Now deeply involved in the home buying process, I can't help but worry about the current enthusiasm around recent home price increases. This is my attempt to dampen this unfounded optimism with a little caution.
What I see as some basic facts:
Factors that are contributing to current home price increases:
- Low interest rates
- FHA lending
- Low inventory
Factors that could contribute to home price declines:
- Higher inventory
- Traditional lending standards
- Unemployment
- Salary stagnation
- Student Loan debt
Basic Questions
What is going to sustain home price increases? Do interest rates stay low or decrease even further in the next 3-5 years? The Fed stated that rates will stay low until late 2014. Low rates are not indefinite and run a good chance of being higher in 2015.
Do FHA loans provide a solid foundation for the full housing recovery everyone wants, and should FHA be the way forward? Not really.
Will low inventory levels stay low? If foreclosure activity picks up again, and lenders begin to clamp down on delinquent borrowers, a much needed flow of distressed property will come onto the market and inventory levels will rise.
From this standpoint, it seems that the factors that are contributing to the recent home price increases are weak, and their effect will not be long lasting. It's an artificial high.
Another important question: are the factors that could contribute to home price declines more than likely to outweigh the recent increases? I think yes.
A higher outflow of distressed property is long overdue.
Lending will eventually return to higher rates and traditional 20% down payments: no more FHA lending subsidy to artificially prop up the market.
Jobs are still scarce, except for the highly skilled. This means less demand for housing on the low end. Companies have been able to hold back on salary increases because of a slow economy, and know full well that employees would rather stay in their job than take chances in the current job market looking for something better. Stagnant wages will widen price-to-income ratios and put downward pressure on home prices over time. And student loan debt will continue to be a huge financial obligation for young, potential first time buyers, which severely constrains the emergence of a move-up market.
What we are seeing now in prices is nothing more than a small rally that is limited to a few, high demand, low inventory areas. This is likely to continue into the Spring of 2013. A large contributing factor to recent price increases is the result of bidding wars for very limited numbers of formerly distressed properties that were acquired through tight connections by investors looking for a quick flip.
The sharp price declines of 2007 should have continued well beyond 2011, but did not because of a government induced slowdown in foreclosure activity early in 2012. Lenders are basically waiting for the outcome of the election next week to know what action they will be able to take next to better deal with large numbers of delinquent borrowers. Lenders hands are tied at the moment, but they want badly to clean this up.
Short sales are providing some relief to lenders who are unable to deal effectively with delinquent borrowers. The few short sales that do hit the market are long overdue. Some lenders give short sellers incentives to move on. But it's difficult to turn a delinquent borrower into a short seller when they have the option to squat indefinitely at no cost. And this behavior is encouraged by tight regulation on lenders to deal with squatters.
The fundamental problem remains unresolved: too many people continue to be way in over their heads. While a short rally in home prices has allowed some people to escape a negative equity situation (like me), this is a much smaller group than the large numbers of people who purchased way too high, refinanced (cashed out), took out a HELOC, signed up for a teaser rate on that second mortgage, and are now delinquent on all of the above. As long as this large lump continues to sit, off the market, we may never see a true recovery.
Another shake out is badly needed.
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