January 28th, 2014 2:40 PM by Eileen Denhard
Since the height of the housing bubble, the number of renter households has grown by 5.5 million (from 2006 to 2013), while the number of home-owning households has fallen by 1.5 million. This shift has pushed the homeownership rate down to 65 percent from the peak of 69 percent several years ago. Some of the adjustments were clearly needed and expected since borrowers with scant credit history or with negative-equity stakes from the get-go (LTVs of 105 percent) should not have been given mortgages in the first place. At the same time, the excessively tight underwriting standards of recent years have held back a number of solid renters - who could have turned into successful homeowners - from realizing their dream of ownership when home prices were low and mortgage rates at unthinkably low levels. Even so, largely because of investors who are bypassing mortgages and offering all-cash deals, home sales notched up two straight years of gains, cumulatively by 20 percent, while home prices still are rising at a fast clip of double digit rates of appreciation in many parts of the country.
The recent respectably strong gains in home sales and home prices, however, are ending. Pending home sales had fallen for a fifth straight month up to October. The housing affordability index has fallen to a 5-year low (though it is at the fifth highest level in nearly 50 years). Affordability conditions will likely further tumble southward next year as the average on a 30-year, fixed rate mortgage will probably cross the 5.5 percent rate by the end of 2014 after having hovered at 3.5 to 4.5 percent for most of the past two years. The Federal Reserve simply cannot pursue quantitative easing – that is, the printing of money to buy bonds – forever, even though both the current chairperson Ben Bernanke and the incoming chairperson Janet Yellen have said that the monetary policy will be as accommodating as needed. The ideal Fed goal would be to leave the monetary spigot open until the unemployment rate reaches 6.5 percent, provided inflation is not a problem.
However, inflation could start to be a problem. The headline Consumer Price Index (CPI) at 1 percent annual inflation to October is clearly not a worry. The headline is always influenced by sudden swings in energy prices, which have fallen after summer. But a closer examination of the core inflation on rent and homeowner rent equivalence is yet to be tamed and in fact, will probably inch higher with each passing month. The renter’s rent component of CPI rose at 2.8 percent in 12 months to October while the rent that homeowners would hypothetically charge on their home accelerated to 2.3 percent, the fastest growth in nearly 6 years. Any reversal in energy prices or neutral price movements on other consumer items could then kick the broader CPI to above a 2-percent inflation rate. The Fed views 2 percent as the implicit red line not to cross. In short, inflation should not be dismissed and the Fed will have to taper its quantitative easing soon … as in, the first quarter of 2014. That, in turn, will force up mortgage rates as projected above.
Given that the housing sector has historically been one of the most sensitive sectors to changes in interest rates, an inflation threat, even a mild one, is not a welcoming one. However, there are compensating factors that can propel home sales even in a rising interest-rate environment. First, the underwriting standards may return to normal from the strict conditions of today. Why? The banking industry is flush with cash. That extra cash came from raking in profits from the active mortgage refinance business of the past two years. Unfortunately though, the refi business will collapse to a 15-year low in 2014 as mortgage rates rise. Lenders will have to look for other revenue sources, and one business line not fully harvested is in mortgages for home purchases. A simple review of the accounting statement will show outstanding loan performances on those mortgages originated in the past three to four years. Homebuyers bought a home at a bargain price and they are now enjoying nice equity gains. Homeowners do not default when home prices rise. And there is little prospect for any nationwide home price decline given the inventory shortage conditions. Therefore, lenders are almost sure to opening up lending for home buying.
The only hurdle is whether Washington policymakers will allow it. There are a bevy of new rules and regulations going into effect in 2014 – from QM and QRM to a three-percent cap on lender fees and the possible elimination of Fannie and Freddie without a proper alternative system that can continue to attract capital for homebuyers. Another new development that is eating up bank capital with no evident benefit for Main Street is the numerous lawsuits being thrown at the banks. No doubt, some cases are to recover from legal wrongs. But other lawsuits could be on shaky legal ground that only raises uncertainty for lenders and takes away capital that could have been available for mortgage underwriting. Let’s hope Washington steps out of the way and the Department of Justice does its proper due diligence and allows the housing market recovery to take place.
Another factor that can greatly counter the impact of rising mortgage rates is job creation. From the low point several years ago, over 7 million net new jobs have been added to the economy. Each new hire brings about a potential new homebuyer. Those states with better job creations will, therefore, do better. North Dakota, Utah, Idaho, Texas, and Colorado head the list of top job creating states. Minnesota, Georgia, Washington, Arizona, and New Jersey are right behind.
All in all, existing home sales in 2014 will be essentially the same as in 2013. The median home price, however, will be modestly higher.
Lawrence Yun is the chief economist for the NATIONAL ASSOCIATION of REALTORS®. He will be sharing his insider insights on the national and regional housing markets in this new, exclusive column for the Power Broker Report.