| |
|
|
February 24th, 2010 by Gary Lucido
It’s hard enough to time investments. Finance theory says it’s impossible and there is plenty of evidence to prove that it can’t be done. So it should come as no surprise that timing a home purchase would be even more difficult.
As I’ve said before, I don’t think people should think of a home as an investment. If it were, it would be the only one that regularly springs leaks, begs for a makeover, and falls apart over the course of 30 years (maybe sooner depending upon your builder). Regardless of what the National Association of Realtors would like you to believe, a home is simply a lifestyle purchase, with some pretty hefty financial considerations. Therefore, the timing of when to buy a home should be largely influenced by lifestyle goals.
That doesn’t mean that there aren’t times when it’s prudent to wait for homes to “go on sale” – such as the last few years. But trying to pick the absolute bottom of the housing market is a fool’s errand. And it’s not just because you don’t know where the price of housing is going. You also have to figure in the impact of mortgage rates, which can have an even bigger impact on the cost of housing than the price of the house.
Let me demonstrate. Consider the purchase of a $500,000 home with 20% down and a 5.1% mortgage. Your monthly payment would be $2,171.80. However, if mortgage rates go up by 100 basis points to 6.1% then the price of the home would have to drop to $458,386 in order for you to have the same monthly payment with the same down payment. That’s an 8.3% price drop. So you have to ask yourself what is more likely at this stage: that housing prices will drop another 8.3% or that mortgage rates will go up by another 100 basis points? How about another 200 basis points?
Look at where Chicago housing prices are right now relative to their long term trend. I’m not saying that they are a steal but they are certainly fairly priced relative to where they have historically been. Now look at mortgage rates. Recently they have been at the lowest level in the past 50 years! I pulled the data below from the Federal Reserve and since that series doesn’t go past April, 1971 I estimated the prior data back to January, 1962 (light blue line) based upon the rate on 10 year treasuries. That estimate is a bit crude but the conclusion is still the same since 10 year treasuries are now at lower rates than they were in 1962.
 Actual And Estimated 30 Year Fixed Rate Mortgage Rates But what about this debate that rising interest rates will depress home prices? Well, let’s look at the period from the 60s to the 80s when 30 year rates went up from around 5% to 18%. According to the theory, during that period, home prices would have dropped by almost 52%! Well, they didn’t.
I’m trying to avoid repeating the realtor’s mantra of “now is the time to buy” because it really does sound lame and self-serving. However, the fact of the matter is that current conditions are extremely favorable for buying.
Tags: home prices, housing prices, Interest rates, Mortgage rates
Posted in Financial Considerations, Home Ownership Costs, Market Insights, Mortgages | No Comments »
February 22nd, 2010 by Gary Lucido
Understanding the relationship between interest rates and home prices is particularly important now because most people believe that interest rates are heading up in the not-to-distant future. One might quite logically expect that when mortgage rates rise it depresses home prices. After all, most people determine the affordability of a home by looking at the monthly payment. In fact, buyers and their lenders usually target their price limit based upon how much they can afford to pay in principal, interest, taxes, and assessments, given their income. And the interest component of that equation is a big driver of the size of the payment. So when interest rates rise you would expect that all buyers would have to shift their expectations down scale and that this would depress home prices.
However, about a month ago one of my clients sent me a link to a BusinessWeek article on the impact of interest rates on home prices. In this article the author, who is the founder and president of Home Warranty of America, claims that the data just doesn’t support the notion that rising interest rates depress home prices. Although he doesn’t provide the direct analysis in his article he does provide links to several data sources so that you can do your own analysis. However, I would like to point out that this is not the first time I’ve heard this claim and I myself have glanced at the data before and found this to be true – especially in the late 70s and early 80s, which is the time period referenced by this author. During that time period home prices rose, despite interest rates that approached 18% ?!?!?! Or at least home prices didn’t decline like you would have expected.
Well, last week a spirited debate transpired on Cribchatter about this very topic. This has to be one of the longest threads in Cribchatter history with 234 comments. The people who argued that higher interest rates would push home prices down were initially arguing based upon the same logic I articulated above. However, eventually both sides of the debate started to link to various studies and articles that proved their point of view. Like most academic endeavors, when someone makes a career out of spending grant money they can prove anything they want so it’s not surprising that there are plenty of studies to support either side. Personally, I got a headache from following the debate, not to mention that it was full of insults.
However, I would like to point out a few things:
- Many of the articles referenced as proof that higher interest rates depress housing prices were nothing more than opinion pieces, based upon financial logic, or were based upon anecdotal data. Hardly real studies. Nevertheless, several legitimate studies were referenced to support this thesis.
- There could be several logical explanations as to why higher interest rates would not depress home prices as expected:
- Buyers assume they can refinance at a lower rate in the future
- Buyers have other financing alternatives, including adjustable rate mortgages and higher down payments. (I remember buying our first home in the summer of 1984 and an ARM was a no-brainer.)
- Higher interest rates are usually associated with inflation and inflation pushes up housing prices
- Buyers assume that if interest rates are higher now they will go down in the future and that will elevate home prices
- When rates go up buyers shift their focus to the lower end of the spectrum but demand at every price level is replaced by demand shifting down from a higher price level – except of course as you get to the higher levels there isn’t as much replacement demand as exiting demand
- When rates go up buyers simply allocate more of their income to interest payments.
For further reading you may want to check out some of the referenced studies and one that I have been meaning to read for a while:
- What Moves Housing Markets – demonstrates that interest rates do not affect home prices. “…our results provide evidence that changes in risk-free interest rates may not have done much to change housing valuations over the 1975 to 2007 period.”
- The Effect of Real Rates of Interest on Housing Prices – demonstrates that real interest rates do affect home prices. “This ebb and flow of real interest rates appears to explain market price levels.”
- Assessing the Role of Income and Interest Rates in Determining House Prices – demonstrates that interest rates do affect home prices. “Our results support the existence of a long-run relationship between actual house prices and the amount individuals can borrow.”
- Why do House Prices Fall? – demonstrates that interest rates do not affect home prices. “Interest rates appear to play a relatively minor direct role, though they may play an important indirect role.”
Tags: home prices, housing prices, Interest rates, Mortgage rates
Posted in Financial Considerations, Market Insights, Mortgages, Uncategorized | No Comments »
February 19th, 2010 by Gary Lucido
I guess it’s no surprise that 2009 was a tough year for the real estate industry but I’ve just run across some information that gives us a pretty good idea of just how bad it was. After losing 4,000 agents in 2008, the Chicago area lost another 1,000 agents in 2009. That’s a 7.6% decline on top of last year’s 25% drop, bringing the total down to 12,054 as of early February. I guess these agents ran through all their relatives and friends – or they’re no longer on speaking terms with them.
Meanwhile, business hasn’t been good for the brokerages either. Realogy, which is probably the largest brokerage organization, just reported a loss of $262 MM on revenue of $3.9 B. In case you didn’t know (most people don’t), Realogy is the parent organization of the following brokerages:
- Coldwell Banker
- Century 21
- ERA
- Better Homes & Gardens Real Estate
- Sotheby’s International Realty (and you thought they were high end)
- NRT
How do you charge outrageous commissions and still lose money? For starters, it doesn’t help if you have a huge overhead and spend a lot of money on advertising of questionable value. However, the biggest issue is that Realogy was taken private in 2007 by Apollo Management, a private equity investment firm. As with most private equity deals this one was heavily leveraged and today Realogy still has around $6.7 B of debt from that deal. Oh…and they have negative equity – close to $1 B worth – which is appropriate given that most of their former clients also have negative equity. Things got so bad last fall that Realogy was on the brink of bankruptcy when Carl Icahn stepped in at the last minute and saved them.
BTW, I find Realogy’s so-called strategy interesting. Either they’re not too bright in having all these brokerages that compete with one another or they’re smart enough to realize that there really isn’t any real competition between them. What do you think?
Anyway, Realogy’s woes are symptomatic of the entire real estate industry. RealTrends and Bloomberg recently reported that the dollar value of real estate commissions dropped by 6.2% last year. So, that’s about in line with the decline in the number of real estate agents in Chicago, which makes sense.
But what does all this mean for you? I’m afraid not much. There are still more real estate agents than there is productive work for them (much more on that topic in upcoming posts). And even if Realogy closed the doors on all their brokerages I maintain that it would have zero impact on the real estate industry because all those realtors would simply get new business cards with a different broker’s name on them. At least that’s the way it works with the independent contractor model (more on this some day soon also).
Tags: real estate agents, real estate industry
Posted in Agents, Industry Issues, News | No Comments »
February 15th, 2010 by Gary Lucido
Chicago’s University Commons development in University Village has a lot to offer – great spaces, and fantastic amenities. However, the development has been plagued with a host of distressed sales – short sales and foreclosures – in the last year. I was actually shocked to discover that, of the 21 2 bedroom/ 2 bath units sold in the last 12 months, fully 11 were either short sales or foreclosures.
If you look closely at the data (sorted above by selling price) you will see that there is a higher concentration of distressed sales at the low end. In other words the lofts that sold were the ones that sold at the biggest losses. However, if you also sort the data by closed date you would see that there is a higher concentration of distressed sales as time progressed. My interpretation of that is also fairly negative – i.e. as time goes on sellers in University Commons are getting increasingly desperate and being forced to sell under distressed circumstances.
Having recently listed and sold one of those 21 units (1000 W 15th #414), I can speak first hand of the challenge in selling the lofts there. You just can’t get the traffic. Part of the problem is that University Commons is just not that well known. People looking for lofts in that price range typically think of either the West Loop or the South Loop and may not even be aware that very nice loft options exist in that area. So when you set up the listing you find out that it does not match the criteria of very many people and very few of the people whose criteria do match the listing will express an interest. You have to really work hard to find a buyer.
However, another problem is that the people who bought these units from the developer received a substantial 8 year property tax benefit – e.g. taxes of $1000/year on a $450,000 purchase. Doesn’t sound like a problem? Well, this tax benefit allowed the developer to charge a premium for the condos. But the tax benefit can’t be passed along to the next buyer so that premium is lost upon resale. I think this has contributed mightily to the losses that sellers are experiencing.
The good news is that if you are interested in buying in University Commons there could be bargains to be had because there is a lot of inventory available relative to the rate at which it is selling.
Tags: property taxes, University Commons
Posted in Market Insights, News | 6 Comments »
February 12th, 2010 by Gary Lucido
FHA has been a popular financing option for condos because of the tightening mortgage guidelines on conventional condo financing and because of the FHA’s low down payment requirement. Currently representing 30 – 40% of the mortgages, any changes to this program can have a huge impact on the housing market. And one such big change just went into effect.
On February 2nd HUD (the Department of Housing and Urban Development), which administers FHA, switched to a new condominium approval process and it represents both good and bad news to the condo market. The good news is that buildings with the right of first refusal (and there are many of them) can now be FHA approved. The bad news is that the FHA spot loan is no longer available – which means that it is no longer possible to quickly approve an individual condo for an FHA mortgage. These changes will cause temporary headaches for lenders and homebuyers. Why? Because in the short run there will be fewer condo properties that are eligible for FHA financing.
So how do you get the condo you want to buy or sell approved for FHA financing now that spot approval is gone? As Pete Thompson’s post explains it is now a bit of a can of worms (or as the British say “a bit of a dog’s breakfast” – not that British dogs eat worms). Basically, the entire building has to be approved and under the new guidelines, there are two ways to approve a building:
- Go directly to HUD (HRAP) and file all the paperwork directly with them
- Go to an FHA Direct Endorsement lender (DELRAP) who has the authority to approve the projects on their own
Despite the complications we are advising our seller clients to pursue these options – after all how can you ignore 30 – 40% of the buyers? There is an entire questionnaire that needs to be filled out but some of the key red flags are as follows:
- Is the project involved in any litigation?
- Does any single entity own more than 10% of the total units?
- Are more than 15% of the owners delinquent with their association dues?
- Are at least 50% of the sold units owner-occupied?
- Does the project meet requirements for FHA concentration (no more than 50%, unless certain conditions are met)?
- Are there any pending special assessments?
We are working with mortgage lenders like Pete who can facilitate the approval process. But there is a cost, since the process is more involved and the lenders need to be really, really careful. For instance, getting an 11 – 25 unit building approved will cost around $2,000. However, when you divide that up among the number of units it’s not that bad and well worth it. Surely this approval increases the value of a unit by more than the $100 – 200 share of costs on average.
Tags: FHA, Mortgages
Posted in Market Insights, Mortgages | No Comments »
|
| |
|
Low Commissions 
