April 9, 2004 A Non Professional look at home prices and what we believe to be
a housing bubble. Please leave your pins at the door.
1. Housing starts and existing home sales remain strong.
2. Low mortgage rates have increased demand for homes.
3. Declining interest rates have encouraged short term mortgage borrowing.
4. It is widely believed that an increase in interest rates will have an adverse affect on the price of real estate. Rising rates would also curtail home equity borrowing, which in turn would curtail the current drunken spending patterns of the American consumer. If rates were to rise, new buyers would not be able to afford the increased monthly payments. Hence, prices could adjust to lower affordable levels. Let’s use an example of a person who can afford to pay $2000 per month in mortgage payments. Currently you can get a 30 year fixed rate at 5.50% (no points). The affordable loan using those givens would be $352,244. If the same mortgage rate rose to 7.00%, the affordable loan would be $300,615. One has to consider the question. Would a home lose 15% value with a rise in interest rates by 150bp? If rates went up to 9.00%, the affordable loan would be $248,564. In carrying cost alone that would be a 30% drop in value.
Please refer to this graph on Japanese land prices.
5. We read that Countrywide Financial is considering a mortgage that will allow the financing of utility bills, along with the purchase price of the home. Other banks are offering ” purchase the home and renovate” loans. Interest only loans are also becoming popular. Using the same affordability as the $2000 monthly in example above, the affordable interest only loan would be nearly a $600,000 loan. What happens to the homebuyer when principal begins amortizing in 5 years? Many of the owners of interest only mortgages are counting on either selling the house during that period, or refinancing as an alternative. If only life was so easy. We believe that the results of these creative vehicles, will be historic and devastating. These creative loans are making current homeownership more affordable. Of course, if interest rates creep up, or when the creative financing term ends, affordability may become a scarce commodity.
7. Affordability for the homeowner is tied into interest rates and continued or recurring employment. The leveraged homeowner needs continued employment and rising real estate prices. It worries us what the recipient of this creative financing or the overleveraged real estate owner will do when the time comes to pay the band. It is of our belief that we will see a period of high reposessions. We are already seeing concerns of the Fannie Mae’s and Freddie Mac’s.