Real Estate Recovery Myth's Unraveled

Like anything else, real estate has its urban legends, its stories that get told so often they seem like they must be true. But unlike urban legends about exploding Pop Rocks or the origins of Jennifer Aniston’s ‘Friends’-era haircut, real estate myths have the potential to create fear, panic, paralysis and all sorts of other decision glitches.

The recent market upturn, coming on the heels of 6 years of near-Depression, has given rise to its own set of real estate myths.  Here is a handful, along with some ways you can and should rethink them.

Myth #1.  It’s recovering too fast.  According to the Standard & Poor’s/Case-Shiller home-price index, American home prices increased an average of 10.6 percent between March 2012 and March 2013. Twelve of the 20 major metro areas tracked had year-over-year median home price increases in the double-digits. The list was topped by Phoenix, San Francisco and Las Vegas, all of which saw 20 percent or greater annual home price increases.

That seems crazy fast, to some. So crazy, in fact, that it’s created the fear that the current market’s exuberance will re-create the steep incline and decline in home values that we all remember not-so-fondly from the last boom-bust cycle. 

Here’s the deal: markets have cycles, period. So I can guarantee you that the ups and downs will repeat, though hopefully not to such extremes. Part of what made the last down cycle so extreme was the fact that lenders were greenlighting massive home loans to borrowers without requiring them to document their ability to pay for the property over the long term. Buyers, in turn, overextended themselves regularly. Today’s loans are allowing people to buy without putting much down, but I haven’t seen almost any examples of the fully stated income or so-called “liar’s” loans that really got people in trouble. (Yet.)

Here’s the other thing: the data can be a bit misleading.  When an area’s home values have been very, very depressed for long, it simply doesn’t take that vast of an uptick to generate double-digit percentage point increases. When you look at the top five recovery markets, according to the Case-Shiller, four of them: Phoenix, Las Vegas, Miami and Tampa – ranked among the hardest hit markets in the foreclosure crisis and resulting downturn. (San Francisco was the anomaly.)  When you look at other markets that skated through the recession relatively unscathed, like New York, you see the percentage point increase year-over-year was much less impressive/ less scary (depending on your outlook), at 2.6 percent.

Myth #2.  Investors are driving demand. In some areas, investors are buying up lots of low-priced homes. From big Wall Street investment groups to Mom-and-Pop investors, people who don’t plan to live in the homes they’re buying were responsible for about 20% of May home sales. But this number is actually on a downward path – investors were responsible for 22% of home sales in April, and investor activity should continue to decline as prices increase, putting a cap on the profits investors can realize. 

While investor activity is declining, buyer demand is increasing, as evidenced by increasing numbers of cash transactions, offers per property and speed of homes leaving the market. 

First-time buyers are responsible for 36% of current buyer activity and repeat homeowners for over 43%. Investors have been active, but by no means are they responsible for creating the intense buyer demand that now characterizes the market. 

Myth #3.  Sellers are stuck.  This time, let’s start with what’s true. Many, many sellers in hot markets are in the midst of an exasperating Catch-22:  they can finally sell their homes, which have been underwater for years. But now they struggle to buy, amidst the multiple offer mania – some report having to make offers on dozens of homes, or even having to rent a place until they can buy one.

As I see it, sellers aren’t stuck as much as they are being forced into being strategic about sequencing their transactions and setting up their deal points. During the recession, millions of sellers had no equity – or negative equity. That meant they couldn’t sell, which meant they didn’t have the money to buy – heck, many couldn’t even refinance. That’s what I call stuck. Now, they have the option to pull cash out to buy first, the option to refinance and stay put, and the option to sell – period.  So for my dollar, today’s sellers are nowhere near stuck, compared with the truly stuck sellers of yesteryear.

Most of the sellers who have recently, truly gotten stuck (i.e., sellers who’ve been forced to rent until they could successfully buy) ended up in that situation because they listed their homes first, unaware that the market truly had shifted and that their home would fly off the market. Now, we know. So, if you’re selling in a super-hot market, work with your agent to put a strategy in place. Consider buying first, if you have the means or can get them. Or list your home with a Seller’s Contingency or a rent-back agreement (where your home’s buyer rents it back to you for a short time), to buy yourself some extra time to score a new place.  Your agent and mortgage pros can help.

Myth #4.  Rates are through the roof.  Have mortgage interest rates gone up?  Yes.  Is the Fed signaling they intend to raise rates, too?  Yes - in 2015.  (Not exactly tomorrow.)

Last week’s reported 30 year mortgage rates were 3.94 percent, and 15-year rates were right around 3%.  Given that the record low rates clocked in at 3.31 (30-year) and 2.62 (15-year), even today’s higher rates are not worth your worry.  Nor is an increase of rates likely to cause all the pent-up buyer demand of the last few years to dissipate.  My Dad used to remind me that people bought homes when rates were 14% in the 80’s, and they will buy them now, even as they inch up – because they need and want places to live.  

Myth #5.  Foreclosures are a thing of the past. Through the recession, many banks and mortgage servicers began to hold hundreds of thousands of foreclosed homes off the market to avoid flooding it, depressing prices even further than they already were. And even now, these institutions continue to trickle them onto the market, rather than creating a deluge of home inventory. Additionally, mortgage regulators now allow servicers to rent out REOs, versus selling them, and to hold them as long as 5 or 10 years following foreclosure, if needed. 

While we are seeing a steep decline in the number of newly foreclosured homes, we can expect to have a higher-than-average number of foreclosed homes – REOs – on the market for some years to come. This so-called “shadow inventory” had declined over 10% nationwide between January 2012 and January 2013.  And with the uptick in demand, we should continue to see this so-called “shadow inventory” of homes decline as banks take the opportunity to get these homes off their books.  

Price it Right the First Time

With house prices increasing across the country, sellers may think they can list their homes at a higher price and adjust if necessary. That may not be a good strategy. This is a post we ran last year by Ken H. Johnson, Ph.D. — Florida International University (FIU) and Editor of the Journal of Housing Research. To view other research from FIU, visit http://realestate.fiu.edu/.

The Research

Are there any negative effects from changing the listing price of a property? This question haunts Brokers/Agents as well as sellers of property every day. At present, there does not seem to be a consensus answer to this question within the professional real estate community. Fortunately, this question was scientifically investigated by John R. Knight. Unfortunately, few know the results of Professor Knight’s research.

In Knight, the impact of changing a property’s listing price is investigated. Additionally, the types of property that are most likely to experience a price change are also estimated. The findings from this research indicate that, on average, properties which experience a listing price change take longer to sell and suffer a price discount greater than similar properties. Furthermore, bigger price changes are found to experience even longer marketing times and greater price discounts. Finally, as for which properties are most likely to experience a price change, Knight finds that the greater the initial markup; the higher the likelihood that any given property will experience a listing price change.

Implications for Practice

Sellers as well as Brokers/Agents should therefore be aware of the critical necessity of getting the price correct from the start. Sellers wanting to over list will ultimately take longer to sell and will sell their property for less, on average, according to Knight. Brokers/Agents’ desire to take a listing and get the price right later will ultimately lead to their working harder according to Knight, and they are not doing their sellers any favors. Thus, an initial and detailed analysis of the proper price is much more critical than many originally thought.

Interestingly, I have found in my own research that the direction (up or down) of the listing price change does not matter. A listing price increase and decrease both lead to similar results found in Knight’s work – longer marketing times and lower prices. Therefore, get the price right from the beginning. It is best for all.

Another Real Estate Bubble???

The recent jump in home prices (near record month-over-month and year-over-year increases reported for May by the National Association of Realtors ) has led to speculation that the rapid surge in home prices could be the sign of a new housing bubble similar to the one that led to the Great Recession.

Is it? The not-so-short answer is, not yet.

Indeed, through May the median price of an existing single-family home has risen by double-digits for seven of the last eight months (and in the eighth, the year-over-year increase was 9.4 percent). For comparison’s sake, note that in the run-up to the collapse in 2006, the median price of an existing single-family home rose by double-digits year-over-year for 11 straight months.

An increase in prices itself does not signal a bubble. An unsustainable increase, not supported by other data, however, would. In the run-up to the 2006 collapse, the higher prices—which had been trending up for four years—led to a sharp uptick in construction wholly unsupported by demographics. Baby boomers were aging, transforming home buyers into sellers, and there weren’t sufficient numbers of “echo boomers” to replace them.

Nonetheless, in the last 12 months, the year-over-year increase in single-family starts has averaged about 26 percent, four times the average year-over-year increase in the 12 months just prior to the bubble bursting in 2006. When housing prices fell when the bubble burst, the construction jobs they supported disappeared along with hundreds of thousands of others as housing wealth vanished, seemingly overnight.

Even though the demographics haven’t changed—the 55-plus population is growing faster than the 25-34 population—builders in the last 12 months have completed 31 percent more single-family homes than they sold. Prior to the housing peak, completions were about 26 percent more than sales, adding to inventories and further depressing home prices.

While the “gap” between completions and sales was wider before the 2006 collapse than today, it has been expanding rapidly, growing in eight of the last 12 months.

So, what happened to the overall economy when the housing bubble burst? As prices and values dropped, so did consumer spending, a function of the “wealth effect.” According to some estimates, the decrease in home values reduced consumer spending by upwards of $400 billion and GDP by about 2.5 percent. That jobs fell as well only made a bad situation worse.

The slowdown in housing prices beginning in 2006 came just as baby boomers—born between 1946 and 1964—were approaching retirement, a time when they might be looking to use their homes as a retirement nest egg, finding themselves with more house than they needed. About a year later, employment began to sag along with wages and salaries, so there were fewer people with less money to spend on buying a home.

Despite the fact we still theoretically have more potential sellers than buyers, which should drive prices down, the inventory of homes listed for sale has remained low. That low inventory, combined with low interest rates keeping affordability high, has driven prices up.

That doesn’t necessarily mean a bubble unless sales increase with the higher prices, and they have even with regulatory changes in the wake of the housing collapse designed to stop banks from making loans borrowers could not afford. Just how effective those changes have been though is still open to question. According to the Federal Reserve’s most recent Senior Loan Officers Opinion Survey , mortgage demand is climbing and more banks are easing lending standards.

Those factors combine to drive prices still higher a cycle which, if incomes fail to keep pace, could inexorably lead to a bursting bubble.

Perhaps more significant than the question of whether we’re in or headed to a bubble and are we prepared for it to burst is what happens if prices again suddenly and dramatically collapse?

Many analysts contend the current prices are justified by low rates, which keep home affordable even as prices rise. This would suggest that as rates rise, prices will move in the opposite direction, a replay of the post-2006 economy. That’s not though what history tells us. If prices fall in response to higher rates, it would mean market behavior has changed, a phenomenon for which we may not be prepared.

Rising prices encourage fewer investor purchases and longer holding times

A recent industry survey found rising home prices are impacting investor activity in a few ways—most notably encouraging them to hold properties longer and to decrease their purchase activity.

The survey, conducted by ORC Internationaland released Wednesday byMemphisInvest.com and Premier Property Management Group, revealed more than half of investors plan to keep their investment properties for five years or more. One-third said they will keep their investment properties for at least 10 years.

Investors in these categories “realize the benefits of rising rents and low vacancy rates,” according to Chris Clothier, a partner at MemphisInvest.com and Premier Property Management Group.

“Cash flow is much more important than appreciation,” Clothier said.

Close to half—48 percent—of the investors surveyed in May said they will purchase fewer properties in the next 12 months than they did in the past year. This is up from 30 percent in the same survey conducted in August 2012.

Twenty percent of survey respondents said they will purchase more properties in the next 12 months than in the previous 12 months, down from 39 percent in the August survey.

Contributing to this trend, “[f]ewer foreclosures, rising property values and competition from hedge funds are making it tough to find good deals on distress sales,” Clothier said.

Rising prices are also affecting the method by which investors pay for their properties, according to Clothier.

Thirty-seven percent of investors said they will pay cash for their next property, up from almost 25 percent in the previous survey.

“Cash sales make sense when prices are rising. They lower investors’ costs,” Clothier said.

The increase in institutional investor activity may appear to be a hurdle for private investors, but the survey revealed a minority of investors—13 percent—have noticed an impact.

Fixed Rates Soar to Highest Level in Years

Encouraging economic data helped lift fixed mortgage rates to their highest level in the past year this week, according to surveys from Freddie Mac and Bankrate.com .

Freddie Mac’s Primary Mortgage Market Survey showed the 30-year fixed rate rising to an average 3.81 percent (0.8 point) for the week ending May 30, up from last week’s 3.59 percent. Since the beginning of May, the 30-year fixed average has jumped up nearly half a percentage point.

The 15-year fixed-rate mortgage ( FRM ) also soared this week, rising to 2.98 percent (0.7 point) from last week’s 2.77 percent.

Adjustable rate movements were mixed. The 5-year hybrid adjustable-rate mortgage ( ARM ) averaged 2.66 percent (0.5 point) this week, up from last week’s average of 2.63 percent. The 1-year ARM averaged 2.54 percent (0.5 point), a slight drop from 2.55 percent in the last survey.

“Fixed mortgage rates followed long-term government bond yields higher following a growing market sentiment that the Federal Reserve may lessen its accommodative policy stance,” said Frank Nothaft, VP and chief economist at Freddie Mac.

“Improving economic data may have encouraged those views,” he added, referencing the week’s reports of increased consumer confidence and strong home price gains .

Bankrate’s weekly national survey saw the 30-year benchmark rate rising to 3.99 percent, an increase of 25 basis points week-over-week. The 15-year fixed was up to 3.21 percent.

Meanwhile, the 5/1 ARM rose more than a tenth of a percentage point to 2.81 percent.