The housing analyst I read, Part 1
.. is the indefatigable Kurt van Kuller of Merrill Lynch, whom I’ve known and appreciated for ten years and whose research reports are consistently great stuff: extensive, quantitative, measured, and perceptive. Though principally a municipal bond analyst, he has for a decade or more specialized in housing because it’s such a major driver of municipal economies and bond marketplaces. His most recent piece, Housing Bubble: Implications for Municipal Bonds, is a forty-page treatise on conditions present, future, and past, which with his permission I’m summarizing and excerpting here.
His headlines?
There is a strong chance of regional housing busts in the near future, in areas of extreme price appreciation. The municipal bond market is not unfamiliar with regional housing crashes.
I love that Anglophilic not-un construction.
“We are not unfamiliar with market corrections.”
1. Bubble? What’s a bubble?
He starts with a linguistic point of order: is there a bubble at all? What the heck is a bubble?
“Is There a Housing Bubble?”
“To some extent, the debate over the existence of a housing bubble hinges on semantics. Common definitions of an asset ‘bubble’ refer to price movements not explained by fundamental measures of value. Bubbles are associated with speculation in an asset class and momentum buying that drives prices to unsustainable levels. The bubble is usually followed by a crash that restores prices to fundamental value, and confirms its existence ex post facto. The causes of bubbles are disputed; some believe they are relate to inflation, monetary policy, financial sector deregulation, or lack of supervision. Debate continues in academic circles over whether many historical booms even constituted ‘bubbles.’” Page 3
The key concept inherent in the loaded term ‘bubble’ is the disconnection between current price and intrinsic worth: the object is bought not for its use but for resale to a bigger fool.
You gonna buy my property, fool?
Tulip bulb prices can bubble; so can gold prices. Housing is an essential commodity bought for consumption much more than investment, so that even if a buyer has overpaid, she will not automatically offload the property. Both psychological tenacity and practical necessity (a roof over one’s head) impel owners who overpaid to grit their teeth and make their monthly payments.
2. Housing prices are very high compared with historical norms
Mr. van Kuller’s opening salvos make clear that we are living in unprecedented times:
There is no denying that a housing boom of historic proportions has occurred. Single-family home prices have surged at annualized rates of 12% to 14% since mid-2004, according to OFHEO. […] Current real rates of increase, adjusted for inflation, are the highest ever recorded.
Those are annualized increases versus a year ago.
Moreover, the current housing boom has lasted for 13 consecutive years, albeit with fluctuations. This is far longer than previous housing booms.
There has been a price boom.
Crank up the prices, daddy-O!
Does boom equal bubble? Or might it be justified? Have there been fundamental changes in market dynamics?
3. Despite high prices, housing fundamentals appear sound
To begin with, more Americans own their own homes than ever before:
“It is easy to see how cheap mortgage money and easier underwriting terms propelled homeownership rates to record heights of over 69%.”
These new homeowners own for one reason: they can afford to. As I’ve previously posted, housing remains affordable in historical terms:
“An index of 100 indicates that a median income family qualifies for a median-priced home. The higher the value, the easier it is to buy.”
Thus, even with both the price increases and the recent the upward creep in interest rates, homes are still more affordable than they were before 1992.
Financial market efficiency has had a lot to do with this. Closing costs are down:
That little graph shows that closing costs, which once equated to 2.5% of the price, are now less than 0.50%, five times more efficient.
Said another way, because the typical home mortgage is held for fewer than ten years (before being refinanced or prepaid), this drop in closing costs is equivalent to a permanent 25-basis-point cut in long-term interest rates. That’s worth something. (As we’ve seen, lowering the Weighted Avearage Cost of Capital by as little as twenty basis points means a big boost in value; when interest rates are low, the boost is even larger.)
Not only are the financial markets cheaper, they also offer more choices:
Moreover, the
Improved technological capacity and financial diversity means more activity, as the volume of homes being sold annually keeps rising:
“Technology has permitted lenders to be more efficient and timely in handling larger volumes and assessing borrowing credit risk.”
The volumes of homes sold in any given year has risen much faster than the population. People are quicker to buy and sell homes. This is more than mere churning, it leads to better home-to-homeowner matching, which means people own as much home as they need/ want/ can afford, no more and no less.
That adds value: think about it. If you need 1,600 square feet but you have to live in 1,200, you’re cramped. Meanwhile, somebody who needs 1,200 but is living in 1,600 is over-consuming. Each of you might want to trade but be unable to because search and matching costs are high, closing costs are expensive and closing procedures cumbersome, and financing is locked rather than prepayable. Remove those barriers, make capital more fluid, and people more readily swap. Swapping brings efficiency, and efficiency soon translates into higher values.
Most of these are resales. For every family stepping up the ladder, another is reaping equity takeout to reinvest elsewhere:
We’re moving up that economic ladder!
Yet with all this activity, homeowners as a class are not overleveraged:
Despite the recent strength of housing prices, home equity has actually declined as a share of net wealth over the last ten years, in favor of other investments.
More equity outside the owned home is a further insulator against price decreases. Bubbles pop because speculators have to sell, and they have to sell if they are fully collateralized already. Home owners, however much they paid for their houses, have non-home assets, which they will tap rather than lose the homestead.
We were bewildered by staggerin’ array of financial products, but if we gotta sell the chickens, then we gotta …
[Continued tomorrow in Part 2.]
