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Rising Interest Rates and the US Housing Market—A Pain in the Asset Class

Slipped girth with path

 

More Heads in the Sand

As we watch donkeys and elephants daily chasing each other’s tails on the news, the real rodeo isn’t what’s going on in the halls of Congress or under the big-top of a left/right national media that prioritizes “shock and awe” (i.e. ratings) over journalism. Nope, the real rodeo is yet another incredibly important and obviously damaged asset class floating right past the talking heads—most of which are in the sand.

Do you remember the last housing bubble which peaked in 05 and then bottomed in 2011? Do you remember the sub-prime mortgages and market crisis that bubble ushered and all the painful lessons we learned from it?

Well, the lessons may have faded, but the housing bubble is back . More importantly, it’s nearing a turning point. The headlines confirm that prices of existing houses are rising by 6% a year, which is true. What the cheerleaders aren’t telling you, however, is that the volume of sales is weakening as the prices are rising.

Not a good sign.

For example, April sales as listed on America’s MLS (Multiple Listing Service) fell by nearly 5.5% year to year. This alarming figure is based upon the NAR’s (National Association of Realtors) “Pending Home Sales Index,” which is apparently too complex (i.e. based on actual rather than “seasonally adjusted” sales) for the ever-hopeful “financial media” to accurately report. (This market methodology, moreover, is far more telling than the Case Shiller indexes, which are essentially five to six months out-of-date by the time they are released.)

 

It’s All about Interest Rates

And the housing numbers tell us this: what we have is a familiar problem (prices rising and sales declining ) as well as familiar cause (the Fed.) Real estate has simply become one more asset class gone wild in the “everything bubble” created by on over-exuberant cadre of central bankers who have been playing with the supply and demand of asset classes the way my cat, Randall, chases cat-nip.

Years of central bank manipulation of credit markets, interest rates and the money supply have jacked up the valuations of everything from Monets to tech stocks to junk bonds. The current real estate distortion/bubble is just another symptom of the same virus.

 

How We Got Here

Record low mortgage rates, which stem from the Fed’s post-08 “zero-bound” rate “easing” have been an undisputed subsidy (“stimulus”) to the real estate market. Cheap credit directly allowed post-08 buyers to buy more homes and thus send prices rising for years. Without that tailwind and low rate policy, however, the buying frenzy ends, and so does the bubble. Then comes the crash in house prices.

April’s year-to-year decline in sales posted by the NAR is a strong indicator that the bubble’s rising phase is ending and a trend toward the popping phase is either approaching or upon us…

 

How It Ends

If low rates are the birth of this bubble, then higher rates will be its mortician. Even scarier: all signs point toward higher, not lower, mortgage rates down the road.

Mortgage rates are partially tied to the yield of the 10-Year Treasury. Currently, those yields (and hence mortgage rates) are still low. This is in part due to the fact that the supply (and hence yield) of Treasuries is currently reduced under the imposed debt-ceiling here in DC. But know this: once that debt ceiling is lifted in the fall (as it will be lifted in order to pay government pension funds and other US debts…), the Treasury will start issuing debt in a big way (just as they did when the last “debt ceiling” was lifted in 2015).

As those 10-Year Notes flood the markets, their prices (notwithstanding market manipulation) will fall and yields should surge, which means mortgage rates will rise… which, in turn, means fewer houses will go to contract. Adding insult to injury, at just about the same time the US Treasury blows through the debt ceiling, the Fed will be embarking on a balance-sheet reduction, which means the US Treasury will need to raise new funds to redeem old holdings. End result: more 10 Year Notes in the market, and thus higher yields…and, alas: higher mortgage rates.

In short, the real estate market is anticipating a rate hike surge, which means a demand plunge.

 

Other Indicators

But it’s not just the yield curve talking.

Lenders, brokers, appraisers and realtors are seeing the first signs of market psychology tilting toward panic. The Closing-to-Contracts ratio has grown quite frothy since January, as more and more lenders loosen their standards and appraisers (under pressure from the lenders) push values up for increasingly less credit-worthy buyers.

Seen this before? Yep. These kind of practices get more and more desperate as the real estate market gets closer to a cliff.

New  home builders , anticipating lower demand, are now beginning to cut prices as existing home prices climb like a tired baseball arcing over center field yet just about to head back to earth…

Another obvious red flag is the widening gap between the rate of growth in full time jobs (rising) and new home sales (falling). The open secret at the BLS and Fed is that all their “full employment” talk ignores the embarrassing fact that most of these “new” jobs don’t pay enough to buy a home—even in a low rate world.

By the way: low wages + high housing prices = a recession.

Perhaps even more disturbing is the decline in sales not as an absolute number, but as a number relative to population size. The limping post-08 housing “recovery,” for example, equates to a monthly average of about 148 home sales per 1 million of the US population.

That rate is pathetic and measures in at only inches above the rates at the very floor of the 1982 recession (when mortgage rates where 18%, not today’s 4%). In short, US home-buying rates are already at recession levels. Buyers of median household income bought 6000 units in April of 2017. In April of 2005, that number was 43,000.  It has been a steady decline ever since, in every income range.

 

The Catch -22

Once again, the Fed has created an anomaly, a distortion, a mess.  By artificially cranking down rates (and hence mortgage costs), they jolted a temporary housing boom, which jacked up housing prices. The irony now, however, is that many citizens cannot afford the bubble their central bankers created. At first blush, this bubble at least seems like a good thing for sellers, but that assumes they can find buyers who will (or can) pay inflated prices. The figures suggest less and less buyers are doing so…

 

So What Do You Do?

Whether I am talking to investors about stocks, bonds, art, or, yes, real estate, I tend to use the same analogy in today’s bizarre era of the “everything bubble”… If we were duck hunting, I ask, would we hike to a calm morning pond and just start blasting shells into the sky? Or would we wait for an actual duck to fly over first?

My point is this: be patient. Wait before you pull a trigger. Wait for a duck. Or in the investment world—be it of equities, credits or real estate–wait for good value. After all, once you know how to determine value (be it of AMZN’s stock, a house in Malibu or the price of sneakers), deciding what price is fair gets a lot easier.

Right now, housing is over-bought and over-priced—and not just in the obvious zip codes, from Cali to NYC. If you are cash-rich and not over your skis in debt, then your chance to buy real estate at real discounts is coming. Just hold still. You’ll make a killing.

If you’re a home owner or investor looking to sell/flip at a top (perhaps not the top, but a top nevertheless), you may want to list now, before rates hike, demand drops and prices fall. Time is impossible to measure, but time is running out in this bubble.

If you’re young, struggling and craving your first home, look at the data, the prices, the rates, your salary and common sense. And then ask yourself this: if you knew a pair of Nike’s was worth $75.00, would you feel smart paying $120.00 for them? Or would you rather wait for a sale and buy those sneakers for $50.00? The same logic is true of a first home. Don’t fall so in love with the idea that you over-pay today for something time will deliver at a better value tomorrow.

And for all of you—just watch those Treasury yields and mortgage rates. They are your saddle (and girth) in this real estate rodeo.

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