Advertiser Disclosure

Housing Recovery? The Housing Boom Arrives

June 10, 2013
Investing
At NerdWallet, we adhere to strict standards of editorial integrity to help you make decisions with confidence. Some of the products we feature are from our partners. Here’s how we make money.
We adhere to strict standards of editorial integrity. Some of the products we feature are from our partners. Here’s how we make money.

House prices are on the rise again – especially in areas hit hardest by the 2008-2009 collapse. But this time it’s not because the small and unsophisticated investors are jumping in. Now it’s more experienced, more sophisticated investors – including many Wall Street investors and hedge funds. Colony Capital and The Blackstone Group are backing up the proverbial truck, spending hundreds of millions, and buying up houses and condos by the tens of thousands.

Yes, hindsight is always 20/20. But now even the dumb know that the house price bubble of the mid-2000s was fueled by dumb money. And the dumb know it because they’re the ones still smarting.

One key difference: While the small-time homebuyers were leveraged 5 to 1 or more to buy houses (frequently on flimsy documentation or no-doc loans), these professional investors aren’t so deeply leveraged themselves. Blackstone borrows 78 cents per dollar of assets, for example.

As a result, housing investment – as measured by the percentage of houses being bought by investors – is on the rise, along with home prices.

In a parallel development, stock prices have enjoyed a rise – jumping over 17 percent in the first five months of the year, before a modest pullback the first week of June.

Is there a spillover effect? There has to be.

A lot was written during the housing boom – and the Internet boom before that – of the ‘wealth effect.’ People were able to leverage their rising home prices to fuel consumption: They used home equity loans to buy SUVs, high-end home theater systems, boats, trips to Europe, and all the other trappings of wealth – all depreciating assets, if they were assets at all. If they didn’t borrow against home equity directly they were simply more comfortable spending their incomes, secure in the fantasy that their home was a reliable wealth generator. The increased consumption fuels increased production, factories and transportation companies hire people and put them to work. The employed want nice houses, and so the economy hires construction workers to build them.

The wealth effect of house prices is particularly strong because increasing house prices contribute to worker mobility. Think about it: If you are upside down in your house and lose your job, you cannot relocate to take another one without coming up with cash at closing. When houses are deeply underwater, it disrupts the labor market, and capital cannot be allocated efficiently, because the most productive potential enterprises have a hard time getting skilled workers from around the country. They go without, or go with second stringers – and workers languish on unemployment benefits.

As house prices recover, workers become unshackled from their homes, and are free to relocate to seek opportunity elsewhere. 

So it makes sense to see a rise in stock prices. But consider how we got here:

The Federal Reserve has kept its foot on the accelerator for years, pushing mortgage rates to the unprecedented sub-4 percent level. The Fed has also gone Hell-bent-for-leather in money creation, crediting reserve banks not just for Treasury bonds they sell to the Federal Reserve, as has been the practice for generations, but also for nearly any financial asset they have under QE3 – the monetary equivalent of urinating in the radiator and getting your wife and kids out behind the car to push it.

In a normal economy, these policies are highly inflationary. But this isn’t a normal economy. Interests stayed low for so long because investors were so spooked by the near collapse of 2008 that they feared a deflationary spiral more than inflation. And as long as the Eurozone was the basket case that Thatcher predicted, this worked out ok. Capital still flowed to the U.S. from Asia and Europe because the alternatives were even more risky.

How long can that last? Well, the canary in the coal mine, for inflationary predictions, is long-term debt. That means the interest rates that mortgage lenders demand, because there isn’t much that’s longer-term than mortgages.

A sustained period of modest expansion in house prices would be nice. But there are some early indications that the smart money, if not heading for the exits, has at least asked the waiter to bring the check. That doesn’t mean the end is imminent, necessarily. There is a lot of money still looking for a home. China, for instance, is still looking for a safe place to invest the savings of a rapidly growing economy with a prodigiously high savings rate – and U.S. real estate is a likely home for a sizeable chunk of it.

Reproduced with the permission of Mortage-X.com – Original graph here.

 

As you can clearly see, something happened in early May that prompted mortgage markets to predict inflation or its result – higher interest rates – in the future. Yes, rates are still very low, by historical standards. But people buy houses based on payments, not on price (this is dumb, but this is reality). Higher interest rates are going to have an effect on the loan amounts buyers can qualify for.

It’s not just the 30-year mortgage borrowers experiencing rate hikes. The rate increases were confirmed by the yield increase on the 10-year treasury, with yields climbing by 46 basis points over the month of May.

It’s simply an illustration of the self-correcting effects of well-functioning markets. It’s tough for people with spotty credit to get a mortgage. However much complaining this causes, this is as it should be. Inflationary fears are finally beginning to discipline bond markets – again, as it should be. This doesn’t set either housing or stocks up for a meteoric rise. But we shouldn’t wish for such things.

 

 

Read More From NerdWallet: