THE BASIS POINT

Why I Don’t See A Housing Bubble

House_BubbleFor someone who does home loans for a living and writes a weekly newsletter I do not often comment on housing. My excuse is that enough other people do it.

However, this is a good time to look at the present state of the housing market.

As always, we start with the notion that housing is local. I live in San Francisco and not only are prices in San Francisco loosely correlated with prices in Florida, but they are loosely correlated with prices in places 50 miles from San Francisco. The strength of any local housing market has to do with demand, and demand is driven by jobs. Nonetheless there is an overview of the national housing market which is important because it affects the economy. Home building creates jobs, jobs create GDP, and both home building and the sales of existing homes inspire other consumer spending, i.e. furniture, appliances, home improvements, garden supplies, etc.

So let’s look at housing-related fundamentals from this week…

S&P Case-Shiller Home Price Index (March 2013)
– 20-city Seasonally Adjusted – Month/Month +1.1%. Previous was +1.3%.
– 20-city Not Seasonally Adjusted – Month/Month +1.4%. Previous was +0.3%
– 20-city Not Seasonally Adjusted – Year/Year +10.9%. Previous was +9.3%.

This was the largest year/year increase since April 2006. Note that this report actually averages three months worth of data so that it reflects prices for January-March

MBA Home Loan Applications (week ended 5/24/2013)
– Purchase Index Week/Week +3.0%.
– Previous weeks were -3.0%, -4.0%, +2.0%,-1.4%, +0.3%, and +4.0%.

– Refinance Index Week/Week -12.0%.
– Previous weeks were -12.0%, -8.0%, +3.0%,+0.3%, +5.0% and +6.0%.

– Composite Index Week/Week -8.8%.
– Previous was -9.8%, -7.3%, +7.0%, +1.8%,+0.2%, +4.8%, +4.5%.

Pending Home Sales (April 2013)
– Pending Home Sales Index 106.0. Previous was 105.7.

– This data comes from NAR and should be a leading indicator of existing home sales. A Pending Home Sale exists when there is a ratified contract but the sale has not yet closed.

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What received the greatest amount of positive attention (positive for the economy, bad for rates) was the Case-Shiller Year/Year Home Price data.

A 10.9% price increase sounds like the start of a new bubble. It is not.

There are two different sources of sales: distressed (foreclosures and short sales) and non-distressed. A distressed sale happens when the owner has to sell or loses the property to foreclosure. A non-distressed sale happens when the owner wants to sell and is not under pressure.

Non-distressed sales are a better indicator of the market. Markets and prices make more sense when neither the buyer nor seller are pressured. As the supply of distressed sales has decreased we have seen an increase in median price as the poorer-quality homes (likely to sell at lower prices) have diminished in number. Also, as that supply decreases, we are also seeing a flattening in sales.

Recently the housing market is more complex than usual because these differing streams of distressed and non-distressed sales have different dynamics. If someone purchases a foreclosure or short-sale, they may rehabilitate the property and sell it for a higher price within a few months. That is not so much evidence that prices of similar things are increasing, but rather the self-evident statement that a home in great shape sells for more than one with years of deferred maintenance. People who are not making their home loan payments are not likely to be maintaining their homes to the same extent that people who have been making their home loan payments have.

In the S.F Bay Area 8.5% of the sales in April 2013 were foreclosures as opposed to 21.9% a year previous. Short Sales made up 15% of the sales in April while they were 22.1% a year before. Distressed sales combined were 24% of the market as opposed to 44% a year previous. This data is from Dataquick.

A large part of that big, fat 10.9% increase in prices has to do not with increases in values of similar homes, but with the fact that fewer funky homes are being sold. In fact there may not be a real housing price bubble but rather modest, sustainable gains in prices coupled with a bubble of quality.

If I am correct, then this quality difference should be subsiding as the percentage of distressed sales continues to fall and values should increase at a slower pace.

The notion of a bubble is an illusion created by fewer distressed sales.
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Housing Stocks:

Homebuilders:
$XHB, $MHO, $PHM, $LEN, $TOL, $NVR, $DHI, $SPF, $RYL, $KBH, $MHT, $MDC

Home Improvement:
$HD, $LOW, $SHW, $DD, $APOG

Funds:
$XHB, $IYR, $ICF

Real Estate Services/Media:
$RLGY, $Z, $TRLA, $MOVE