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 FutureWe 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 StimulusThe 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 RatesA 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/IncomeA 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 FutureWho 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 RecoveryInvestors 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!
