The Short-Run vs. the Long-Term Picture

June 23, 2010

The Short-Run vs. the Long-Term Picture

Never did we see a more important dichotomy in the releases on the state of real estate in the past week. First, Standard and Poor’s released a report that stated it will take three years to clear the shadow inventory from the markets, though this number will vary widely based upon location. Three years of shadow inventory indicates that the real estate market will continue to be a drag upon the economy for the next few years. Second, an article was released by CNN/Money that indicates we are heading towards a long-term housing shortage (See Real Estate News Section For More Information). There is plenty of present excess inventory as the amount of shadow inventory has been estimated at anywhere from four to eight million homes, however, in the long-run we are not building or replacing enough units to keep up with the long-term demand of population growth. What does this say? It says that real estate is a great long-term investment, especially at today’s prices and rates. The problem always arises when we think about real estate in terms of the short-run. During the boom everyone was looking to make a killing. However, real estate is a long-term investment and anyone purchasing a home should be measuring its worth over decades, not months.

Meanwhile, there seems to be some life in the markets. In the past several weeks the stock market seemed to be taking every piece of news negatively while it adjusted to the fact that the economy was growing more slowly. The past week was not only the second positive week in a row for the markets, when negative news was released the markets seemed to bounce back more quickly. For example, the housing start and permit data was well below expectations on Wednesday and jobless claims rose more than expected Thursday. However, each day the markets ended the day recovered from early losses. Could this be the turn after a correction? Oil prices seem to be reacting pretty much the same way. Higher oil prices point to markets that are seeing brighter days ahead for the economy. Of course two weeks do not constitute a trend, but certainly the period provides fodder for optimists.

The Markets. Rates were stable at historically low levels in the past week, with fixed rates rising slightly and adjustables falling. Freddie Mac announced that for the week ending June 17, 30-year fixed rates averaged 4.75%, up from 4.72% the previous week. The average for 15-year fixed rose to 4.20%. Adjustables were down with the average for one-year adjustables falling to 3.82% and five-year adjustables decreasing to 3.89%. A year ago 30-year fixed rates were at 5.38%. “Rates were little changed this week amid preliminary signs that the expiration of the homebuyer tax credit in April may have led to a slowdown in new construction,” said Frank Nothaft, Freddie Mac vice president and chief economist. “Starts on single-family homes fell 17 percent to an annualized pace of 468,000 units in May from April’s 20-month high. In addition, permits on one-unit homes fell to the slowest pace since May 2009. Nonetheless, household balance sheets have been improving over the past four quarters. In aggregate, households gained $6.3 trillion in net worth in the first quarter from a year ago, according to the Federal Reserve. In addition, homeowners have regained $1.1 trillion in home equity over the same time period. Rates indicated do not include fees and points and are provided for evidence of trends only. They should not be used for comparison purposes.

Current Indices For Adjustable Rate Mortgages
Updated June 18, 2010

The number of U.S. borrowers failing to pay their home loans has fallen significantly in the last few months, according to RBS Securities Inc. Of borrowers with subprime loans wrapped into bonds issued in 2007 who had never previously missed a payment, an average of 2.6 percent failed to pay at least once in March, April or May. That’s a drop from 3.7 percent in February and a 15 percent decline after seasonal adjustments, RBS calculates. “We believe that the last few months’ performance points to a fundamentally positive shift in borrower behavior,” Paul Jablansky, Desmond Macauley, and Ying Wang, analysts at the Royal Bank of Scotland, wrote in a June 8 report. Source: Bloomberg

As the nation struggles to shrug off the worst housing crash since the Great Depression, it may be hard to believe a housing shortage could be on its way. The nation is simply not building enough homes to keep up with potential demand. Just 672,000 new homes were started in April, less than half the long-term run rate needed to meet the nation’s natural population growth. "It is ironic, but there is a growing consensus that there may be a new housing shortage coming," said James Gaines, a real estate economist with Texas A&M. So far, the shortfall has been masked by a weak economy that has put a damper on homebuying. Once the job market rebounds, however, people will look to have their own homes again. This pent-up demand could get unleashed on unprepared markets, causing shortages and rising local prices. Household formation has been on hold during the past few years as young people, especially, have been unable to find jobs. In the past, an average of more than 1.3 million households were formed each year, causing demand for 1.5 million new homes. More homes than households are needed to replace those destroyed by fires, floods, teardowns and neglect. In 2009, only 398,000 new households were formed, according to the Census Bureau. That is much lower than average and a quarter of the number formed just two years earlier. "The decline in household formation is artificial," said Gaines. "The young are moving in with their parents. There’s even doubling up among working class people. There’s a pent-up demand coming if and when the economy recovers." Those doubting a new bubble is near point to a large inventory overhang. As many as 7 million homes are vacant but not for sale, according to the Census Bureau, which should provide cushion to offset increased demand. The inventory number, however, can be deceiving for two reasons: People may not want to live in hard-hit areas where the houses are or the homes may be beyond repair. "Many of these vacant homes may not be habitable or are in locations where nobody wants to live," Gaines said. Source: CNN/Money

If the demographics bode well for the for-sale sector of the housing market, the numbers look absolutely smashing for the rental side of the business, according to panelists at PCBC’s Multifamily Trends day. For every 1% decline in the ownership rate, there is a corresponding increase in renter households, said Clyde Holland, chief executive officer of the Holland Partner Group, a Vancouver, Wash.-based developer. So, if there is another 2% decline in the ownership rate to a long-term average of 64%-65%, there will be a need for 5.5 million to 5.7 million rental units, he told the conference. "Even if (the potential renters) double up, there will be demand for 2.5 million to 3 million apartments," Holland said. And that’s on top of the 3.4 million potential renters in the 18- to 34-year-old age bracket—"the largest cohort since the baby boom of the 1960s"—who will enter the market between now and 2015, Holland also pointed out. "This year alone, some 800,000 persons will enter the rental market, and an even larger number will enter the market next year," he said. Household formations, added Brian McAuliffe, managing director of acquisitions at RREEF, Chicago, "are just as critical as job growth, if not more so," to the apartment sector. Source: National Mortgage News

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Sean Wheelan
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