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By Scott Burns | 10-03-2012 01:00 PM

The Real Driver of a Housing Recovery

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.

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