The housing recovery that wasn'tJanuary 30, 2012: 5:00 AM ET
The evidence for a recovery is compelling, but optimists should actually be watching rising interest rates.
The evidence is compelling. It now costs almost as much to rent as buy. Since the housing bubble burst in 2006, home prices have fallen by 33% nationwide -- more than they did during the Great Depression. Waves of foreclosures and tighter lending standards have helped drive a surge in rentals. And during the third quarter, the median monthly mortgage payment totaled $698 compared to the median monthly asking rent of $700, according to Capital Economics, citing data from the National Association of Realtors and the Census Bureau. What's more, the cost of borrowing has fallen to record lows, with interest rates for 30-year fixed rate mortgages hovering around 4%.
Builders are even building again. (Albeit, at a very modest pace and driven largely by construction of multi-family homes.) As a January report by CoreLogic shows, both single-family starts and permits rose at an annualized pace of 15% over the six months ending November 2011. The California-based mortgage data provider also notes that existing home sales nationwide have been trending up, rising 12% higher in November 2011 compared with January 2011. "While we cannot say with a high degree of certainty that 2012 has in store for us, indications based on the latter part of 2011 are that both the broad economy and the housing market are moving toward positive growth in 2012," CoreLogic wrote in a research note.
That optimism is well-deserved, right? Not exactly.
Since the housing market imploded, analysts have predicted year after year that prices might at long last bottom out. Will it finally happen this year? Perhaps next? Bottoming out necessarily precedes turning the corner -- and until that happens optimists should be cautious. Economists widely cite the short-term obstacles weighing down prices. These factors range from high unemployment and household debt to the so-called "shadow inventory," or all the properties that have yet to come into the market because of pending foreclosures or skittish homeowners delaying sales until prices improve.
These threats are very real. But there's a bigger threat -- and drag on any future recovery -- that doesn't get nearly the attention it deserves: rising interest rates.
Admittedly, rates probably won't increase any time soon. In a sign that the economy is recovering slower than expected, the Federal Reserve announced last week that it would keep its record-low rate for another three years. The central bank has already kept its key rate at nearly zero for three years. And last summer, officials launched "operation twist," whereby the central bank bought $400 billion in long-term bonds in hopes to give the economy a boost and, more specifically, lower the cost of taking out home mortgages.
Problem is, interest rates can't stay low forever. Eventually they'll have to rise, which could very well drive home prices down since the cost of taking out a mortgage becomes more expensive. Even if rates rise slowly over several years, prices could either fall much further or, at best, stagnate. This is partly why the Fed has been so obsessed with keeping rates down. "The market will look like a frog in boiling water once rates rise," says Lance Roberts, CEO of Streettalk Advisors, a Houston, Texas-based investment advisory company. Roberts, who also contributes to Advisor Perspectives, which publishes newsletters and online articles focused on investment strategies, laid out his case in a recent post.
At some point, interest rates will start rising back toward the long-term median of 8.9% from the current 4%. Depending when and how quickly, the jump would make homes much less affordable for the average American family. Roberts notes that, back in 1968, U.S. households on average spent 7% of their real disposable income on their mortgage payment with a down payment typically at 20%. Assuming the same down payment, that share has more than doubled to 15% today or likely higher since many mortgages approved over the last decade required little or no money down. "With real disposable incomes stagnant as inflation pressures rise, that 15% of the budget is becoming much harder to sustain," he says.
Say a family earning $55,000 a year (the U.S. median household income) wants to buy a home. They decide they can afford roughly a $600 a month mortgage payment after taxes and other expenses. At a 4% interest rate they can afford a $125,000 home. However, at a higher rate of 5%, they can't afford as much and are looking at a $111,000 home. If rates rise higher to 6%, they're looking at a $100,000 home. And so on.
So while the housing market may eventually overcome the immediate bumps of foreclosures, high unemployment and the like, real optimists should be looking at the direction of interest rates before they get their hopes up.