A Picture of Stagnation
No reason to sell. No reason to buy. That about sums it up. Unfortunately, that is about as optimistic a scenario as I can come up with, supported by equally optimistic growth expectations. In reality, the market has no support. We can only hope that it will not crash at the first sign of trouble.
In a flat market, real estate transaction costs are prohibitively expensive. Commissions, closing fees, loan fees, mortgage insurance, transfer taxes and recording fees can easily add up to 8% or more, depending on where you live. Add a few trips to Home Depot or Ikea and the out of pocket expense of a move can be over 10%.
In the coming year, or years, many home owners are going to find that they do not have the equity to pay for a move. At a low or no appreciation rate, it will take years to build up enough equity just to break even. Some who financed their purchases in recent years with low down payment programs will have to incur out of pocket expenses in order to sell. Others may find that their existing homes have not appreciated enough to offset the expenses, providing little down payment and incentive for the trade-up.
What percentage of the millennials is stuck in jobs, versus careers? How many are waiting on tables while figuring out what to do with their masters degrees in anthropology? These are not home buyers. Not only do they lack the financial means, they need to be mobile so they can pursue career opportunities wherever they may find them. There are no cradle to grave companies left in the world. Mobility is far more important today than ever. Pride of ownership may become a major obstacle, blocking career moves.
On the other side of the spectrum – the boomers – are equally restricted. Many are reaching retirement age and finding themselves financially unprepared to enjoy their golden years. Never mind that second home they dreamed about ten years ago. If they are fortunate enough to have a home, with equity, they can ill afford to blow away a chunk of that equity just to move from miserable Pittsburgh to equally miserable but sunny Miami.
Stuck in the middle are the working class poor of today, as they watch their aging parents and their boomerang kids fight over the room on top of the garage, with free board. They are not moving anywhere.
$ 1.74 trillion in mortgage backed securities piled up on the Fed’s balance sheet – click to enlarge.
Meddlers with Nothing Left and the New Normal
Real estate financing is a simple math problem. The real estate market is heavily subsidized by the Fed’s QEs, which are supposedly ending. Mortgage rates are at all time lows, around 4%. If rates go up by just 1%, mortgage payments will increase by over 12%, offsetting any appreciation in real estate prices and/or increase in household incomes. Any upside in real estate is capped by the removal of Fed accommodation.
On the down side, there are no more QEs that can benefit the real estate market. Just imagine the circumstances that would force the Feds into more action. Economic conditions would have to be deteriorating. So would you want to buy into that market, assuming you have the means?
The 30 fixed rate mortgage has been on a steady decline all year, from above 4.5% to below 4% today. In spite of these favorable rates and very easy comparables against a dismal 2013, real estate prices barely appreciated in 2014. What if the prices depreciate? The interventionists have nothing left. If mortgage rates were to go down further from the low levels of today, I would hate to imagine how bad the global economy would have to be.
Average 30 year fixed mortgage rates since 1971. Scraping along near the lowest levels ever.
In the meantime, supply and demand in the housing market are mismatched. Builders continue to build where they can. For proof, look no further than Las Vegas, Phoenix or non-coastal California. They are replenishing the REO inventory of tomorrow. Redeveloping city centers will be more attractive to the changing life styles of the millennials, and to provide support services for the aging boomers. Unfortunately, these projects prove to be too difficult and may be politically infeasible.
In summary, the real estate market is changing along with ever changing demographics, as well as the changing economy. There are always good reasons to own a home, a place to raise a family. However, home ownership via extremely leveraged financing carries enormous and unprecedented risk. I think many potential buyers recognize the risk and are correctly staying out of the market. The new normal in real estate terms is unlikely to be what the market is hoping for.