Posted tagged ‘real estate’

How Much of Housing’s Recovery Depends on Interest Rates?

October 11, 2013

Low interest rates did much to float the housing bubble of the 2000s, but like all bubbles the higher pressure inside the bubble eventually caused it to burst as it rose higher and encountered the  thinner atmosphere at high elevations.  Recently, even lower interest rates (lower than those that helped create the bubble) have significantly helped the housing recovery .Median price and Mortgage Rates

I haven’t written about the housing market lately because you can only jump off the “booming housing market” bandwagon so many times before people start wishing it causes you a fatal injury.   I won’t jump off the housing recovery bandwagon this post so much as I will move to the back of the wagon.  There is a nice modest recovery occurring in New Hampshire’s housing market.  It is not the boom that some national headlines indicate,  or even as strong as some data on median sales prices in New Hampshire would suggest, but the market is recovering.  CoreLogic’s home price indices show New Hampshire prices appreciated at about 5% over the past year.  Not bad but still 30 states had greater home price appreciation.  Home prices in the Granite state remain almost 17% below their peak levels and in only 12 states to prices remain  further below their peak levels.

Population growth (largely through in-migration) appears to be resuming again in New Hampshire and as household formations and job growth accelerate the market should improve at a faster rate.  Housing affordability is as high as it has been in decades.  The chart below shows a housing affordability index, or how  the monthly income of a NH household at the median income in the state relates to the monthly principal and interest costs of buying a home at the median price in the state.  When the index is above one, the index shows that the “typical” household with income at the state median, has more than enough income to cover monthly principal and interest costs (it says nothing about whether they have enough to make a 10 or 20% down payment to make the purchase or the ability to qualify for a mortgage).  The chart also shows how affordability changes at higher interest rates, indicating that for every 1% rise in mortgage interest rates, affordability declines by about 10%.

affordability index

The final chart shows how dramatically the combination of lower prices and falling interest rates affects the monthly principal and interest payments required to purchase a home in New Hampshire at the median purchase price and prevailing interest rates.   The chart also shows how the monthly principal and interest payments on a median priced home in NH would have been affected by interest rates that were 1% and 2% higher than they actually were.  The chart shows how significant changes in monthly payments can be at higher interest rates.  The impact of interest rates on monthly payments is more dramatic when home prices are higher so lower prices in this case suggest that an uptick in rates may have  somewhat less  of an impact than in the past.  Nevertheless the impact on affordability and prices of higher interest rates will be clear.

monthly pruchase costs and interest rates

A key question is how much of the recent rise in prices is the result of a genuine increase in effective demand for homes and how much is the result of the capitalization of interest rates into the purchase price (when rates are low sellers can get higher prices and still keep housing affordable but when mortgage rates are higher sellers must charge less to keep the same level of affordability).  For certain we know that more homes are being purchased, what we will find out, if interest rates continue to rise, is how much of that and sales prices are driven by low interest rates.  In new Hampshire this is especially critical because we have a relatively high percentage of homeowners with negative or near negative equity in their homes and changes in interest rates may determine whether or not they can sell their homes without incurring a loss.

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Spotting Bubbles After They Burst

October 25, 2012

I’ve lived through two housing bubbles since I was old enough to know and care about them.  During the first one I was writing quite unpopular reports for developers and lenders (I’m still not very popular with realtors) that  indicated, to me at least, that the “effective demand” for housing in many areas just would not support a viable project (based on the fundamental underlying determinants of the demand for housing – population, employment, and income growth as well as new household formations).  I did not understand then nor do I do now, how an industry (home building) can survive when so many decisions it makes are made with a view toward the immediate past (what sold last week or month and at what price).  Of course everybody, including me, recognizes a bubble after it has burst.  But there really is no substitute for understanding the fundamental underlying demand for housing in a region or community when making a decision about building or buying housing.  Few have the patience or knowledge to assess the “effective demand” (the willingness AND ability to purchase) for housing versus the desire to purchase based on the current sentiment about the housing market.  Potential home buyers are not likely to get that understanding from a real estate industry that can make money from a purchase regardless of whether the purchase increases in value or not.   It is easy to see the “effective demand” for housing and the real conditions of the market after the fact, as with the many charts I see that show how  the relationship between home prices and household incomes in a region was widening prior to the last housing market crash.  Its a great way to make a call after the game is over.  Household income data is reported with a lag of more than a year for smaller areas, is subject to a significant margin of error, and may likely be revised sometime  down the road.

There really is no substitute for understanding the fundamentals but a quick and easy way to get a sense of where the home buying market is, is to look at the ratio of the monthly cost of purchasing a home (at the average selling price) versus the monthly cost of an average rental.  Both selling and rental price data is readily available in NH from, among other sources, the NH Housing Finance Authority which regularly does rental price surveys.  The chart below shows the ratio for NH going back to 1990.  The ratios can be calculated for sub-areas of the state and for communities as well.  The ratio is not a substitute for a thorough analysis of “effective” or fundamental underlying demand that all home builders should undertake, but for home buyers, it clearly shows that when the ratio gets above 130% or 140% (which can be determined with a data lag of only a few months at most) a bubble is likely forming.


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