As home prices continue to climb and housing construction is on the rise, many people are beginning to wonder if this housing recovery is too good to be true. There are 3 main concerns: 1. the gain on demand owes to investors and international buyers, which suggests it is fleeting, 2. the Fed’s QE3 is creating another housing bubble and 3. the home building industry is not prepared for a gain in construction which explains the fall in sentiment.
Focusing on the first factor, investors have played a key role in spurring the housing recovery. In markets like Phoenix and Atlanta, investors have made up a disproportionate share of sales by buying properties in bulk. By doing so, they’ve cleared out excess inventory and stabilized the market, prompting primary buyers to return. Investor concentration held at 22% over the last three years while international buyers made up 2%, holding true to the past 3 year average. International buyers have a higher market share in major metropolitan cities such as Manhattan and San Francisco. Primary home buyers still make up the largest share of the market however, the tight credit conditions has resulted in a larger share of all-cash purchases. Over 20% of buyers who are relocating and 60% of second home purchases have been all cash. Buyers of new construction homes are more reliant on financing so we see a greater correlation between mortgage applications and new home sales.
Many are looking at the Fed’s direction for possibly creating another bubble. There is little evidence to suggest this as the term “bubble” is used to describe an asset priced above a level determined by economic fundamentals. For starters, homeowners were made painfully aware after the 33% plunge in prices nationally the downside risk of real estate. Additionally, with the amount of investor buying that I discussed above, markets are beginning to stabilize as we’re seeing a greater percentage of people believe in the housing market again. And lastly, considering how tight the credit market has been, the quality of borrower has improved dramatically in today’s mortgage market. With CoreLogic home prices increased at an accelerating rate in March at +1.9% month-over-month translating to a 10.5% gain year-over-year, we’re seeing a slower price appreciation. And lastly, recent data showing spending on home improvements has declined sharply, however we’re seeing a 9.1% increase in retail sales on building materials and Home Depot reported an increase in activity at the turn of the year. The expectation is that the Census data will ultimately be revised higher to reflect the recent sales data. However, we’ve also seen an increase in input costs as the price of lumber and cement have increased putting construction costs at a +5.5% gain year-over-year. The good news is that there’s a positive correlation between new home sales and construction cost inflation indicating a stronger housing market and greater demand. With the forecasted price improvements and the stability in the market, there are positive signals to believe in the housing recovery
Today Fed Chairman Ben Bernanke broadened the Federal Reserve’s oversight beyond big banks and now monitors financial institutions as the shadow banking system continued to pose a threat to financial stability. In a wide-ranging speech explaining the Fed’s role in monitoring the stability of the banking system, Bernanke also stated that the central bank would watch asset markets for signs of excessive risk taking. On the budget side, U.S. defense spending is down which is a major factor in the 23 percent the deficit has dropped this first part of 2013. April usually sees an average surplus of $49.7 billion whereas this year the April surplus was at $59.1 billion. And lastly in our MBS world, markets have sold off in dramatic fashion. And lastly in our MBS world, futures have sold off in dramatic fashion. July FN30 3s are trading at 102-25 (-0.59375), July FN15 2.5s are trading at 103-25+ (-0.265325), July GN30 3s are trading at 104-14 (-0.625) and July G230 3s are trading at 104-11 (-0.625).
Economic Update Next week we have a busy week on the economic calendar. On May 13th, Retail Sales will measure the total receipts of retail stores. Consumer spending accounts for more than two-thirds of the economy so investors watch this closely to see where we are headed. On May 14th, International Trade will update the index in import and export prices. Changes in these levels are a valuable gauge of inflation here and abroad and can directly impact our competitiveness overseas. On May 15th, Producer Price Index (PPI) will update the price index of goods at the wholesale level. PPI measures prices at the producer level so it can provide a measure of inflation before it is passed to the consumer. Also on May 15th, Industrial Production will update the fixed-weight measure of the physical output of our nation’s factories, mines and utilities. Investors watch this as it acts as the pulse of our economy. On May 16th, Consumer Price Index (CPI) will measure a fixed basket of goods at the consumer level. This is essentially the most widely accepted inflation calculator. And lastly, also on May 16th, Housing Starts and Building Permits will provide the number of residential units on which construction is begun each month. Investors watch this for the ripple effect as real estate tends to have a powerful multiplier effect through the economy.Written by Marcus Lam of Opes Advisors on May 10, 2013