US Housing Prices Within 7% of 2007 High – That’s Not A Bubble?

Monthly Home Sales and Inventory - Click to enlarge

Monthly Home Sales and Inventory – Click to enlarge

The NAR reported existing home sales in June of 501,000 units, a decline of 13,000 from May, as about 4% of contracts that were due to settle in June apparently failed due to the rise in mortgage rates. Contracts reached in April and May, which would normally have closed in June projected a sales rate of approximately 520,000 units. Sales were up by 38,000 or 8.2% versus June 2012. This was significantly slower than the breakneck annual pace of 14.7% in May, but well within the range of year to year gains of the past 18 months.

The data on June contracts will tell us more about whether the higher mortgage rates are dampening demand. Much of the rise in rates had already occurred by May, and there was no sign of a slowdown in demand in the May contract data. The bubble was still going strong at that time.

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Why do I call it a bubble? Prices have now risen 13.5% in the past 12 months to a median price of $214,200.   Prices have risen by 21%, not seasonally adjusted, over the past 4 months. Those are bubble numbers. These price gains were driven by the Fed’s subsidized mortgage rates, which have led to a buying panic amid restricted supply. Prices are now within 7% of the highest prices reached in the great housing bubble of 2003-2007. If that was a bubble, and it was, then so is this.

Home Prices and Contract Volume - Click to enlarge

Home Prices and Contract Volume – Click to enlarge

Not only does the Fed’s mortgage rate subsidy artificially inflate demand, its Zero Interest Rate Policy–ZIRP– contributes to restricting supply. Older homeowners with substantial equity, who often own their homes free and clear, might otherwise wish to downsize or cash out completely as they become empty nesters and near or reach retirement. The lack of suitable risk free returns on their cash motivates them to hold their real estate rather than liquidate and be forced to consume principal due to inadequate cash return on any liquidated equity.

These two forces, artificially inflated demand and restricted supply combine to cause prices to spiral higher. At this point it does not yet appear that higher mortgage rates have stopped or even slowed that dynamic. In my 40 years of experience working in or analyzing the housing market the pattern has always been that rising mortgage rates initially spur demand. They force fence sitters and procrastinators into the market for fear of subsequently being shut out by rising rates. This is another aspect of bubble dynamics.

At some point, a rise in mortgage rates, which closely track the direction of the 10 year Treasury yields, will slow or shut down demand. That point hasn’t been reached. However, a meaningful increase in supply is only likely when the Fed relents on ZIRP, and allows people a reasonable risk free return on cash.

Inventory did rise by 40,000 units in June to 2,190,000 units. June has historically had wide variability in inventory changes, so I don’t want to read too much into the increase. The June level is still 7.6% below June 2012.  It is well within the trend of declining inventory of the past 3 years. As of May, the inventory to contracts ratio was at a record low. The NAR will release June pending home sales on July 29.

Inventory To Contracts Ratio - Click to enlarge

Inventory To Contracts Ratio – Click to enlarge

Departmentofnumbers.com reports median listing prices and inventory for 55 large US metros in real time.  As of July 15, total inventory was down 15% year to year in these markets, which are representative of the US as a whole, suggesting that the tightening of inventories is continuing.

Their index of median US listing price has accurately shown the direction of prices in real time for the past 7 years including the timing of both the top of the bubble, bottom of the crash, and the recent rebound. As of July 15 listing prices were up 8.5% since July 2012. This compares with a 6.8% year over year gain in June. The current rate of increase in listing prices is the highest since the price recovery began in late 2011.

Just because prices are in a bubble does not mean that they can’t keep rising for some time. Bubbles have a typical life of approximately 5 years from liftoff to final blowoff high. This one lifted off in 2011, so it could have a ways to go. As long as ZIRP is in place, supply is likely to remain depressed. Restricted supply means that prices should remain under upward pressure for some time even with rising mortgage rates forcing some buyers out of the market. The first signs of more competitive markets should show up in real time listing price data.

To the Fed, the bubble in home prices is all good. It doesn’t consider the rising price of the cost of shelter to be inflation.

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