The Housing Bubble

A weekend look at housing supply and demand starting with the Lincoln County Journal. “We keep hearing how low inventory is in today’s housing market, but why is that the case? New Construction– Though housing starts were up 12.4 percent in 2015’s first quarter, homebuilders are constructing new single-family homes at a 680,000 annual rate, which is roughly 400,000 units below historic averages. So all builders have to do is up their construction and our inventory problems will be solved, right? Well…not necessarily.”

“The relatively low rate of new construction is a common target of industry analysts (NAR has especially harped on that point), but we think the problem is more insidious than that, and for a number of reasons. For one, new construction has responded to consumer demand and shifted towards multifamily developments in a major way, with 90 percent of those units being intended for rentals; so new construction is higher, but it’s not as top-heavy for single family as it used to be.”

“Two, the vacancy rate for new single-family homes remains historically high, so builders are keeping their construction numbers in check (indeed, some have argued that today’s level of construction is even too high).”

“And three, the new construction that does make its way to the market, on both the buying and renting side, is intended almost solely for more affluent consumers (and is therefore unaffordable to most consumers). Why? Simply, builders are limiting their products for safer terrain, aka the more affluent consumers who can absolutely buy what they are offering. So yes, new construction is low by historic standards, but for very precise (and deliberate) reasons.”

“Exclusionary Inventory – Finally, even when housing inventory has increased, it has not done so in an equal manner. In the first seven months of 2014, housing inventory jumped 18.5 percent over 2013; yet, according to a Redfin study of that increase, those gains were exclusively for higher-priced listings. So while the inventory of homes priced $549,800 and above rose 15.6 percent, the inventory for homes priced $227,500 and below fell 15.7 percent.”

From Quartz. “Across the country a wave of dual-income couples and down-sizing baby-boomers are skipping home ownership and choosing apartment living instead. Meanwhile, other renters—who have a median household income less than half that of homeowners—are finding that fewer and fewer homes fit their budget. Developers have responded by flooding the market with new apartments—nearly 250,000 were completed in 2015 alone.”

“However, those who hope the building boom will provide shelter for the huddled masses are in for a nasty surprise: Three out of every four new apartment buildings are luxury designs targeted at high-end renters. Housing data compiled by RentCafe, a rental search company, track completion of all new apartment buildings with 50 or more units. These buildings are graded based on presentation and amenities. The top two grades are classified as ‘luxury,’ indicating that they are primarily targeted at those who choose to rent, even though they could afford to buy. Last year there were 895 such buildings completed in the US, up 134% from 2012.”

From Bloomberg. “Central banks may be partially to blame for the misperception that economic conditions will be materially better than they are now when inflation is higher, contends Citigroup Inc. Global Head of G10 FX Strategy Steven Englander. To the extent that this true, it probably has much to do with the increased emphasis the Fed has placed on the wealth effect as part of the transition mechanism by which unconventional accommodation boosted activity when policy rates approached zero.”

“Asset price inflation, improving Americans’ aggregate net wealth in the process, has been an explicit goal of Fed policy.”

“This combination of low interest rates and large-scale asset purchases laid a solid foundation for the improvement of household balance sheets that occurred during the recovery. But it can’t do much to spur a higher trend rate for real growth. ‘It may be more accurate to say that the economy at 2 percent inflation will be as good as it gets, but as-good-as-it-gets may be very mediocre,’ Englander concludes. ‘Expectations of currency strength and asset market stability are likely exaggerated as well.’”

The American Enterprise Institute. “If anything, this election cycle has revealed the anger and frustration on both sides of the aisle with an economic and political system that many view as rigged. Maybe nowhere more so than in the housing finance ’system’ do the people have a point. After all, the deck is stacked against low- and moderate-income borrowers due to to rent-seeking behavior of special interest groups such as the National Association of Realtors (NAR), which government loan guarantee agencies and regulators are all too willing to accommodate.”

“The resulting loans enable borrowers to buy more expensive homes than they can truly afford, typically through minimal downpayments, underpriced mortgage insurance, or monthly payments too high in comparison to the borrower’s income. These various forms of excessive leverage continually set the little guy up for failure.”

“The fundamental problem in today’s government-centric housing finance system is a supply-demand imbalance that works in favor of homeowners who see their assets appreciate faster than wages and inflation. According to S&P/Case-Shiller, house prices are now over 30% higher than four years ago.”

“Who else benefits from higher prices? Realtors. That is why the NAR, whose sole mission is to ‘help its members become more profitable and successful,’ keeps pushing for even more demand against a constrained supply, which will ultimately drive prices even higher and make commission checks even fatter.”

“Who benefits from more demand? The Federal Housing Administration (FHA) — which is in the business of providing loans to primarily lower-income borrowers — was able to overcome its chronic funding shortfall by expanding demand through a mortgage premium cut that not only drew in new borrowers by providing them with more leverage, but also poached from other agencies.”

From Reuters. “Conventional wisdom maintains that the bubble in UK home prices is due to inadequate supply. Conventional wisdom is wrong. Despite tough British planning laws, the shortage of housing across the country is not acute. Overvaluation is largely the result of ultra-low interest rates. London property prices have also been boosted by foreign capital inflows. Low interest rates may be with us for a while. Global capital flows, however, are prone to sudden reversals.”

“A better explanation for high house prices is that interest rates are incredibly low. Over the last 15 years, falling interest rates have reduced the cost of buying a house with borrowed money. Land and home prices have climbed. This all suggests that Britain’s housing crisis is largely the consequence of the extreme affordability of mortgages. This conclusion is confirmed by the behavior of other housing markets around the world where interest rates are also at abnormally low levels.”

The New Zealand Herald. “Government ministers seldom lose an opportunity to lambast Auckland Council, as Housing Minister Nick Smith did again at the weekend, for inhibiting residential development in and around the city. It is convenient for the Government to attribute the price of houses entirely to a lack of supply because it enables it to avoid taking effective action to reduce demand for investment homes. It is an argument that makes the Government popular with home owners who have already invested heavily in multiple houses, for it not only relieves them of effective taxation but promises to supply Auckland with many more potential investment properties.”

“The pace of house price rises cannot be slowed just by building more houses, particularly more ‘affordable’ houses. Those are exactly the stock investors are looking for. The cheaper the house for its location, the better the likely capital gain. There is no limit to the demand for speculative property in and around Auckland, and making more land and housing available will only add more fuel to the fire.”

“Obviously Auckland’s projected population growth requires a much greater rate of house building than we have yet seen. But the problem does require a multi-pronged solution. Whatever the source of the demand for Auckland houses, it will remain insatiable if the Government pretends it is purely a problem of supply.”