Whether it is 'cover' for the all-too-obvious collapse to come (when another round of ratings agency litigation will take place as blame is apportioned) or more likely a 'fool-me-once...' perspective on reality, Fitch has a new report blasting the "unsustainable" jump in home prices, adding that "the extreme rate of home price growth is a cause for caution." While they note, rising prices are a positive indicator for a recovery, Fitch adds that unprecedented home price growth should be paired with economic health that is similarly unprecedented, the evidence for which is lacking in this case.
Based on the historic relationship between home prices and a basket of econometric factors, Fitch considers estimates national prices to be approximately 17% overvalued in real terms (Bay Area home prices to be nearly 30% overvalued, which approximates the environment in 2003, three years into the formation of the previous home price bubble) - as "speculative buying, not increasing demand" is driving the market. Between this 'speculation' and interest rates, affordability is "strained."
As a whole, the signs of a strengthening economic recovery are present, with momentum continuing to trend in a positive direction. Fitch expects these trends to continue, although the high rate of home price growth is not considered to be sustainable. Currently, Fitch’s Sustainable Home Price Model estimates national prices to be approximately 17% overvalued in real terms, with individual geographic regions varying widely.
Based on the historic relationship between home price levels and the primary drivers of supply and demand in the market, there is a misalignment. A continuing recovery and exuberant home-buying population could well push prices further for many more quarters, or even years. However, Fitch identifies a bubble risk in continuing price rises and sees several factors which could halt or even reverse recent gains in the market.
Interest rate concerns are rising...
The NRI, which measures the relative default risk of a constant quality loan as compared to average originations of the 1990s, has risen in two consecutive quarters, showing a rise for the first time since 2007.
Currently at 1.14, the NRI implies that the default risk of a loan originated today is 14% higher than the 1990s average. Since the peak in early 2007, risk has been declining for newly originated loans as the bubble unwound and prices reverted towards historic averages. On the back of the abrupt price rises across the country and interest rate rises which are expected to limit prepayment speeds for the next several years, the NRI has now increased.
...the extreme rate of home price growth is a cause for caution. Prices remain below the pre-recession peak, but the region never saw the extent of declines that much of inland California did, and prices never fully unwound the effects of the bubble. In San Francisco, prices hit a bottom in 2009 at nearly 125% above 1995 prices and have grown another 30% from that point. In San Jose, prices are up 48% from their post-crash trough and are now only 11% away from setting new highs.
Of course, rising prices are a positive indicator for a recovery and the growth is encouraging to a region that has seen the largest up- and down-swings in the housing market over the past few decades. However, Fitch expects that unprecedented home price growth should be paired with economic health that is similarly unprecedented, the evidence for which is lacking in this case. Based on the historic relationship between home prices and a basket of econometric factors, Fitch considers Bay Area home prices to be nearly 30% overvalued, which approximates the environment in 2003, three years into the formation of the previous home price bubble.
Most concerning, there is growing evidence that recent gains have been bolstered by an increase in investment sales, both to institutions and local investors.
Cash sales are often indicative of investor behavior and the concern is that housing prices are being driven up more through speculative buying than from an increasing base demand.
Typically, bubble cycles form when an initial catalyst causes prices to rise and the increase in prices drives investment activity to the market, hoping to cash in on the rising prices. As investment activity increases, demand builds artificially, reflecting a level of demand that fluctuates drastically with the growth rate of prices instead of long-term demand based on housing necessity.
And yes... a rating agency - the same entity that enabled the last housing market crash - just warned of a housing bubble. How the times have changed - maybe it is different this time?