Tuesday, June 14, 2016

Home Price Inflation: Good for Some, Not so Much for Others

(Random Housing Development)

According to this article on GlobeSt, homeowners are doing well, very well:
Nationwide home equity increased year-over-year by $762 billion in Q1, bringing the number of mortgaged residential properties with equity at the end of the quarter to 92% of all mortgaged properties, according to CoreLogic.
It shouldn't surprise anyone that home equity is increasing. You have 2 factors contributing to the substantial increase:

  1. Home prices have appreciated over the same time period by 6.2%, according to CoreLogic. Note that any increase in the price of a home (assuming a standard mortgage structure) all goes to equity and most people only put in 10-20% of equity into their home purchase. Let's take the purchase of a 500k home as an example to see how an increase in home prices has a levered effect. If you put in 20% of equity, then you've invested 100k into the home. If that home increases in price by 6.2%, it's now worth 531k. That's a 31k increase in value in just a year, which is a 31% return on equity! Not a bad deal, right? As you can see, homeowners have a very strong interest in seeing home prices appreciate year-over-year. By the way, They forecast a 5.3% increase over 2016...
  2. Loans are getting paid down which increases homeowner's equity. Most mortgage payments are composed of both interest and amortization. The amortization portion of the payment goes towards paying down the loan, thereby decreasing the loan balance and increasing the owner's equity. Employment is doing great. People are flush with cash right now, paychecks are stable, and people are making their loan payments.
The article continues:
In addition, negative equity—often referred to as “underwater” or “upside down” and applying to borrowers who owe more on their mortgages than their homes are worth—decreased 6.2% quarter-over-quarter from 5.1 million homes (10.3% of total mortgage inventory), in Q4 2015 to 4.3 million homes (8% of total mortgage inventory) at the end of Q1 2016. These findings bode well for the housing industry.
Interesting how these articles always seemingly have a very positive bias towards home price appreciation. It makes sense--more likely than not the person writing the article and the person from CoreLogic being interviewed own homes and have a strong interest in seeing the value of their most important investments increase. There are other less cynical reasons as well, of course. The single family home industry supports several million construction related jobs and a multitude of non-construction related jobs as well--think of how many neighbors / acquaintances you have who worked as a realtor or mortgage lender at some point in their life.

Governments also have a strong interest in seeing home prices increase. Most counties reassess home values periodically. I don't know any tax assessors personally, but I would guess they're big fans of being able to justify jacking up their respective county's home values as much as possible and generating a lot more tax revenue.
On the sales side, Khater says most people roll over their equity into the next home they buy, which serves as the down payment, and they then don’t have to pay anything as a down payment; this makes increased equity a motivating and enabling factor in people putting up their homes for sale. “Also, if they want to refinance, and they were previously unable to do so because of negative or not enough equity, they are now able to do so.”
Homeowners are almost forced into rolling the money from selling their houses into their new purchase. That's obviously where a lot of their money is tied up, but they're also heavily incentivized to roll all the money into the purchase of a new home because of tax laws. The government has decided it'd be a great idea to allow homeowners to roll all that money, including the gain over the original purchase price, into the new home, tax free. I'd bet many people defer gains on their houses indefinitely and let their kids deal with it when they die.

Home price appreciation certainly is great and benefits the economy in the short term, but if the appreciation rate, largely driven by existing homeowners taking advantage of the increased equity in their homes trading up and up and up in home size / value, exceeds wage growth, then all you're left with is a bunch of asset holders pricing out the non-asset holders and creating this sort of self-contained speculative bubble with nothing supporting it (note the government's complicit role in the bubble by not taxing the gains on these investments as well).

The reasons above are why I always cringe a little bit on the inside when I see an article cheerlead for enormous home price growth. A healthy housing market should be supported by both the improved financial position of non-asset holders (primarily the younger generation as they climb the ranks in their careers and make more money) and the improved financial standing of asset holders (job promotions, but also increases in their investments). If you agree with the previous sentence, then you should also agree that housing prices should more or less track wage growth.

Over the last 10 years, the BLS reports that wage growth has averaged approximately 2% per year and hasn't exceeded 4% in any of those years. Meanwhile, the housing market has had unbelievable double digit price appreciation in several of those years and mid to high single digit appreciation in many of the others. Of course, there was the housing crash of 2008 that has skewed things. Even if you look at from 2014 and on though (hard to argue the economy wasn't stabilized by 2014...), home price appreciation has been mid to high single digits in many markets, far outpacing wage growth.

To me, this suggests there's a certain amount of speculative behavior as discussed above taking place. Homeowners are using the increased value of their homes to trade-up into bigger, more expensive homes, which then gives another homeowner a fresh injection of money that they then need to put into a bigger, better house. The cycle continues, driving up the price of homes. None of those investment gains are taxed, by the way. Have I mentioned that yet? These speculative conditions are preparing the foundation for, not necessarily an '08 magnitude crash, but certainly a volatile market in the medium / long term that will financially devastate thousands and thousands of people participating in the speculation.

Besides the market volatility created by rapid price appreciation, it also adversely affects the younger generation that doesn't own a home. They are systematically getting priced out of the housing market which hurts household formation, deprives them of being able to establish roots in a community, takes away the opportunity to invest a good portion of their net worth in a home, and forces them to rent and face ever increasing rent prices (owning a home provides a certain amount of protection against increases in the cost of housing--mortgage payments are fixed and property taxes are capped at 2% growth per year--rent can growth exponentially unless your unit is rent controlled).

Not only does rapid price appreciation hurt the younger generation, but it hurts the asset holders as well by keeping fresh blood / capital out of the housing market. As mentioned above, a healthy housing market needs new participants to enter driven by their wage growth surpassing or matching home price appreciation. At some point, existing home owners will want to sell their McMansion and downgrade their home. There better be someone there to buy the home or else they're taking a hit financially.

Maybe we shouldn't be cheerleading every time housing prices increase by a huge percentage. Maybe it's not a good thing for home prices to far outpace wages as they've done over the last 10 years. Maybe it's actually not a good thing for first-time buyers to be priced out of the market. The issue, of course, is decision makers own homes and the government wants higher home prices, so don't expect much to change. Expect volatility, boom / bust cycles to persist in the single family home market as speculative behavior is encouraged.

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