From Jason Payne, Market News Analyst …
Today’s timely Market News Update uses a bit of “old school” research to decipher some potentially confusing housing market data released during recent days.
In my former career as a stock market analyst, some stockbrokers used to make fun of my Real Estate Research team for caring about this stuff.
“Why do we need real estate analysts anyway?” they would wonder aloud, as they hurried past our “boring” offices to ask the Technology Research team about a hot new IPO. “It’s not like real estate ever changes… What is there to research?!”
That was before 2008, of course.
Real estate analysts became rockstars overnight in August 2008 when trouble in the U.S. housing market catalyzed numerous “crises” across financial markets worldwide, kickstarting 5 years (and counting) of global economic turmoil.
Suddenly, the news about real estate data seemed much more dynamic – and often contradictory.
Investment yields shot through the roof as terrified buyers balked at even the most conservative real estate deals, frequently confused by the latest headlines from Wall Street and Capitol Hill.
Property values plummeted. Interest rates soared. Stockbrokers contemplated leaping out of their windows. And “foreclosure” became many investors’ favorite new F-word (closely followed by “Fannie Mae” and “Freddie Mac”).
And although the gut-wrenching rollercoaster of 2008-2009 is now safely behind us, real estate investors still find themselves adjusting to “the new normal” for our ever-changing industry.
Not Your Grandfather’s Economy
No, this isn’t your grandfather’s economy anymore.
(It's not your father’s economy either, for that matter.)
To wit, even during the last 48 hours, investors of all stripes have been hit with two surprising and “contradictory” developments within the U.S. housing market:
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Growth in average U.S. home prices reached a six-year high
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Declines in pending home sales slumped to a three-year low
And both of these recent developments come on the eve of the U.S. Federal Reserve’s latest high-stakes policy meeting (Tuesday 10/29 through Wednesday 10/30), in which officials are once again considering their willingness to maintain the unprecedented economic stimulus measures currently enjoyed by domestic real estate investors.
Accordingly, today’s Market News Update seeks to shed light on the confusing (at best) and contradictory (at worst) housing news from recent days – including a few implications for your REI portfolio.
If you typically struggle to stay abreast of all the latest industry data, then the following update should be profitable for getting you up-to-speed. Or, if you have been struggling to decipher the tea leaves in your recent examination of national real estate trends, then this analysis might help you find your analytical footing.
U.S. Home Prices Rise at Highest Rate in Six Years
On Tuesday, Standard & Poor’s reported that its S&P/Case-Shiller index of property prices in 20 U.S. cities increased 12.8% annually during August, compared to a prior annual gain of 12.3% during July.
Boosted by low inventories of homes for sale in most cities, this robust improvement in average home prices handily exceeded analysts’ expectation for 12.4% growth and represented the index’s largest gain since February 2006.
Most importantly, the acceleration in home prices’ improvement was also delightfully broad-based, with positive growth stretching across each of the 20 major cities surveyed.
That’s right, folks: Every major metropolitan area across the nation reported higher selling prices – led by Las Vegas (up 29.2%), San Francisco (up 25.4%) and Los Angeles (21.7%).
Other notable takeways from this encouraging development include:
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Thirteen cities posted double-digit annual gains in their home values.
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Denver (up 10.1%) and Phoenix (up 18.6%) each posted their 20th consecutive annual gains.
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Miami (up 13.5%) and Minneapolis (up 10.2%) each posted their 19th consecutive annual gains.
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Despite showing 26 consecutive annual gains, Detroit (up 16.4%) remains the only major city below its January 2000 index level.
On average, U.S. home prices have now returned to mid-2004 levels, up approximately 22.7% from their low in March 2012, as buyers compete for a limited number of properties for sale.
And it should be noted that U.S. home prices also remain approximately 21.0% below their peak, measured at the height of the housing bubble in summer 2006. But more on that in the following sections…
Pace of Pending Home Sales Declines to 3-Year Lows
On Monday, the National Association of Realtors (NAR) reported that its Pending Home Sales Index fell 5.6% to 101.6 in September, compared a downwardly revised reading of 107.6 in August.
Economists consider pending home sales to be a “leading” indicator for the housing industry, because they track purchase contracts (whereas existing home sales are typically tabulated 1-2 months after a contract closes).
Weighed down by a variety of economic and political factors, September’s significant decline in sales contract signings was 490 basis points worse than analysts’ expectation for a modest 0.7% deterioration. It also represented the index’s largest loss since May 2010, when the extension of a major government tax credit expired.
Additionally, September’s decline represented the fourth consecutive month of declines for this forward-looking housing market indicator, albeit at a much stronger pace than August (down 1.6%), July (down 1.4) and June (down 0.4%).
All four regions of the U.S. showed deterioration, led to the downside by the Northeast (down 9.6%) and the West (down 9.0%).
Reading the Tea Leaves
So how should real estate investors interpret this ongoing season of bipolarity in our industry? The current market is obviously setting some records – but which ones are most important? And are they good, or are they bad?
Most importantly, should you be buying, selling or holding onto your properties?
To answer these questions, we must begin by examining the most painful pressure point in this latest news cycle – the declining pace of pending home sales…
Don’t be fooled by September’s large decline in pending home sales.
As mentioned above, the recent reading of pending home sales was significantly depressed by a variety of political and economic factors.
These factors included the following:
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Higher Home Prices – As home prices rise, they become less affordable.
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Hopeful Homeowners – Although home prices are undoubtedly on the rise, some homeowners are reluctant to put properties up for sale as they wait for prices to climb still higher.
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Slow Labor & Wage Growth – Limited improvement in the markets for labor and wages keeps many would-be homebuyers on the sidelines.
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Federal Budget Concerns – In the weeks preceding October’s 16-day partial government shutdown, government and contract workers who wanted to purchase homes were understandably hesitant, with growing insecurity over lawmakers’ inability to agree on a federal budget. Similarly, the national uncertainty's broader hit on general consumer confidence also curbed major expenditures such as home purchases.
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Mortgage Rate Spike – In September, mortgage rates spiked to two-year highs, driven by fears that the U.S. Federal Reserve would soon begin tapering its latest round of “easy money” economic stimulus. Less “easy money” translates into higher interest rates – including mortgages – and higher mortgage rates translate into less housing affordability.
In the list above, the first three factors contributing to September’s decline in pending home sales – Higher Home Prices, Hopeful Homeowners and Slow Labor & Wage Growth – can be classified as “normal” economic variables. These are the factors that would normally influence the supply and demand for residential housing within the U.S. economy…
…and it is good for these first three variables to be in tension with each other, because it indicates healthy functionality of the free market.
Even when such forces are pushing would-be buyers to the sidelines and slowing the pace of recovery in real estate, investors should breathe a collective sigh of relief that these “normal” factors are reemerging as primary economic variables. Over time, as the supply and demand for residential housing continue to seek equilibrium, sales volume will become less turbulent and the average home price will increase in-step with general technological progress. That’s the way healthy markets function.
On that note, it is also worth observing that September’s reading of the Pending Home Sales Index – although much lower than expected – came in at 101.6 on a seasonally-adjusted basis, which is slightly higher than the index’s base value of 100. Skittish real estate investors would be wise to remember that the index’s base value coincides with the average level of contract activity in 2001 and should be interpreted as historically healthy home-buying traffic, according to the NAR.
Regarding the other two factors contributing to September’s decline – Federal Budget Concerns and the Mortgage Rate Spike – these variables would be more appropriately classified as “abnormal” economic forces, neither of which poses a threat to the long-term growth and health of U.S. housing or its underlying sales volumes.
It is a rare thing for the federal government to experience even a partial shutdown, the most significant of which seem to occur every 15-20 years. Before October’s 16-day furlough, it had been almost two decades since Washington’s previous shutdown, which lasted 21 days during 1995-1996. And prior to that, no major disruptions occurred at all during the 80’s or early 90’s, following a constellation of multi-week shutdowns during the Ford and Carter administrations of 1976-1979.
Although there is always the possibility that Washington will be unable to implement a new federal budget by January 15th and/or raise the nation's debt limit by early February, these “abnormal” failures seem unlikely to occur in such close succession to the recent shutdown – especially when so many politicians have begun to publicly stake their political futures on avoiding these undesirable fates.
Similarly, the recent spike in mortgage rates should also be viewed as an “abnormal” weight tied temporarily around the housing market’s neck. When mortgage rates soared this summer on fears that the Federal Reserve might soon taper its $85 billion monthly economic stimulus, the Fed quickly scrapped all plans for a near-term deceleration of its helpful market intervention.
Mortgage rates immediately returned to earth. To wit, the average rate for a 30-year fixed mortgage was 4.13% for the week ended October 24th, down 45 basis points from 4.58% at the peak the recent spike.
As described in last week’s Market News Update, the Fed will eventually need to bite the bullet and begin reigning in its current easy money policies, but occasions such as this summer's quick response to market concerns have bolstered its leaders’ reputation as policymakers who will patiently wait until “the right time” to make necessary moves.
If anyting, September’s dramatic decline in pending home sales gives Fed policymakers yet another reason to delay any tapering of stimulus measures when they meet together this week, thereby giving real estate investors a reason to cheer, not frown.
As an added bonus, despite its recently-recorded decline in home sales volume, the National Association of Realtors estimates that this year's pace of existing home sales will be 10% higher than 2012, reaching more than 5.1 million – a pace that the group expects to be maintained throughout 2014.
This is still a good time to be investing in residential real estate.
While broad-based gains in U.S. home prices during August brought the S&P/Case-Shiller index back to 2004 levels, national home prices remain approximately 21.0% below their peak, measured at the height of the housing bubble in summer 2006.
It will surely take many years for home prices to reach new heights (as opposed to the blistering 2-year pace set between 2004 and 2006), but that’s a good thing. After all, the purest heartbeat of fundamental real estate investing marches along a long-term timeline.
If you want to make a consistent quick buck from “buying low” and “selling high”, you can always talk to the stock jockeys on your local Technology Research team. But we’re not talking about Internet IPOs here; we’re talking about real estate. And real estate has the benefit of moving at a relatively slow pace, even within the dynamic (and sometimes confusing) parameters of this industry’s new post-bubble reality.
Accordingly, fundamental real estate investors should rejoice to see that asset prices are enjoying such impressive upward momentum (with plenty of room to spare) while “normal” market forces are gradually regaining control of sales volumes.
Will the real estate market be on a bumpy ride for the next few years? Yes.
Have the best bargains of our generation already come and gone? Probably.
Will classic economic models occasionally fail investors like us? Of course.
Will career politicians continue to flirt with inappropriate fiscal policy? Definitely.
But should you bet against the long-term benefits of investing in fixed assets (land, housing, etc.) within the world’s most powerful economy? Never!
And even if it takes several years for the U.S. economic engine to fully return to normalcy and begin “hitting on all cylinders” once again, the beauty of being a fundamental real estate investor is that you can get paid handsomely to wait...
...by collecting sizeable rental and/or mortgage payments on a regular basis.
Jason Payne’s next Market News Update is currently scheduled for Wednesday, November 6th.