Tag Archives: housing market

subprime is still suspect (revised)

ss-subprime

The housing market has seen a rise in subprime lending recently. As banks slowly returned to the market, they offered harsh terms involving large down payments (25% or more) and charged rates between 8-10%. As reported in the Wall Street Journal, the down payment requirements have recently been dropped to 5% of the loan. The individuals in the article that took the loans gave reasons such as “I wouldn’t have been able to get the place I wanted without this” and being “ priced out” of the market if they waited. By analyzing subprime mortgages more closely, we can get a better idea of the assumptions these buyers are making.

Assume that it is possible to repair a borrowers credit in 2 years. This is reasonable, assuming there are no bankruptcies or judgments in the borrowers recent history. Using the average housing price of $272,000, I assume a subprime borrower would have a down payment of 5%, or 13,600, and that they borrow at 8%. Assume that the loan will be refinanced no sooner then 2 years; banks often require such a condition on subprime loans to ensure they get enough interest for the risk they are taking. I will not include a prepayment penalty for simplicity, but there will generally be a prepayment penalty.

Whether the subprime loan is better comes down to whether or not the buyer can accumulate enough equity to refinance the home out of the subprime loan and into a prime loan as soon as possible. The amortization schedule of a subprime loan with the above assumptions is in this Google doc. Assuming the house price stays the same, the schedule shows when various equity milestones occur.

Assuming that the loan is for 30 years, the subprime borrower would have a monthly payment of almost $1,900, yet all but $173 of the initial payment goes to interest, assuming it is not an interest only loan. By month 24, the borrower has paid about $41,000 in interest equivalent to $1,708 a month. With all that interest, they have only paid about $4,500 on the principal. With the down payment, they now have $13,600+$4,500= $18,100 or about 6.65% equity. The situation could be even worse if any of the payments where interest only.

In order to refinance, the owner needs to have equity in the house, typically around 20%. Since the borrower isn’t going to have anywhere near that amount of equity, the house would also have to appreciate to roughly $317,000, a return of 16.5% on the purchase price. To put this in perspective, the highest growth rate over two years in the national composite home price index was 29.5%, between Q1 2004 and Q1 2006. Whether 16.5% is a reasonable assumption is up to the borrower, but in a sense the subprime borrower is speculating on the value of the house in two years, where the payoff is the ability to refinance their mortgage before it ruins them.

fredgraphMany subprime borrowers cite the investment benefits of owning a home. They are tired of paying rent, and want to start building equity. However, by taking on a subprime loan, they are gambling with their financial future for very little payoff. Since so much of the early payments go to interest, the owners may end up paying more in interest then they may have in rent for the same period. More over, should they fail to refinance the loan, they will most likely lose thousands, if not the house. The analysis presented here shows some of the math that needs to be done by subprime borrowers.  Subprime loans are not inherently bad, but borrowers need to understand the assumptions they are making about the value of their home in the future, their ability to refinance. The gains may not be worth the cost.

 

 

 

 

(Revised) A Constantly Changing Landscape

The landscape in which financial institutions operate is very different now than it was before the financial crisis of 2008. Mergers and acquisitions between healthy firms and failing firms allowed the strong to get stronger and subsequently gain market share. As the market has grown more concentrated, it has also grown less competitive. Although competition is a corner stone of capitalism, maybe large banks help promote financial stability. Whether or not this is true, new government regulations have been enacted with the sole purpose of reducing risk taking by financial institutions.

Unable to put as much capital at risk as before, banks are shedding operations that were once major profit centers. For example, the Volker Rule bans propriety trading and limits commercial banks to hedging and market making. Return on equity (ROE), a closely watched measure of profitability, has dropped from double digits to single digits for most banks and I believe this is representative of increased regulation. Higher capital requirements mandates that a significant portion of cash is set aside. Essentially, cash must be tied up as an unproductive asset (rather than being put at risk in order to earn a return).

While some aspects of bank operations have been forced to shrink (or be eliminated), an area of growth for banks has been in commercial lending (i.e. lending to businesses). According to the Wall Street Journal, “Lenders, too, are making bigger bets on an economic expansion at a time when tighter restrictions on many banking functions have placed more importance on core lending activities to boost earnings”. Although banks might have preferred riskier operations in order to earn a higher return, more lending to businesses is certainly better for economic growth. In addition to being less risky than certain activities such as proprietary trading, lending is a vital source of credit that promotes booming business cycles.

The increase in lending to business has been a two way street. According to the Wall Street Journal, “The rise is being driven both by banks, which are loosening their lending standards, and companies, which are seeking more money, bank executives said”. On the one hand, companies are seeking cash. If businesses use this cash to cover day-to-day expenses (i.e. meeting current obligations), then this might not mean so much for economic growth. If businesses use this cash for capital expenditures (i.e. long-term investments in equipment), then this businesses might be indicating a positive outlook for economic growth. On the other hand, banks very much want to lend the cash as evidenced by lower lending standards. Although increased availability of credit is important for economic growth, an over-leveraged can easily fall into a financial crisis. According to the Wall Street Journal, “And while relaxed standards aren’t likely to cause banks much trouble in the near future, it was reckless lending that helped fuel the financial crisis”. As long as commercial lending is monitored correctly, then the risk should be manageable.

Although banks have increased lending to businesses, the same cannot be said for lending to consumers. In order to reverse this trend, banks have loosened standards for homebuyers. According to the Wall Street Journal, “Mortgage lenders are beginning to ease the restrictive lending standards enacted after the housing boom turned to bust, a sign of their rising confidence in the housing market”. A meaningful re-acceleration of the housing market is crucial for justifying expectations for economic growth. Although the housing market seemed to heat up last year, it slowed down in the fourth quarter and the first quarter of this year. Although one factor contributing to the slowdown might have been the winter weather, rising interest rates also certainly played a role. Higher interest rates decrease affordability for homebuyers.

Changes in interest rates have significant implications for both borrowers and lenders. According to the Wall Street Journal, “Some banks said the prospect of rising interest rates in the next few years could spur additional growth in commercial lending”.  Rising interest rates make lending more appealing for a few reasons. First, creditors get to collect higher interest payments. At the expense of debtors, banks earn increased revenue from lending activities. Second, many financial institutions have a mismatch between asset and liability maturity structures. Banks’ assets are mainly long-term loans and their liabilities are mainly short-term deposits. When interest rates rise, the value of the assets decrease more than the value of the liabilities. Banks can hedge interest rate risk and realign asset and liability maturity structures through commercial lending.

I cannot help but be concerned when I hear banks are lowering their lending standards because I am reminded of bank conduct during the housing bubble. I can only hope that regulators are watching more closely this time.

subprime is still suspect

ss-subprime

Subprime lending has been making a comeback.  As banks slowly returned to the market, they offered harsh terms involving large down payments (25% or more) and charged rates between 8-10%.  As reported in the Wall Street Journal, the down payment requirements have recently been dropped to 5% of the loan. Considering subprime borrowers will most likely want to refinance as soon as possible to get better terms on the loan, would prospective subprime borrowers be better off taking out the loan or waiting and rehabilitating their credit to become a prime borrower?

Assume that it is possible to go from subprime credit to prime credit in 2 years.  This assumption is convenient to use because of terms in subprime lending contracts, but it is reasonably realistic, assuming there are no bankruptcies or judgments in the borrowers recent history.  If there are, then the borrower’s ability to refinance out of the loan in a timely manner is questionable to begin with. Using the average housing price of $272,000, I assume a subprime borrower would have a down payment of 5%, or $13,600, and that they borrow at 8%.  For this analysis I will include the requirement that the loan be held for 2 years.  This is not unreasonable; banks often require such a condition to ensure they get enough interest for the risk they are taking.  I will not include a prepayment penalty for simplicity, but for subprime loans, there will generally be a prepayment penalty. Calculations are done in nominal terms, as that is what the borrower would see on their statements.

Whether the subprime loan is better comes down to whether or not the buyer can accumulate enough equity to refinance the home out of the subprime loan and into a prime loan at the 2-year mark.  The amortization schedule of a subprime loan with the above assumptions is in this Google doc.  For those that wish to play with it, the values at the top can be changed as inputs, but there must be a % symbol with the rates.  Assuming the house price stays the same, the schedule shows when various equity milestones, as well as credit rehab events would occur in the life of the sub prime loan.

Assuming that the loan is for 30 years, the subprime borrower would have a monthly payment of almost $1,900, yet all but $173 of the initial payment goes to interest, assuming it is not an interest only loan.  By month 24, the borrower can finally get out of the loan, but they have paid about $41,000 in interest, and only about $4,500 of the principal.  With the down payment, they have $13,600 + $4,500 = $18,100 in equity, or about 6.65% equity.  They have also spent the equivalent of $1,708 a month in interest.  While shorter loans would result in equity accumulating faster, it would also result in a much larger monthly payment. The results would only get worse if we included a prepayment penalty.

In order to refinance the loan, the owner needs to have equity in the house, typically around 20%.  Since the borrower isn’t going to have anywhere near that amount of equity, the house would have to appreciate to roughly $317,000, a return of 16.5% on the purchase price.  This is possible, but in a sense the subprime borrowers are speculating on the value of the house in two years, where the payoff is the ability to refinance your mortgage before it ruins you.

Contrasting that with a prudent alternative, a borrower that lived in a modest apartment with only $1,200 per month rent would accumulate an additional $12,000 to add to what ever else they had saved, resulting in a much larger down payment.  Assuming they rehabilitated their credit to prime, they get a much lower rate, and a more manageable monthly payment.

Many subprime borrowers cite the investment benefits of owning a home, tired of paying rent, they want to start building equity.  However, by taking on a subprime loan, they are gambling with their financial future with very little to gain.  Since so much of the early payments go to interest, the owners may end up paying more in interest then they would have in rent for the same period, and should they fail to refinance the loan, they will most likely lose thousands, if not the house entirely.

The analysis presented here shows some of the math that needs to be done by subprime borrowers.  Subprime loans are not inherently bad, but borrowers need to understand the assumptions they are making when they sign up for them.  They may find that patience could pay off.

 

 

 

 

Commercial Lending on the Rise

Since the financial crisis, the climate has been constantly changing for financial institutions. Bankruptcies allowed banks to grow in size as healthy banks absorbed failing banks. Since then new regulations have been imposed on the largest financial institutions changing (and in some cases eliminating) many of their most profitable operations. For example, the Volker Rule bans   propriety trading by commercial banks. Return on equity (ROE), a closely watched measure of profitability, has dropped from double digits to single digits for most banks and this is representative of increased regulation. For example, higher capital requirements mandates that a significant portion of a bank’s capital is tied up being unproductive rather than being put to use (i.e. put at risk in order to earn a return).

While some aspects of bank operations have been forced to shrink (or be eliminated), an area of growth for banks has been in their lending to businesses. According to the Wall Street Journal, “Lenders, too, are making bigger bets on an economic expansion at a time when tighter restrictions on many banking functions have placed more importance on core lending activities to boost earnings”. Although banks might have preferred to continue running certain risky operations such as proprietary trading, I think the increase in lending is is more beneficial for economic growth. In addition to being less risky than certain activities such as proprietary trading, lending is an vital source of credit that can promote booms in business cycles.

The increase in lending to business has been a two way street. According to the Wall Street Journal, “The rise is being driven both by banks, which are loosening their lending standards, and companies, which are seeking more money, bank executives said”. On the one hand, companies are seeking cash. If businesses use this cash to cover day-to-day expenses (i.e. meeting current obligations), then this might not mean so much for economic growth. If businesses use this cash for capital expenditures (i.e. long-term investments in equipment), then this might indicate a positive outlook for economic growth. On the other hand, part of the jump in lending is due to banks lowering their standards. Although increased availability of credit is important for economic growth, an over-leveraged can easily fall into a financial crisis. According to the Wall Street Journal, “And while relaxed standards aren’t likely to cause banks much trouble in the near future, it was reckless lending that helped fuel the financial crisis”. I agree that we are far from the dangerous lending that occurred prior to the financial crisis, however, I hope a minimum level of lending standards can be maintained so that we avoid another financial disaster.

Although banks have increased lending to businesses, the same cannot be said for lending to consumers. In order to reverse this trend, banks have loosened standards for home buyers. According to the Wall Street Journal, “Mortgage lenders are beginning to ease the restrictive lending standards enacted after the housing boom turned to bust, a sign of their rising confidence in the housing market”. A meaningful re-acceleration of the housing market is crucial for justifying expectations for economic growth. Although we had a nice pop last year, the housing market slowed down in the fourth quarter and the first quarter of this year. Part of the slowdown might have been due to weather as well as the rising interest rates.

Rising interest rates making lending more appealing for a few reasons. According to the Wall Street Journal, “Some banks said the prospect of rising interest rates in the next few years could spur additional growth in commercial lending”. First, higher interest rates help creditors and hurt debtors. Although debtors must make higher interest payments, creditors get to collect higher interest payments. Second, many financial institutions have a mismatch between asset and liability maturity structures. Banks’ assets are mainly long-term loans and their liabilities are mainly short-term deposits. When interest rates rise, the value of the assets decrease more than the value of the liabilities because longer duration securities are more sensitive to changes in interest rates. Making more commercial loans enables banks to realign asset and liability maturity structures.

Inflation Rises and Eases Fed’s Worries

The new data on inflation suggests that there has been an increase in inflation rate from 1.1% to 1.5%, easing worries of the Fed for the low inflation rate. As I have repeatedly wrote in the past posts about US recovery and surfacing evidences that might suggest this, I would like to touch base again on stock market, housing price, employment, US financial climate and worldly financial climate.

First and foremost, I want to reiterate that this should be a great relief for the Fed. Taking away the food and energy bundle from CPI, the core inflation rate is actually higher at 1.7% only three basis points away from the inflation target of 2.0%. Just two months ago, chairwoman Yellen was worried that inflation rate was too low at 1.1%. However, the current situation will give the Fed more room to play with easy money supply and (real) interest rate. Continuing from previous worries over early interest rate increase among investor also can be mitigated a little bit. The unemployment rate still has not changed from 6.7%.

Screen Shot 2014-04-16 at 10.40.47 AM (source: here)

As chairwoman Yellen stated last month that interest rate increase will be on schedule with incumbent plan in place, this is a good news for most investors.

A WSJ article suggests that this increase in inflation is largely due to housing and food price rise. However, I have some doubts in this article. First of all, the food prices are very volatile anyways, so what we should be looking at is the core inflation rate. In regards to the housing market, yes, the homebuilders have beat the market expectation, but if the trend of expectation was very low in the first place, they do not have to much influence in the market. The article I found suggests the following:

U.S. housing starts rose 2.8% in March to a seasonally adjusted annual pace of 946,000, fueled by growth in single-family homes, the Commerce Department said Wednesday. Starts for February were revised higher, showing a slight gain that month instead of the initially reported decline.

But other figures indicated the recovery remains dicey despite the onset of spring. Compared with a year earlier, housing starts were down 5.9% in March. And building permits, a bellwether of future construction, declined 2.4% in March from the prior month to a pace of 990,000, marking the fourth drop in five months.

Therefore, I think it is still early to predict that the recent turnaround in the housing market can be a positive sign for long term stability.

In terms of stock market, the market has been faring very well in the past 5 years or so. Ant the Pesky Indicator says US stocks are still undervalued, leaving room for more appreciation in value in the future. For more macro US stock market analysis, please refer to my recent blog here. In short, the market has been faring well since the great recession, and even at 10 year level of macro investing, it would have given you close to 5% return–much higher level you expect from safe bonds and other savings.

At international level, I want to talk specifically about China. Although their GDP growth is at 6th quarter low at 7.4%, that is still a very big number. Also this number is still beating most analysts’ and economists’ expectation. We know from rule of 70 that in less than 10 years China would double the size of their economy. There also has been a recent regulation cut down from Chinese government that rural banks’ reserve requirement would be lower. This would work as easy money for Chinese and many investment projects can be financed more easily.

Overall, I would like to restated–as I have repeatedly done so in my past posts– US economy is on a recovery track. A very good one too. Thusly, I am pretty optimistic about the market for the next 2 and a half quarter to about a year or so.

Difficult Time for Housing Market Recovery

In recent months, many voices predicted a promising future for U.S. housing market recovery. However, after several months, the situation changed. According to Wall Street Journal, sales of previously owned homes fell 0.4% in February from January to a seasonally adjusted annual rate of 4.6 million. Sales have been on the decline since hitting an annual rate of 5.38 million in July, a four-year high. Rising mortgage rates and soaring home prices have sidelined many prospective buyers, while cold and stormy weather has dissuaded others from going house-hunting in recent months.

A couple days ago, I wrote an article about rental housing market in the United States. Many house builders realized that the sales of owned homes fell while the demand for rental apartments increased. Therefore there is an increase in supply of rental housing — especially in places such as college towns, many new rental apartments are under construction. Home-building activity, a key driver of broader economic growth, has also slowed in recent months. U.S. housing starts fell by 0.2% in February and by 11.2% in January, though building permits, an indicator of future construction, rose by 7.7% last month.The mixed situation for rental and owned housing makes investors hard to make decisions.

The rising mortgage rates and soaring home prices drive affordability to continue to weaken. What does the Federal Reserve react? New guidance from the Federal Reserve on Wednesday could put further upward pressure on mortgage rates in the coming weeks. Though the Fed’s official policy statement affirmed its plan to keep rates below their longer-run trend for the foreseeable future, the projections of individual officials did point to a slightly more aggressive path for interest-rate increases in 2015 and 2016. In addition, the yield on the U.S. 10-year Treasury note, a reference point for many loans to U.S. businesses and consumers including mortgage loans, rose Wednesday in response.

I agree that the drop in existing home sales may be caused in part by declining affordability. The problem is that, just as rising prices have scared off investors, they have also caused prospective homebuyers to pause as well. This could explain why there was a surge in demand for rental houses. Consumers postponed their purchases of houses and instead rent a place to live temporarily.

In addition, the rise in mortgage rates could also be caused by the decline in homebuyers’ affordability. In this sense, the banks and other lenders have to bare higher risk. The higher the risk, the higher the interests charged. At the same time, the rise in mortgage rates make it harder to find borrowers. This in an infinite negative cycle. Hopefully there is a way out soon for the U.S. housing market.

Is The Next Housing Bubble Upon Us?

Most bubbles have been associated with new technologies or with new business opportunities. When delving into the Internet bubble of the early 2000’s in A Random Walk Down Wall Street, Robert Shiller’s book is referred to as he describes bubbles in terms of “positive feedback loops.” For example, he states that a bubble starts when any group of stocks, in Shiller’s case those associated with the Internet, begin to rise. The updraft encourages more people to buy the stocks, which causes more TV and print coverage, which causes even more people to buy, thus creating big profits for early Internet stockholders. Stocks continue to rise even higher, pulling in a larger and larger group of investors. More and more investors must be found in order to buy the stock from the earlier investors (A Random Walk Down Wall Street, 81). The bubble eventually bursts when the pool of “greater fools” runs out.

Similarly, a housing bubble begins when changed government policies and changed lending practices lead to an enormous increase in the demand for houses. Fueled by easy credit, house prices begin to rise rapidly which encourages even more buyers. Buying houses appear to be risk free as house prices consistently go up (A Random Walk Down Wall Street, 102). Speculators can enter the market believing that profits can be made by short-term buying and selling. This continues to drive demand until there is a point where demand eventually decreases, thus resulting in a drop in prices and causing the bubble to burst.

Housing bubbles become visible when housing prices begin to diverge substantially from rental costs.

Home Price Index

As you can see, most recently, home prices peaked in 2006 and then started their plunge. Due to government housing policies, this bubble was caused by making it possible for many people to purchase homes with little or no money down. The “affordable housing” goals allowed mortgages with zero-down payments to be made to home buyers who were at or below the median income. By 2006, it was reported that 45% of first-time buyers put no money down; basically, anyone who could breathe could get a mortgage. Today, after the financial crisis, the recession and the slow recovery, it looks as if the bubble is beginning to grow again as measures have been implemented by the Fed to re-inflate home prices. Between 2011 and the third quarter of 2013, housing prices grew by 5.83%, exceeding the increase in rental costs which was 2%.

Although mortgage rates have jumped a bit, to about 4.3% up from 3.5% in April, they are still near their lowest levels in history. While these adjustable-rate mortgages typically mean lower payments in the short-term, the interest rate that you are likely to face in five years or so down the road could be much higher than your initial rate. This means that you’ll be paying a high rate on a principle that has been largely undented. These adjustable-rate mortgages that led to the financial crisis could be indicating the next U.S. housing bubble. If this is in fact true, when the bubble bursts, the feedback loop will go into reverse. Prices will decline and many peoples’ mortgage indebtedness will exceed the value of their house. Credit will tighten and the negative feedback loop will lead to a recession (A Random Walk Down Wall Street, 105).

The successor of Fannie and Freddie

Owning a house is also an essential part of American dream. In fact, it is also the main goal of many countries that dedicate to helping their citizens get places to live. For example, in some developing countries like China, the government builds plenty of affordable houses and only offers them to low-income families. However, in countries like US, the government relies on mortgage market to facilitate the process of owning houses.

Fannie Mae and Freddie Mac are the two most important companies that offer cheaper loans for clients. If we want to understand the mortgage market of US, we should have a closer look at the way that these two companies work. First of all, it needs to be clarified that Fannie and Freddie don’t provide loans, but instead they buy huge amount of loans from banks and other lenders. After that, they package the loans and turn them into securities that can be widely traded in the market. Mortgage-backed securities and corporate bonds were the two kinds of securities that were issued by the companies and purchased by investors. What made these securities so popular before the crisis was the credit guaranty of the government. Investors had a very strong faith in their investment because they know the role of Fannie and Freddie in housing market and the government would have to rescue them if the companies ran into trouble. Fannie and Freddie, in turn, made use of the advantages of their highest credit rating to expand their business without carefully managing the potential risk.  The middle role of Fannie and Freddie are vital because they match banks with different capital sources such as sovereign wealth funds and pension funds that wouldn’t otherwise invest in mortgages. They not only help millions of people get cheaper loans but also release the burdens of banks. However, the system is also weak because the breakdown of a single part would cause disaster to the entire market.

The collapse of the housing market in the crisis makes people question about the efficacy of Fannie and Freddie. Some start to come up alternative method that could fix the problem. The potential successors of Fannie and Freddie are big banks and insurance companies. Since these financial organizations have the most capital in their pocket, they don’t need to worry about the potential default that almost made Fannie and Freddie bankrupted. However, large banks would have more control over the end-to-end loan production process than Fannie or Freddie ever did and it would cause a bigger concern about “too-big-to-fail” according to the analysis of World Street Journal.

It is a challenge for the government to solve the problem in the $ 10 trillion mortgage market. The companies that provide cheaper loans such as Fannie and Freddie should pay a fee for their guarantee to make sure their would take too much risk. What’s more important is to find the proper leverage and require them to maintain enough capital in case of bad scenario.

(Revised) Time to Buy

Anyone with a basic understanding of the economy knows that now is a good time to buy a house. Mainly because interest rates and prices are low – and rising. The longer people wait, the more they will have to pay for their home, and with higher interest rates on mortgage payments. But there is a clear challenge for home-buyers right now: Wall Street investors looking to “Flip This House”. Big businesses are also taking advantage of low housing prices – and are capitalizing on their investments by buying cheap homes, renovating them, and selling them at a higher price.

This isn’t bad for anyone, really, except for unlucky home buyers that are caught in bidding wars with these investors. On one side, the seller gets to sell his property, the buyer makes a profit from “flipping” the house, and surrounding home-prices consequently rise as the standard for homes in the area increases. However, for average home buyers caught in a bidding war with big investors, it is pretty much a lose-lose as they stand no chance against their bidding capacity. Considering their hefty wallets, it is best for home buyers to simply back-off. So the competition to find houses is no longer a matter of outbidding someone else looking for a home – it’s now a matter of hoping that no big investors (who pay mostly in cash) notice your future-house. Despite this challenge to home buyers, though, now is still the time to buy.

In 2012, big investors bought about 140,000 houses in the United States (3% of sales). But this small percentage obscures the real impact on individual markets. For example, in July of 2012 corporate buyers accounted for 25% of house purchases in Atlanta, and 20% in Tampa. Though they are not investing all over the country, their concentration in real estate-desirable locations has a large impact in those particular areas. Other areas of concentration include Florida, Phoenix, Las Vegas and California’s Central Valley. Not only are these investors making it more difficult for home buyers, but they are also slowly driving up home prices.

Of course, this is something the economy wants. So comes in the need to purchase homes now.  A report from the National Association of Realtors shows that 5.1 million houses were sold in 2013, a 9.2% increase from 2012 and a 20% increase from 2011. In 2013, the median price of a house sold was $197,100 – an 11.4% increase from 2012. Increasing prices, lower unemployment, a decrease in foreclosures, an increase in demand, and low mortgage rates (though rising), have fueled the growth in the housing market.

WE-AA524_HOMEJU_G_20130918112706

The Home Price Index of the Federal Housing Finance Agency shows a 14% increase in home prices from 2012 to 2013. Though this is an excellent sign for the economy, it is a call-to-action for home-buyers. And not only because of prices: today’s 30-year fixed mortgage rates are far cheaper than they have been in 40 of the past 42 years (at 4.57% last week). But again, this rate is more than a percentage point higher than in January – mortgage rates are on the rise.

Thus, as we look at the recovering economy with positivity, we also see its impact on home-buyers. Although corporate investors are making it more difficult for some in real estate, there is no doubt that now is the time to buy.

Rental Apartments, a New Trend in Home Building

Many economists expect the U.S. this year to finally eclipse the 3% annual growth rate that has eluded its economy since 2005. Whether that happens or not will depend to a great degree on how much new housing is built. The category of gross domestic product that includes home building and renovations accounted for about 3% of growth last year, and consumer spending is also increasing. When home prices are rising and owners are building equity, they feel richer and tend to spend more. The housing sector already is starting to make up that ground, but a larger-than-normal share of it is coming from rental apartments.

Housing market is an important part of U.S. economy. According to a new article on Wall Street Journal, the share of new homes being built as rental apartments i s at the highest level in at least four decades, as an improving jobs picture spurs younger Americans to form their own households but tighter lending standards make it more difficult to buy.

P1-BP392_APARTM_G_20140309173630

 

As we can see from the above graph, the multifamily rental apartments built as a share of total U.S. housing grow rapidly in 2013 at 30.8%. This is almost the highest percentage over the past 30 years.

On the demand side, in my understandings, the shift toward apartment construction reflects the convergence of several trends. Firstly, mortgage credit is still tight. Homes buyers may find it hard to borrow money from banks when purchasing houses therefore renting apartments would be a good choice. Secondly, other expenses such as high student-debt loans would increase consumers’ daily expenses so as to force people to rent instead of buying homes.

At the same time, on the supply side, more home builders would be willing to focus on rental apartments because they view a large demand. As the job market improves, larger numbers of young adults are leaving their parents’ homes and forming their own households — adding more to the demand for apartment rentals. Therefore, the supply of new apartments hasn’t kept pace, especially in some key markets such as San Francisco. I also notice that the improvement on job markets does not enough to make a surge in first-time home buyers. Instead, the improving jobs picture for young adults will mean more renters this year. The new labor force would still find it hard to afford to buy a house. Therefore, more of the home builders are betting on the more young adults leaving the nest this year.