How to increase home prices in the face of stagnant household incomes.

It is easy to get swept into the momentum of the housing market. The Federal Reserve has managed to push interest rates to historically low levels creating additional buying power for US households. As we enter the slower fall and winter selling season, there is unlikely to be any major changes until 2013 as the election year concludes. We do face major challenges ahead. This current momentum in housing isn’t being caused by flush state budgets or solid wage growth. No, this is being caused by low inventory, big investors crowding out households, and a concerted effort to push mortgage rates lower. If you simply follow the herd, you would think that prices are now near peak levels again (or soon will be) and household incomes are hitting record levels. Let us examine where things stand today deep in 2012.

California and nation

california and us home prices

It is clear that 2012 has pushed home prices higher overall. This has occurred both on a nationwide basis and also for California. Yet California home prices are far away from that peak reached in 2006. However, some mid-tier markets never really corrected and we are now seeing flippers selling homes for prices that are near peak levels. The argument is that overall things corrected but then this is applied to niche areas where prices are now back near peak levels (at least with the current prices being seen with some flips). The low inventory and the narrative that the bottom is here is causing a flood of people to buy especially with low interest rates. In lower priced areas, a good portion of the market is being over bought by Wall Street and big money investors. This is still anything but a normal market.

US home prices

us home prices oct 2012

It is evident that US home prices have hit a new trend in 2012. Prices are moving up. Yet the driving force behind this is low interest rates, low inventory, and the high amount of investors buying up properties. Keep in mind that low interest rates and especially investment buying is finite. This money will dry up. In housing what you want to be seeing is sustainable appreciation in combination with rising household incomes and a healthy employment market. Those should be the driving forces instead of the Fed committing to another $500 billion of MBS purchases via QE3.

Median household income

median household income

This is the one argument that is always missing from the home boom 2.0 narrative. Is it possible to have sustained rising home prices when household incomes are falling or stagnant? It isn’t and the Fed and banks are fully aware of this. So the Federal Reserve has decided to push affordability via low rates as far as they can. It is a win-win for the financial industry. They can unload properties at much higher prices courtesy of the low interest rate. Some people think this comes at no expense. It does. Carrying a negative interest rate is pummeling those on fixed incomes and also, with one out of seven Americans on food stamps many are seeing those monthly deposits not going so far when they go shopping for food. Ultimately the cost is being shouldered by those who can least afford it. Ironically this flood of investors has also pushed rental prices higher as well creating a double-whammy.

LA Tiered home prices

la home tiered prices

Probably one of the better measures of price is the Case Shiller Index. This looks at repeat home sales so we are measuring apples to apples. The median price is also important but it is prone to changes with the mix of sales. Right now, the big drop in foreclosure resales is causing prices to surge. Yet it is important for trend shifts and also because the media and the public rely on this for their purchasing behavior. As you can see from the chart above, each tier in Los Angeles County has shifted up a bit. We are far from peak prices and given the mania in certain areas, you would think this would be rising much faster. You are not missing anything. For those thinking they are missing something you might as well go to Las Vegas and try your hand at the tables. There is a mini mania in prime areas of California happening right now. As you see from the above charts, household incomes simply do not justify this movement. The momentum right now is in favor of higher prices but for fleeting reasons.

Home sales and trends

home sales

If things are so hot, why are home sales not running at a higher pace? The 12 month moving average is running a little bit higher than 35,000. This is the pace we’ve had since 2009 when the market was flying off a cliff. From 1998 to 2007 the moving average was above 45,000 sales per month. So what really is going on then with prices rising so fast overall? The explanation comes from a few items:

-1. Inventory is low (we even hear complaints from real estate agents about this) -2. Low rates increased leverage in the face of falling incomes (refer to earlier chart) -3. From the bottom everything is higher (the increase is big from the bottom but put into context, still has us way below the 12 month moving average from over a decade ago) -4. You are competing with big money investors

This is why sales are not exactly off the charts given all the favorable elements that are being perceived. For this market to continue on this path, nothing from the above can be removed. Keep in mind that with the “fiscal cliff” some items on the table include the mortgage interest deduction cap. This will hit California hard especially in these mania locations. There is no reason for the nation to allow mortgage interest deduction above a certain level (i.e., $500,000 or capped at certain income levels).

“(LA Times) But since only about one-third of taxpayers itemize on their returns — the rest opt for the standard deductions — who's really getting these tax savings? As you might guess, people who have higher incomes are more likely to itemize and claim mortgage interest and other housing deductions. Citing the latest data on the subject, published by the IRS in 2009, Kolko found that only 15% of households with incomes below $50,000 took itemized deductions, while 65% of those with incomes between $50,000 and $200,000 did. Just about everybody with incomes above $200,000 — 96% — itemized on their returns.”

And guess who was number one on the list?

“California ranked No. 1 in the size of home mortgage deductions, with $18,876 on average. Next came Hawaii ($16,730), the District of Columbia ($16,720), Nevada ($15,502), Washington ($14,262), Maryland ($14,162) and Virginia ($14,094).”

There is little reason for the mortgage interest deduction to allow for such a large write-off especially when the typical US home price ranges from $150,000 to $170,000. We are in massive debt and for the nation to subsidize expensive California housing does not make sense.


Mortgages underwater

Even with home prices moving up we still have over 9,000,000 underwater homeowners. This is a sizeable number. The above chart highlights underwater mortgages at various increases or decreases in home prices. The distressed inventory is still large but is decreasing. The thing with the housing market is that it largely isn’t a market anymore. So with all of these market incentives and the fiscal situation looming next year, there has to be a catch. We have yet to see household incomes increase. The economy is still on shaky ground. Yet in many pocket markets you have people ignoring the macro economy and just running around their little enclaves with blinders on. Hot money is flowing in. There is no doubt about that. Yet it is not sustainable. Since election years usually produce very little change, we’ll have to wait until 2013 to see if this trend actually has some real teeth. Do you think household incomes are important when it comes to home price?

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