By Mark Hanson Of M Hanson Advisers
Bottom Line: House prices and end-user, shelter-buyer fundamentals have never been further apart in key, economically significant cities.
The two charts presented in this note highlight just how diverged house prices have become from end-user, shelter-buyer, employment and income fundamentals in the most populated, economically significant US cities.
I maintain that House prices are always drawn to the purchasing power — or, economic strength — of the end-user, shelter-buyer cohort, as the dominant, permanent demand driver.
But, sometimes House prices, like other asset prices, go through periods of separation from end-user, shelter-buyer cohort fundamentals. And based on the most recent data of incomes, mortgage rates, and House prices in key cities around the nation, house prices and end-user fundamentals have never been further apart. Even in Bubble 1.0, the divergence wasn’t this bad because exotic loans, which were the incremental driver of House prices, made for legitimately low monthly payments.
Some positive or negative divergences can be solved through lots of time, as the economy shrinks or grows. But, over the past several years, as the economy barely grew each year, house prices soared at a pace that exceeded Bubble 1.0 in most regions.
As such, it’s reasonable to assume that the massive divergence in most key metros has been driven largely from the three things that just so happen to be present in all bubbles throughout history; SPECULATION, LEVERAGE, AND EASING CREDIT STANDARDS, regardless if on an individual, corporate, financial market, or Gov’t level.
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THINK ABOUT IT THIS WAY…
If everybody had to buy a house the exact same way — say, with a 30-year fixed, fully-documented mortgage and 20% down — HOUSE PRICES could never detach from the end-user, shelter-buyer employment and income fundamentals for a particular region. In other words, HOUSE PRICES would be attached to and track these fundamentals, perfectly.
But, in times, of increased speculation, leverage, and declining credit standards, the end-user, shelter-buyer employment and income fundamentals get drowned-out and asset prices attach to the incremental spec and high-leverage drivers. How long and far asset prices are driven by the incremental, spec and leverage drivers determines the scope of the divergence and ultimately the possible downside risk in an asset class.
For housing, in particular, using these data, I can easily calculate the potential HOUSE PRICE downside in each area.
Bottom line: This massive HOUSE PRICE/fundamentals divergence will close at some point, either from surging wages, plunging credit standards or rates (make monthly payments less), falling HOUSE PRICES, or a combo of all three.
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Onto the data.
A big problem with house prices experiencing even a “moderate” correction of 10% to 20% — already underway in many of the most over-priced regions — is with between 40% and 50% of all house purchases for years being of the “less than 10% down” variety — and because it takes 8% to 10% equity to sell plus the 3% to 10% down payment on the new house — it doesn’t take much downside to swamp the nation in “NEGATIVE EQUITY” once again. And we know for certain that many homeowners rather pay their credit cards and car payments before their mortgage when they are underwater.
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ITEM 1) Household income INCREASE needed to Buy the Median Priced House in Key Cities.
Bottom Line: On a “national” basis the divergence isn’t too bad…6%. But, in the key cities that drive the US economy, Bubble 2.0 has blown large. This represents significant downside, especially in the sand states, just like in Bubble 1.0.
ITEM 2) DIVERGENCE between Actual Household Income & Income Needed to Buy the Median Priced House.
Bottom Line: Here too, on a “national” basis the divergence isn’t too bad…-6%. But, in the key cities that drive the US economy, Bubble 2.0 has blown large.