Mar172014

Reflating housing bubble pricing out first-time homebuyers

House prices rise faster than incomes forcing first-time homebuyers to pay more from their income to buy a house. Marginal buyers are priced out.

next_generationrealtors often try to scare potential buyers into action by instilling the fear that they will be priced out forever. This is most effective when house prices are rising rapidly and affordability is plummeting, much like it is today. It isn’t possible for first-time homebuyers to be priced out forever because they are the foundation of the housing market; however, with a heavily manipulated market, first-time homebuyers can be priced out for a significant period of time — either that or be forced to overpay in a potential housing bubble.

I think it unlikely the reaction bubble we are watching form today will carry on very far. As banks resolve more of their lingering bad loans, including future redefaults on loan modifications, and as more supply comes to market, prices will find equilibrium at price points first-time homebuyers can afford. It’s an open question as to when first-time homebuyers will return to the market, but they will eventually. They must; investors are abandoning the market, and without first-time homebuyers, there is no move-up market, and sales volumes will really crater.

Surging Home Prices Are a Double-Edged Sword

Affordability Troubles Grow, Especially for First-Time Buyers

By Nick Timiraos, March 9, 2014 4:35 p.m. ETrecovery_2013

The U.S. housing market faces a challenge at the start of the spring sales season: higher prices.

It is hard to overstate the benefits of rising prices to the economy broadly and to homeowners, banks and home builders specifically after years of declines.

It’s also hard to overstate the detriments of rising prices to first-time homebuyers and to the broader economy as those buyers are forced to divert increasing percentages of their income toward housing costs and away from consumer spending.

Price gains have pulled more Americans from the brink of foreclosure and given home buyers more confidence that they won’t get stuck with an asset whose value will decline.

Yes. I noted back in 2012 that rising home values will halt strategic default. It has.

But those gains have a painful edge, too, especially because prices have bounced back so strongly. The increases have rekindled concerns about affordability, particularly for first-time buyers, and could damp the gains of a housing rebound still in its early stages.

Prices ran up so fast in 2013, it hurt first-timers’ ability to become homeowners,” said John Burns, chief executive of a home-building consulting firm in Irvine, Calif. “It’s going to be a slower recovery than people had hoped because a number of people have been priced out of the market.

Slower than who expected? The circle-jerk of Pollyanna economists telling people what they wanted to hear?

affordability

This pinch on first-timers is troubling because, so far, the housing recovery has depended to an unusual degree on cash buyers and investors.

And investors and owner-occupants purchase fewer homes.

The relatively weak position of entry-level buyers could further suppress the homeownership rate—now off more than four percentage points from its 2004 peak—as more of them rent, said Vishwanath Tirupattur, a managing director at Morgan Stanley.

Making matters worse, home prices are going up fastest in markets that are already expensive, such as San Francisco and Los Angeles. Just 32% of California households at the end of last year could afford the monthly payments on a median-priced home in the state of $431,510, assuming a 20% down payment, according to the California Association of Realtors. That was down from 56% of households that could afford the payments on a $276,040 median-priced home in early 2012.

Affordability has declined, but the housing market overshot to the downside during the bust. Prices currently are where they should be relative to rent.

OCHN_OC_Housing_Market_Report_2014-3

Rising prices are only part of the problem for first-time buyers. Inventory shortages and tougher mortgage-qualification standards benefit buyers who can make large down payments and those who can forgo a mortgage altogether. Because many markets have low supplies of homes for sale, all-cash buyers have routinely beat out first-time buyers by guaranteeing a quick, worry-free closing for sellers.

This is a problem, but the GSEs are making sales to owner-occupants a priority; the GSEs provide an exclusive look period to owner-occupants, and the GSEs also extend cash incentives to owner-occupants (See: Fannie Mae offering cash incentives to some home buyers)

Meanwhile, federal officials have repeatedly increased insurance premiums on loans backed by the Federal Housing Administration, which serves many first-time buyers because it requires down payments of just 3.5%. While mortgage rates at the end of 2013 reached their highest levels in more than two years, the all-in cost of an FHA-backed loan—due to insurance-premium increases—was closer to a five-year high. …

(See: Has FHA increased their fees so high they are now a predatory lender?) [dfads params=’groups=4&limit=1&orderby=random’]

Others fret that low interest rates have allowed prices to rise too fast relative to incomes, which have stagnated. While homes are still affordable on a monthly payment basis because of cheap financing, homes no longer look like a bargain when comparing prices to incomes.

For the past few years, policy makers have focused on breaking a vicious downdraft in home prices. Now, it wouldn’t hurt housing to see price gains flatten out, especially if income growth remains tepid. If not, the housing market’s roller-coaster ride will continue.

Will the spring house price rally may inflate new housing bubble? It’s a legitimate concern. Incomes are flat, so increasing home prices would not be a result of buyers armed with more income bidding up prices. With interest rates rising, any increase in income is offset by increased borrowing costs. If prices do to up, it will be due to all-cash buyers competing over limited inventory. While this may serve the interests of bankers, it does not help the housing market, and it will further price out first-time homebuyers, and a lack of first-time homebuyers is a drag on the housing market.

I believe lenders, encouraged by their government enablers, will allow a reaction bubble to reflate in order to bail them out of their bad loans. Most first-time buyers will be forced to overpay over the next several years by competing over restricted inventory with all-cash buyers. These first-time homebuyers probably won’t drift underwater as the amortization on their low interest-rate loans will keep pace with the inevitable slow deflation of the reaction bubble several years from now.

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