Housing Market Enters Potentially Pivotal Period
By Seth Van Brocklin

Will rising mortgage rates serve as the death knell for home price appreciation?
Inside: Why more people are calling rentals Home Sweet Home.

This Special Edition of Independent Living features stories that focus on the hard asset that is the square footage beneath your feet: real estate. Whether you’re a renter or a home owner; whether you’re looking to buy, sell, invest, relocate, upgrade, downgrade, or stay put – what happens in the housing market is crucially important to your finances.

The decisions you make in response to the threats and opportunities presented in the housing market will heavily impact your financial future. Even if you plan to continue living in your current home permanently, you’ll still want to maximize and protect its value. You’ll still need to better secure your home and your home’s contents from hazards such as burglary. (Yes, crime rates are back on the rise after falling for three decades.)

You may be happy where you’re at now, but down the road you may need or want to move. Perhaps you’ll be looking for a great place to live out your retirement years. Perhaps you may be looking for a way to enable a frail relative to live semiindependently close by without actually moving in and sharing a bathroom. We offer specific suggestions in this issue.
Before getting into strategies, however, let’s consider current housing market conditions…

Negative Equity Still Haunts Housing

Housing continues to nominally recover throughout most of the country. Most of the housing data came in better than expected in the first half of the year. At least, that’s the superficial truth the financial media reported.

The Case-Shiller home price index rose at a 4.1% annual pace in the latest reading. Home price appreciation is still occurring but on a decelerating pace.

Despite 6 years of nominal price recovery, 15% of home owners still owe more on their mortgages than their homes are worth, according to a recent Zillow report. For perspective, the proportion of upsidedown mortgages has been cut in half since the depths of the financial crisis. But 15% of homes with negative equity is still a long way from the 2% or so that normally characterizes a healthy market.

Buying into a city or a neighborhood with high rates of negative equity is risky. People with negative equity are less likely to invest in upgrades or make necessary repairs. They are also more likely to walk away and let their properties go into foreclosure. High rates of foreclosure in a neighborhood tend to depress home values.

Meanwhile, lenders are more exposed than ever. Average mortgage loan amounts have exploded upward since 2011 to nearly $300,000. Is all this leverage sustainable against the backdrop of an economy that is barely growing? Or is another mortgage bubble in the making? If (when) the economy heads toward recession, we’ll find out.

Real Estate “Recovers” Even as Home Ownership Rates Recede

According to the National Association of Realtors, home sales hit a nine-year high in June. Yet behind the seemingly positive momentum for home sales, the actual rate of home ownership continues to fall. According to the Commerce Department’s most recent report, the seasonally adjusted home ownership rate came in at 63.8% – the lowest level since 1989.

How could home ownership be falling if the housing sector is recovering? The answer is that sales growth is being driven less by traditional owner-occupants than by second-home purchasers and investors. Many investors are buying houses for rental income. Nothing wrong with that – in an environment where it’s difficult to get a decent yield on capital, real estate is a viable avenue for income investors.

But a healthy housing market can’t be sustained in perpetuity just by investors. If millennials and younger people who traditionally become first-time home buyers keep renting, future demand for single-family homes (especially higher-end and new construction) simply won’t be there. Prices might have to fall in order to make homes more affordable to more people and more financially attractive than renting.

There is also the potential in the years ahead for retiring empty-nest Baby Boomers to trade out of large suburban family homes and into smaller houses. Or move to planned retirement communities in warmer climates. Generational changes in housing needs could result in an inventory glut in areas where retirees are migrating from (and boom times in areas that are popular with retirees).

Mortgage Rates Rise from Record Lows

All real estate is local. However, aggregated local conditions make for national trends. Going forward, the housing market faces potential headwinds from rising interest rates.

In June, average 30-year fixed mortgage rates surpassed 4% for the first time this year. Mortgage rates remain low by historic standards. But any increase reduces affordability and thus puts downward pressure on prices.

Mortgage rates probably won’t go much higher in the immediate future as long as the government is subsidizing the market and the Federal Reserve is holding its benchmark rates artificially low. Even though Quantitative Easing has ended, the Fed hasn’t exited the market. Far from it. The Fed still holds an eye-popping $1.7 trillion in mortgage-backed securities – all acquired since 2009.

Economic Dark Clouds Ahead

The great debate over whether the Federal Reserve will raise rates should be resolved later this year. If the Fed doesn’t raise rates despite months of telegraphing that it will, the reason would be because the economy is too weak.

Although the data remains mixed, recent reports paint a picture of a steadily deteriorating economy – heading, perhaps, toward recession. This spring, factory orders fell to multi-year lows, consumer
confidence sank, GDP for the first quarter was revised into negative territory, and the workforce participation rate continued to dwell near 30-year lows.

HSBC chief economist Stephen King recently warned in a note to clients, “The world economy is like an ocean liner without lifeboats. If another recession hits, it could be a truly titanic struggle for policymakers.”

The upshot is that if the economy shows further weakness, interest rates are likely to fall. You may get another opportunity to take out a mortgage or refinance near record-low rates in the months ahead.