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U.S. house prices: The dragon takes wing

A new bubble forming?
A new bubble forming?
Photo by Christopher Furlong/Getty Images

Home-buyers need to proceed with caution. History may repeat yet again in the U.S. mortgage and housing market.

In United States, the common wisdom for decades was to buy a house as soon as possible since it is considered a great investment with mouth-watering payoff. That wisdom turned many people upside down during the 2008-2009 mortgage crises when many home-owners defaulted after they suddenly discovered that the values of their houses did not appreciate as was expected.

Yet timing is very critical when it comes to buying a house in America. Sometimes, it can be a challenging task to figure out the right time to buy a house. Generally speaking, houses are horribly expensive in America, with the slightest up-tick or down-tick in the market costing or saving huge sums to both the sellers and the buyers. In the past few years, house prices has soared, which means that those buyers who had waited turned out to be the losers. But, scrambling onto the housing ladder now is still unwise given that the current slowing prices, weak construction data and jitters about a possible interest rate rise are good indicators that prices may drop as they did half a decade ago(Economist, 2014). The big question, of course, is whether scrambling onto the housing ladder makes any sense at all.

Home-buyers in America has real reasons to be nervous: they are living witnesses to the crises of 2008 and 2009 in which home values(prices ) fell by 60 percent in many states. Yet the country’s housing market has recovered in a remarkable way. In the north-east the median property prices are well above highs, rising by 51 percent from 2009 to 2013. In the Midwest and Southern part of United States, prices rose more than the previous peaks observed in 2012. Home prices are, however, worth less now than in the bubbly mid-2000 only in one region: the Western part of America. In spite of this, their prices in this area are rising fast, increasing by over 20 percent in 2013(Dougherty, 2013). If this current trend continues in that region, there’s a high chance that the prices increase will beat past records by the end of the year.

Many home buyers, and even some real estate agents worry about this rebound, because it could mean that a new housing bubble is forming(Pinto & Oliner, 2014). Broadly speaking, house rents are a good yardstick for measuring or forecasting housing bubbles: when there’s high demand, it makes sense if house prices rise in line with rent. In contrast, it doesn’t make sense when house prices outstrip rents, as has been the case recently. In other words, there’s good reason for homebuyers to worry.

The signs that the housing market is stalling are already showing up. On April 22nd and 23rd, the National Association of Realtors(NAR) released an interesting data that revealed a bloodless market. According to the NAR data, existing home sales were down for the seventh time in eight months. In march 2014, the home sales was 7.5 percent lower than the same period in 2013. The performance of new-home sales were not better than the existing ones: they were 14.5 percent down between February and March. Overall, price rise are slowing: In April 2014, annual prices rises was 6.9 percent, which represents a decrease from over 8 percent recorded the previous year. In places like New England, the price decrease was even bigger, with a value of 2.5 percent in a single month(Economist, 2014).

Deal, or no deal?

In spite of these omens, buyers can still be brave, for three reasons. First, the steady flow of cheap distressed houses in the market is drying up. Over a third of all house sales made between 2008 and 2011 belong to this category. Note that those houses in this category are either foreclosed homes or are homes that are being sold at a loss, with a significant proportion of them belonging to different banks. On the positive side, the backlog is clearing, and in this current year(2014) only about 11 percent of house sales is expected to be from this distressed stock.

Second, new houses are not being built fast enough. As a matter of fact, the supply of new houses is severely crimped. It should be pointed out here that during the financial crises, many small builders in America went to the wall. Among this category of builders, the survivors are having a difficult time because banks seldom give them loans to build more houses. This means that the pace of building in America has remained far below its pre-crises average. Thus it is not surprising why the supply of new homes has not responded to perky prices. This period is also a good time for the larger home builders. Since they can easily get loans, they have the field almost to themselves. Given that they have less competition from the small builders, they can influence supply, which in turn, may cause prices to drift even higher.

The third reason is that new homes will not be cheap ones, even if supply does improve in the long run. This is because of the rising construction cost, which is more than 15 percent from 2012 to 2014(Turner Building Cost Index, 2013; Economist, 2014). In addition, the median prices on new and existing homes have also diverged: the current cost of new homes can be as much as 38 percent more than than a lived-in home.

The recent housing data, to some reasonable extent, makes an increase in interest rate even less likely. The Federal Reserve does not have much to worry since the overall household debt is falling and the number of cash-funded sales in the country is rising. Also, due to predictions of future rises in interest rate, buying new homes have become more challenging: In March 2014, a 30-year mortgage rates was 4.34 percent, compared to 3.57% at the same period in 2013(Mortgage Information Service, 2014). By combining the effects of high rates, lower leverage and evidence that the current high prices reflect supply constraints more than speculative demand, it makes sense to infer that the Federal Reserve has no reason to increase the interest rate – an act that can make homeowners’s lives less easy.

References

Dougherty C. (2013): Home Prices Rise Steeply in West, Sunbelt. Wall Street Journal. Retrieved May 20, 2014 from http://online.wsj.com/news/articles/SB10001424127887323838204579000911160750246

Economist(2014): House Prices – Buy Now or Later. Retrieved May 19, 2014 from http://www.economist.com/news/united-states/21601296-lack-supply-means-americas-lofty-house-prices-are-unlikely-fall-far-buy-now-or

Mortgage Information Service(2014): National Monthly Average Mortgage Rates. Retrieved May 20, 2014 from http://mortgage-x.com/general/national_monthly_average.asp

Pinto E.J., Oliner S.D.(2014): Homebuyers – Proceed With Caution. American Enterprise Institute. Retrieved May 19, 2014 from http://www.aei.org/article/economics/financial-services/housing-finance/homebuyers-proceed-with-caution/

Turner Building Cost Index(2014): 2014 First Quarter Forecast. Retrieved May 20, 2014 from file:///C:/Users/jojih/Downloads/CostIndex2014Qrtr1.pdf