Fantastic, everybody made some good money in the past 18 months thanks to the Fed’s aggressive monetary policy — or, to be specific Twist, QE3, and QE4 — which dropped mortgage rates from 5.5% to sub 3.5% almost overnight in late 2011. This made it so everybody could instantly “afford” 20% more house. Over the next year this increase in “purchasing power” pushed house ‘prices” higher. Throw in top aggressive Wall Street and private all-cash “investors” regularly paying 10% to 20% over appraised value / list price for their buy-to-flip/rent schemes and viola’…everybody who owns a home is a lot more “wealthy” — on paper — than 18 months ago.
This note is to throw out some compelling data on where housing actually sits relative to the bubbly years. And that although it may look different, conditions may be quite similar. Greed and fear, as they relate to financial assets and decision making, are powerful emotions. When you see them driving markets, step back, breathe, have a drink, and a think.
Now, of course, I could be wrong about all this. Airplane loads of foreigners with suitcases full of money to buy houses could start coming to the US in waves; new-era “Pay Option ARMs”, stated income loans for wage earners, or some other exotic, high-leverage loan program could be introduced/reintroduced; 30-year mortgage rates could plunge below 3%; wages could soar while unemployment plunges; Wall Street investors — presently getting probably 3% or less annual return on rentals bought at today’s prices — could suddenly think that’s a great deal and deploy $10s of billion more of other people’s money in rental houses, or a myriad of other things could happen.
But as of now…with demand off sharply post the rate surge; inventory rising quickly and about to go positive on a YoY basis; the all-important “distressed” trade, which for the past several years has been responsible for boosting housing through the double-counting of sales and artificial house price appreciation from “flips”; and new-era investors backing off sharply, the housing market definitely sits at a pivotal point in time.
CA Housing Bubble 2.0 in pictures
Bottom Line: Unless exotic loans are reintroduced and widely accepted literally overnight, incomes surge, rates plunge to sub 3%, or all-cash buyers/investors substantially increase market share house prices are in store for period of retracement/mean reversion. And at present, all of these variables are going in the opposite direction. This data in this report present a big problem from housing market sentiment and consensus estimates.
When comparing house prices and affordability today vs the bubble years people make a critical error. That’s, they don’t “normalize” the bubble years metrics to account for the fact that the incremental buyer/refinancer used “other than” 30-year fixed mortgages. In other words, they forgot about the popularity of “exotic loans” and assume everybody always used market-rate 30-year fixed rate financing.
During the bubble the “incremental” buyer/refinancer used high-leverage loans such as the 5/1 interest only, which was popular from 2003 to 2005 and the Pay Option ARM, which surged in popularity from 2005 to 2007, as rates continued to rise. This observation changes everything. Of course, from 2003 to 2007 the “stated income” feature, which allowed everybody to earn exactly what was needed to qualify for the loan, was also very popular. But in order to remain conservative for this analysis it wasn’t factored in.
Bottom line: When normalizing the monthly mortgage payment required to buy the median priced house in order to account for high-leverage, exotic loans of each period — even though “house prices are not back to peak levels — it’s plain as day we sit in another housing bubble right now.
1) Median CA household income(green) vs income required to buy the median priced house clearly shows that house prices are in “Bubble 2.0″
Looking at the chart below, In the past when the black line poked through the green line (houses became unaffordable as prices surged) new, high-leverage loans were invented to increase affordability. In 2007/08 when the black line poked through — when we lost all the high-leverage loan programs all at the same time — house prices “reset” lower.
Bottom line: Once again, expense is going vertical through income and unless we reintroduce exotic loans that are widely adopted literally overnight, incomes surge, rates plunge, or all-cash buyer/investors substantially increase market share CA house prices are destined to fall sharply. And at present all of these variables are going in the opposite direction.
The past year of relative “unaffordability” has been masked by historical numbers of all cash buyers. But as they retreat and the market turns more “organic” by default, then the absolute lack of affordability as shown below will present itself swiftly.
Note, results such as this can be found — not coincidentally — in all of the high-beta, former crash regions/states in which new-era :investors’ swarmed for their buy-to-rent/flip schemes.
2) CA median household income used to buy the median priced CA house also clearly shows the “Bubble 2.0″
Again, this chart has been normalized to account for the fact that from 2003 to 2007 the “incremental buyer” used “other than” 30-year fixed rate mortgages. This created faux-affordability allowing people to keep buying more house.
In 2002, when this metric peaked, the response was to introduce the 5/1 interest only loan, which was widely adopted in 2003 and remained extremely popular through mid-2005. As affordability once again got out of control due to surging house prices from 2003 to 2005, as a response, the Pay Option ARM gained popularity and “affordability” improved through 2007. Then in late 2007/08 when all the high-leverage exotic loans went away at the same time the housing market “reset” to the affordability levels of the market-rate 30-year fixed mortgage and prices plunged. Then in 2012/13 as rates plunged on Twist — and cash buyers swarmed the market masking the “unaffordability” — house prices once again rose in response to the increased affordability.
Bottom line: Based on today’s rates and house prices, to the organic buyer using a mortgage to buy a house, CA housing is as “unaffordable” as it was in 2005/06.
3) Peak CA Monthly Payment buys much less house than from 2003 to 2007
Bottom line: Just because “house prices” are not back to 2003 to 2007 levels does not mean we are not in another housing bubble.
Based on median income levels and house prices then vs now either exotic loans need to be reintroduced and widely accepted literally overnight, incomes must surge, rates must plunge, or all-cash buyer/investors must substantially increase market share, or house prices are in store for period of retracement/mean reversion.