramp up faster the shortage is likely to last a very long time. The prospect of exceeding the pricing highs of 2006 start to become credible in this scenario. Not in the immediate future, but much sooner than we thought two years ago.

Chris Tiller MBA

Russ Lyon Sotheby's International Realty

17207 N. Perimeter Dr. Suite 120

Scottsdale, AZ 85255
Office: 480.502.3500

Cell: 602.561.1346
Fax: 480.624.3795
chris.tiller@russlyon.com

http://tillersreupdate.blogspot.com/

Thursday, June 13, 2013

Do Rising Interest Rates Cause Home Prices to Decline?? Yes or No?

NO!!!

This is a timely message, as it speaks to what many may be concerned about in the current housing market atmosphere of generally rising prices, high demand, low supply, but new (albeit inevitable) evidence of a rising trend in interest rates.

While the sample data I gathered is from Maricopa County, the fundamentals of this message apply statewide.

There is no inverse correlation between interest rates and home prices. In the past, home prices have often gone up when interest rates went up and they have also gone up when interest rates went down. Home prices only go down in unusual situations when supply is well in excess of demand. Prices have fallen like this in the Phoenix area between 1989 and 1991 and between 2006 and 2011. Between mid 1989 and mid 1991, the fall in prices was about 9 to 10%. During this time 30-year fixed mortgage interest rates fell from around 10% to around 8.5%. No inverse correlation there.

Between June 2006 and August 2011 prices were also in a strong downward trend, though most of that decline happened between 3Q 2007 and 1Q 2009. Between 2006 and 2011 mortgage interest rates dropped from around 6.75% to around 4.5%. No inverse correlation there.

Interest rates went up sharply during 1994, during 1996, between 1998 and 1999 and between 2003 and 2006. Did prices go down during these time. No they did not, they went up just like the interest rates. No inverse correlation there.

During all these times the direction of home prices and the direction of mortgage interest rates were the same. At other times they can move in opposite directions. There is no clear correlation either negative or positive. The fact that the majority of people believe there is a correlation, does not change the reality.

Prices have moved strongly upward between August 2011 and June 2013. During that time interest rates drifted down from 4.5% to around 3.5% and very recently have moved back up to around 4%. There is little evidence that low interest rates had any major influence on the market pricing. Demand has been only slightly above normal during this time despite the very attractive interest rates. It was lack of supply that drove these huge price increases.

So now that interest rate have finally started to rise from a ridiculously low level, some people have said this is going to cause home prices to fall. There is no logical basis for this assertion at all.

When interest rates rise, this causes affordability to fall. However affordability does not equate to demand. Demand is one of the two key factors that influence prices, affordability is not. The highest demand we have seen in the past 30 years was in 2004 and early 2005 when affordability was extremely low.

In fact increases in mortgage interest rates often cause an increase in demand in spite of falling affordability. That is because many people expect the upward trend to continue, so they want to lock in the current rate by getting a mortgage now before it rises higher. This "sense of urgency" phenomenon is very real and has been observed many times in the last 60 years and confirmed by many experienced Realtors®.

Now if interest rates were to increase dramatically and suddenly, this could destroy the "sense of urgency" because people would immediately feel they were too late to make the move. I am talking of a jump from 4% to 9% or something of that nature. But is that really likely? I doubt it. The government likes to interfere with interest rates and they are unlikely to let that happen.

Gentle and predictable rises in interest rates will actually be good for the housing market because the rising gap between low and high rates will probably encourage lenders to be a little more flexible with their underwriting practices. Opening up the market to more people will have a much larger effect than the increase in their monthly payments. It's no good being able to afford a mortgage payment if you can't get approved for it.

Of course demand is not sufficient to determine prices. Supply is the other key factor. The foreclosure crisis has caused us to under-build new homes by a huge amount for over 5 years. This is still creating a supply hole that has been largely unrecognized by the general public. This effect is likely to dominate the market for a very long time, except in areas where the population is shrinking. Only the builders can create significantly more supply. It is not coming from lenders, it is not coming from landlord investors and it is not coming from ordinary homeowners. Ordinary homeowners and landlord investors usually involve homes that are occupied. So when they sell they do not create net new supply. The families or individuals living there move into a new home, often not too far away. This means they add 1 to supply and 1 to demand. The net effect is zero. Only when that home is somewhere other than Greater Phoenix do we see an increase in our supply. For the foreseeable future those people are likely to be outnumbered by the people who are moving here from somewhere else, who add 1 to demand and 0 to supply.

This housing cycle still has a very long way to run before it turns down again. None of the negative factors mentioned by observers recently have enough market power to overcome the dominant effect of the chronic supply shortage.