Unexpectedly Intriguing!
22 April 2014

Following our analysis that median new home sale prices in the U.S. have begun to contract, we decided to dig deeper to find out more. We'll begin with the Wall Street Journal's description of the general climate in the U.S. real estate industry throughout the first quarter of 2014:

Reports from local real-estate agent groups in some of the markets that were the first to rebound, including Las Vegas, Phoenix and San Diego, show year-over-year declines in March home sales. February data for pending home sales nationally—a barometer of early-spring activity—show a decline of 11% from a year ago.

And in markets around the country, fewer people are showing up at open houses. An index of home-buyer traffic in 40 U.S. markets compiled by Credit Suisse was down a little more than a third from March of last year. In some parts of the country, cold weather has put a damper on traffic.

New construction of single family homes is also increasing slowly, according to new data released Wednesday. New building permits for single-family homes in March fell 1.2% below the year-earlier level, the Commerce Department said Wednesday. New single-family home starts rose 1.9% from a year earlier.

"Overall, even after adjusting for weather, it has been worse than what most people expected," said Tom Lawler, an independent housing economist in Leesburg, Va.

The WSJ goes on to confirm one of our earlier observations that the sudden increase in mortgage rates is a major factor behind the deceleration that appears to be taking hold:

The sluggish start to the spring home-buying season—a crucial period for sales because families typically want to lock into a school district by the end of summer—comes as investors cut back on purchases of homes that can be rented or flipped for a quick profit. Meanwhile, potential buyers are still adjusting to a sharp rise in both home prices and borrowing costs over the past year. With prices and mortgage rates up, the nation's median monthly home payment—including principal and interest—has risen 20% in the past year to about $900, according to John Burns Real Estate Consulting.

The WSJ then went on to identify the recent cost trends for a number of local real estate markets that were seeing rapid price increases in 2013:

WSJ: Trends in Home Prices in Selected 'Hot' Local Real Estate Markets

Here, we see that the increase in home prices is decelerating for a number of markets, and that they have actually begun to fall in the Phoenix metropolitan area. Based on that, we decided to drill down into local news coverage to see the factors at work in that market. Here, we found a good description of the trends in Phoenix' home sales since the beginning of 2014:

A drop in home sales and an increase in listings helped pull down metro Phoenix home prices in February.

The Valley's median home-sales price fell to $195,000 in February, the lowest since August, according to Arizona State University's W.P. Carey School of Business.

The median also fell in January, to $196,500. The median sales price was $205,000 in December. That means median prices have dropped almost 5 percent since the start of 2014.

The number of sales in February also was a concern for the real-estate analyst who prepares the report.

"Home-sales activity was a startling 26 percent below February 2013," said Mike Orr, director of the Center for Real Estate Theory and Practice at W. P. Carey School of Business. "Despite the large price gains since last year, this is the weakest February in four years."

He said metro Phoenix home sales typically climb in spring, but the market is still on track to see little or no appreciation this year.

What makes what's happening in Phoenix' local real estate market particularly interesting is that the region was completely unaffected by the winter weather that would appear to have negatively impacted other regional real estate markets in the United States.

Phoenix was also one of the markets most negatively affected by the deflation of the first U.S. housing bubble, which subsequently benefited from the influence of investors who bought up large quantities of distressed and foreclosed properties from July 2012 through July 2013 - the primary inflation phase of the second U.S. housing bubble.

Having drained the supply of inexpensive properties, the same investors that drove the recovery of home prices in the Phoenix metropolitan area have begun to exit the market:

The house-flipping frenzy is over in metro Phoenix, though a few investors are still able to make it work if they can find the right house.

The dramatic drop in foreclosures across the Valley means there are few houses to be bought cheaply, fixed up and resold quickly for a profit.

"There was the point where we had 11,000 foreclosures in one month," said Marty Boardman, a real-estate business owner who began investing in Valley houses in 2002. "From what I understand, today the average is around 500 or 600."


"Last year I just decided that enough is enough," said Boardman. "The profit margin was just too thin in Phoenix, and there were too many investors in the market."

Now, let's zoom out and see how the #1, #2 and #3 national investment firms in residential real estate are now playing the markets:

Blackstone’s acquisition pace has declined 70 percent from its peak last year, when the private equity firm was spending more than $100 million a week on properties, said Jonathan Gray, global head of real estate for the New York-based firm.

American Homes 4 Rent and Colony American Homes, the second- and third-largest single-family landlords, also have been scaling back as bargains dry up. Home prices have risen 24 percent since a post-bubble low in March 2012, which was about when corporate buyers started their buying spree, according to the S&P/Case-Shiller index.

Note that Blackstone, the largest player, really didn't get started buying up available residential real estate until July 2012, marking the beginning of the inflation phase for the second U.S. housing bubble.

With investors having run up home prices enough to effectively price themselves out of the market, the inventory of homes for sale in Phoenix and other markets has begun to rise. But because mortgage rates also rose sharply in the second half of 2013, the remaining consumers in the market, who are primarily people who are seeking to buy homes to live in themselves, are at a financial disadvantage. The typical prices of homes available for sale in the market, when translated into the monthly payments of a mortgage, are simply too far above what these ordinary home buyers can support on their household incomes.

Annual Expenditure for Owned Dwellings vs Annual Income Before Taxes for Various Income Ranges Reported in the Consumer Expenditure Survey, 1984-2011 [Current Year U.S. Dollars]

But don't just take our word for it. Others have noticed that effect as well:

"People are coming out and shopping [for new homes], but they're not buying," said Brad Hunter, chief economist for home-construction analysis and consulting firm Metrostudy, a division of Hanley Wood LLC. "My analysis is that a lot of this has to do with sticker shock."

Mr. Hunter and other housing-market observers theorize that sales volumes won't pick up markedly until builders rein in their price increases and first-time buyers and less-affluent buyers are ushered back into the market by better job and wage growth and a slight loosening of mortgage-qualification standards.

That state of affairs is not a sustainable situation, so something has to change so more transactions can take place. That something is the price of homes for sale, which are now responding to the increase in supply and the decrease in demand by either decelerating their rate of increase or by falling outright, depending upon the local real estate market in question.

That dynamic, played out in varying degrees in all the real estate markets across the country, but especially in the markets that had seen the most volatility in prices during the years of the first housing bubble and the most investor activity in the second, is what is now causing the second U.S. housing bubble to enter into its deflation phase.

U.S. Median New Home Sale Prices vs Median Household Income, 1999-Present, through February 2014

And that's how the U.S. real estate market entered into such a state of malaise in early 2014, with housing prices stalling out or falling in enough local markets to show up as an outright decline in the trailing twelve month average of median new home sale prices in the preliminary data for February 2014.


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