Wed, 3 Oct 2012
The real mortgage rate--the nominal mortgage rate minus the rate of appreciation or depreciation in homes--is one of the most important housing statistics to watch, and it recently went negative again, says Schwab's Liz Ann Sonders.
Scott Burns: Catching up on the housing market.
Hi there, I am Scott Burns, director of fund research, coming to you from Morningstar’s ETF Invest Conference 2012.
Joining me today is Charles Schwab’s, Liz Ann Sonders. Liz Ann is a senior vice president and chief investment strategist.
Liz Ann, you recently have written about housing--well, you've been writing about housing for a while, as everybody has. But you really took a bold step. You wrote a piece a little while ago and have updated it recently called "Bottoms Up." So, you called the bottom. How did you do?
Liz Ann Sonders: I think pretty well; it was at the beginning of this year. We're now five consecutive quarters where residential investment, which is the housing component of GDP, has been a positive driver of GDP, and that's following six consecutive years of it being a drag.
So, one of the key metrics that I not only focused on in attempting to figure out when we were in a transition to a recovery, back in 2006--when Schwab, I think, did a pretty good job of warning our investors that the bottom was about to fall out--was the housing market index, basically a builder sentiment index put out by the NAHB, and that had really cratered into late 2006. And the turn was pretty meaningful earlier this year, and it has a very, very tight correlation to home sales and home prices, and even things like broad job growth.
So, it was starting to kick in. More important recently was the real mortgage rate went negative, and I think this is one of the most, if not the most, important, housing statistic that one should pay attention to that very few people that I have seen focus on. So much like real GDP is nominal GDP minus inflation, the real mortgage rate is nominal mortgage rate, 30-year fixed mortgage rate, minus the rate of appreciation or depreciation in homes, because it doesn't just matter the rate you're borrowing to buy, but what's happening to the asset you are borrowing to buy.
So, at the peak in the housing market, in the bubble, you had a 6% 30-year fixed mortgage rate and a 17% rate of appreciation in homes, which meant you had a negative 11% real mortgage rate--no wonder why we had a bubble. Who wouldn't want to borrow at negative 11% interest rates?
Burns: Free money, magic money machine.
Sonders: Fast forward to when it was at its ugliest point, mortgage rates had come down to 5%, but then you were subtracting a negative number, so 5% minus ironically negative 17% was plus 22%. The nominal mortgage rate was not the part of the equation you needed to fix. You needed to stop the massive depreciation in homes.
The latest NAR data is almost a 10% increase in homes. So, now you have a 3.5% 30-year fixed mortgage rate, minus a 10% rate of appreciation in homes. You've got about a 6% negative real mortgage rate again. That to me has been the driver. That's to me what's been pulling people off the fence. Now not only do I have record low mortgage rates, but now the asset I am borrowing to buy is appreciating in price again.
Burns: Right. Housing is such a big important part of the economy--it’s the average American's biggest asset. What does this turnaround mean for the psyche of [Americans]?
Sonders: You're right. Household net worth's two biggest components by far is the stock market and homes, and if you think about it, those were the back-to-back bubbles from 2000 to 2008. Now both are moving in the right direction. So, the next print on household net worth is probably going to be in addition of about $2 trillion. So, you have dual cylinders firing right now, and then of course you just have the ripple effects in the confidence, because when you finally start to see healing in the thing that took the global economy down, and because it’s such in our heart not to mention our net worth, I think the ripple effects into confidence--even if it's a smaller driver of GDP than it was before--I think the ripple effects are being underestimated.
Burns: I think you're absolutely right. And just the "underwaterness" of things…
Sonders: And as prices go up, there is a smaller percentage of people under water.
Sonders: You take underwater mortgages to overwater mortgages.
Burns: Anecdotally, you see the evidence--labor wasn't moving, people couldn't take jobs in other places…
Sonders: Right. Exactly.
Burns: … because the cost of leaving the home for the new job wasn't going to work out. Just the ability to make other purchases …
Sonders: Even just the refi cycle. We're not just talking about new home purchases, but the ability to refinance. Now, we know there are still constraints in the lending environment, but those are well improved from where they were a few years ago, and I think if demand continues to pick up, financial institutions, mortgage companies, they’re still for-profit businesses.
Sonders: If the demand is really accelerating, they will bring the staff on that’s necessary, they will I think continue to loosen lending standards--hopefully not to a ridiculously degree, but enough that will start to unclog the system a little bit.
Burns: The other thing--and I think viewers are going to have different experiences in the housing market--housing is very personal it turns out.
Sonders: Yes it is, and very local.
Burns: And very local, and I think your perspective on that where we've gone from what seemed like a national rising tide, everybody's houses went up.
Sonders: It was.
Burns: Are we seeing a national rising tide right now?
Sonders: Well, if you look at the numbers, whether it's Case-Shiller or home sales, at first blush, it seems like the tide is starting to lift all boats, but you can certainly still find pockets of real weakness, and where the foreclosure pipeline is still high, a high percentage of underwater mortgages, not much traction in terms of prices.
So, I think we are back to what is normal in real estate, which is that it is local, it is regional. It's a function of supply demand at the local level. It's a function of the local economics, what the businesses are, what the job growth is, all of those things.
So, I think we're starting again to see a little bit of a national lift, but unquestionably, if you're going to analyze real estate, you cannot think of it as this national monolithic thing anymore. You arguably could when the bubble was inflating and when it was deflating, because it was this monolithic thing.
Burns: Right. It was monolithically financed.
Sonders: Now, we're back to, I think, if you’re going to appropriately analyze it, you have to look at regions, at local economies.
Burns: For those regions that are struggling, what's going to be the way out for them? Why is it some are doing better than others?
Sonders: Well, one hope that you're starting to see--and it’s starting to really unclog things in places like Miami and places like Phoenix--is you're getting a lot of investor dollars coming in and buying pools of foreclosures, whether it's in the condo market, the rental market. And not just to flip them, but really in many cases to take over full, half-empty condo complexes in the Miami area and turn them into rentals, and that's really helped…
Schwab: Return them to their natural state of rental.
Sonders: To their natural state of rental, and we are going back to probably a more appropriate balance between buying and renting. I think now the balance is tipped toward it being beneficial to buy over rent, but that certainly was not the case a couple of years ago.
So, not only are you seeing investor dollars a lot--whether its funds been put together, hedge funds coming in and making a much bigger real estate play--they are not just doing it in foreclosures now. A lot of these big funds have figured out how to work through the glitches in the short sales as well. That had been a real problem. It was very difficult to make a purchase of a short sale, but they're even figuring out how to package those up, and investor dollars are coming in there, too. So that’s certainly been a recent help to try to take some of this inventory down. And the inventory having come down is part of the reasons why prices are going up significantly in certain areas, because there is just not a lot of inventory of the lower-priced homes for the first home buyer.
Burns: It turns out they still only made so much land, even though we built way too many houses.
Sonders: And we now have household formations picking back up again. So, whether it's your boomerang kids finally leaving the house, or the double and tripling up are saying I'm done with the roommate thing. So household formations jumped this year from last year for the first time since about 2006, but housing completions has continued to come down. So you now have a big mismatch, where housing formations are well higher than housing completions. That doesn't turn things around immediately, but those are the types of supply-and-demand imbalances that you want to see to start to stimulate construction again.
Burns: Well, thanks for joining me. It's so good to actually have some good news on housing to talk about after so long.
Sonders: I try.
Burns: But thank you and good luck at the conference later today.
Burns: I'm Scott Burns coming to you from the Morningstar ETF Invest 2012 Conference.