Hot U.S. housing markets turning cold -James Saft

December 12, 2013

Dec 12 (Reuters) – After rapid gains, some of the hottest
housing markets in the United States look like they are starting
to roll over.

Whether this is a reaction to the run-up in mortgage
interest rates in recent months or represents a waning bid from
the all-cash financial investors who have so often been marginal
buyers is unclear. Either way, volatility in house prices may
now prove to be a feature of the system rather than a bug.

In Phoenix, where house prices have risen more than 40
percent in less than two years, pending sales fell 32 percent in
October, while the number of months (at current sales rates) of
supply is up 111 percent from May.

In Sacramento, the October figures are equally grim, with
year-on-year supply up 93 percent and sales down 20 percent.

Both Sacramento and Phoenix are markets that have seen a
large influx of financial buyers, private equity firms and
others trying to put together large portfolios of single-family
homes to manage and rent.

Volume isn’t slumping just in the classic boom and bust
towns. Washington, DC house sales fell 14 percent in November,
while sales in Silicon Valley, now in the midst of a technology
IPO boom, fell 20.9 percent in November.

Mark Hanson, a real estate adviser and mortgage banking
veteran, argues that as supply and volume usually lead price, we
could be on the verge of a substantial downdraft in values.
“I feel like it’s 2006-2007 again,” Hanson said. “Data is
everywhere but nobody is looking, or wants to look.”

To say the current state of the real estate market is
unusual is an understatement.

Investment firms like Blackstone have raised almost $20
billion to buy as many as 200,000 houses. Blackstone itself has
bought more than 30,000 so far. While that is not huge compared
with the 5 million or so existing U.S. home sales every year,
these funds have been joined by uncounted legions of mom and pop
outfits cobbling together mini-rental empires.

That has been a boon to a market that otherwise faces some
difficult math.

According to Hanson, about 22 percent of mortgage borrowers
are underwater, meaning they owe more than their house will
fetch. Add to that the number with bad credit, no job or simply
not enough equity to pay real estate and moving costs and you
have a market in which 40-50 percent of mortgagees are trapped,
he argues.


Given how hedge funds and private equity are paid, they are
likely to have been impatient buyers of real estate. If that bid
is fading and we are heading for yet another strong fall in
housing prices, we are going to have to face up to a distressing
reality: shelter prices have become highly volatile, perhaps on
an ongoing basis.

I’d argue this has strong parallels in other markets and has
in part been driven by monetary policy, though obviously the
approach to the banking and mortgage fiascos has also played a
huge role.

Compare the U.S. housing market with the credit markets, as
detailed in a recent Bank for International Settlements study.
Both markets are very “hot” with lots of investors competing to
take on risk, sometimes in ways that have not historically had a
good track record.

In housing, the new marginal buyer is a financial buyer,
just like in the credit markets, where the buyer is an investor
in publicly issued securities.

Yet the traditional buyers of both credit and housing are
arguably still in bad shape. Banks are still funding themselves
on worse terms than the non-financial corporations they serve,
while actual owner-occupiers are, as detailed above, also partly
taken out of the game.

So what happens in a situation where monetary policy drives
hot money?

If interest rates rise, as they are now, and surely will
when the Federal Reserve slows its bond buying, the hot market
often turns cold. Indeed, the slowing in real estate may well
have been driven by a taper-driven run up in mortgage rates
earlier this year.

What we have done in both cases is to paper over cracks in
the foundations of the market by bringing in new investors
while not properly sorting out the traditional risk-takers, be
they banks or underwater homeowners.

What this will mean for borrowers when rates rise is a
credit crunch that exposes the existing problems within the
banking system. For actual homeowners, this means they will face
substantial ongoing volatility in their most important, arguably
indispensable asset – housing.

If you scraped together 15 percent down to buy in Sacramento
two months ago, you may well find yourself underwater in a year.
That kind of volatility is costly, and not just in economic

Financial markets are great and useful things, but they are
not the answer to all problems.

(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at and find more columns at

(Editing by Dan Grebler)

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