Kelowna, BC -- (SBWIRE) -- 12/11/2013 -- Ignore all the headlines about housing recovery and rising home prices. The market, nationally, is now in real trouble, thanks to the surge in mortgage rates triggered by the Fed’s spring musings on when it might start to slow its bond purchases. The thought that the single biggest buyer of government and mortgage securities might soon step back from the market spooked investors, both domestic and foreign, and they now demand higher rates on their investments.
This has translated into average 30-year fixed mortgage rates rising from a low of 3.59% in early May to 4.46% last week. As a result, sales of both new and existing homes have dropped, and price gains are slowing. These trends have some way yet to run, and I can’t rule out completely the idea that home prices might fall outright for a time in the first half of next year.
Potential homebuyers today need to find $780 per month to buy a median-priced new home with a 20% down payment and a 30-year fixed rate mortgage. In early May, the monthly payment was $702. That’s a big increase, and it has removed a large swathe of would-be purchasers who could only just afford the cost back in May, and now can’t. Sure, mortgage rates remain very low by historical standards, but over short periods what matters is the change in rates, not the level.
The adjustment to the rate increase is not yet over. The number of people applying for a new mortgage to finance a home purchase has dropped about 16% since rates began to rise, and the trend is still downwards. This is beginning to filter into both new and existing home sales, which have fallen from their summer peaks and are now clearly headed lower.
Price gains tend to follow home sales in the short-term, and the rate of increase of the Case-Shiller index of prices in 20 major cities has begun to slow. Back in the spring, home prices were rising by about 1.5% per month, but the past three months have seen gains at only about half that pace. A further slowing looks inevitable in the wake of the drop in sales volumes.
Homebuilders have been very keen in recent years to see prices rising, because nothing gets people into the housing market faster than expectations of making a profit on a tax-advantaged asset which doubles as the family home. In order to keep prices rising, homebuilders have kept inventory very low relative to sales, not much above the levels seen at the peak of the boom. Inventory has been kept down by homebuilders’ collective willingness to restrict the pace of construction, holding it in line with the increase in new home sales. With sales now falling, construction is likely to head south too.
This is very unfortunate, because housing construction has contributed about a quarter of all the economic growth reported over the past year. That’s not bad for a component which usually accounts for only about 3% of economic activity. Housing has been punching far above its weight, and it’s hard to see what will fill the gap in the economy now that homebuilders are set to retreat for a time.
Eventually, the housing recovery will resume. The pent-up demand is enormous after seven years of low activity, and the relative cost of home purchase has fallen as rents have risen, pushed up by the lowest vacancy rate in 12 years. The availability of mortgages has increased too, though it will still take years before the market returns to normal pre-boom conditions. We understand the idea that a generation of homebuyers has been scarred by the experience of the past few years, but the lesson of other countries which have experience housing booms and busts is that buyers return in droves once confidence returns.
That day has not yet come, except in certain local markets where specific factors overwhelm the national story, and in the short-term you should be braced for a wave of bad news. It is not an accident that the homebuilders component of the S&P 500 is down 6.2% so far this year, while the index as a whole is up 22.9%.
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