Tuesday, May 28, 2013

Case Shiller 20 City growth 23% - Twice yearly measure




On Tuesday Case Shiller reported year over year growth of 10.9%.  But this is a backward looking measure over a period that saw the index fall, then recovers after FHA loan limits were reinstated, then taper off to 3.3% annual growth in July 2012, before the renewed interest in housing and more importantly lower mortgage rates, drove  price growth in March to 23%.   The California cities in The Case Shiller 20 (Los Angeles, San Diego, and San Francisco)   grew to 34%.   These trends are compared to the year over year average in the  following chart: 
                     


You should understand the following technical points. March data will be updated in April and May as more transactions are processed. March will change but it is highly unlikely that the 34% annual growth would drop below 30%.  Case Shiller is weighted by housing value. The 3 California cities make up 27% of the index and 12% of U.S. housing value.  The annual rate is calculated by taking the monthly growth over the prior month to the 12th power. The March Data is composed of transactions negotiated in January. Monthly data is five months old compared to the year over year average which is a year old

Most economists working with old data did not believe that this is a housing bubble. 
  • Ed Stansfield, at Capital Economics says: “Talk of a house price bubble seems premature, In relation to incomes, rents or their own past, U.S. home prices still look low.”             
  • Daniel Silver at JPMorgan Chase says: “Spending has been doing quite well, at least for this expansion, over the first half of the year, due in part to these wealth effects.”                         
  • John Ryding, at RDQ Economics says: “Five years after the start of the financial crisis in earnest, and four years and a week’s time from the beginning of the economic recovery, we’re finally starting to get more of a pickup, more of a reduction in caution in terms of consumers’ behaviors,”    
 
If this were true why are the prices outside the Case Shiller 20 growing at only 5%? Why are consumer behavior and wealth effects so different in these regions which accounted for 75% of U.S. housing sales?  House prices are one third that of the Case Shiller average and one fifth of the California average. Inventories are high.  They did not experience a big gain in the housing bubble and the house prices average 15% below the inflation adjusted price at the start of the bubble in 1997, while Case Shiller cities are 30% above.  Case Shiller publishes a “national index” which performs much like The Case Shiller 20 City. This index only covers urban areas. It is a nonsense number.

Investors buying houses to rent to profit from house appreciation drive price increases. They base their investment on how far prices fell from the 2006 peak.  As Investors push up the prices the inventory declines which also drives prices higher. The decline from the peak drives price growth because buyers look at the peak and believe that they could return to those levels.  It won’t- despite the new sub prime mortgages (3.5% down FHA) and low mortgage rates. The 2006 peak was 337% of the price at the start of the expansion.  Yes thinks housing looks cheap by that measure but it is an unrealistic benchmark.

American has a history of housing cycles. The price at the start of the expansion contracts to the price at the start adjusted for inflation any increase in the activeness of housing. Prices adjusted for inflation in California were excessive before the recent run up because expensive market react to government actions to increase prices.   The cities in California have a history of volatile price swings because permitting new house lots takes a long time so prices take off because supply is constrained. 


The high priced cities are likely to decline.  First, because they always do.  A city that is expensive will slowly lose business to lower cost regions causing a slow grinding decline that goes on for years.  This process continues even as the economy grows. The investor performance in the future will not look as good in the future as it does now.
        


Saturday, May 18, 2013

House price variation by city correlates to three factors




In the last 14 months, prices in the Case Shiller 20 Cities grew at rates that differ from 28% in Phoenix to 0.5% in New York.  House price increases are driven by lower mortgage rates resulting from the Fed’s purchase of long term bonds.  This analysis explains the city differences that correlate at 85% to three factors:  months of inventory, income growth, and the percent decline from the 2006 peak.   The two biggest outliers are Washington DC and Phoenix. Washington price growth is 8% below the predicted level. 2012 was an election year and the city is haunted by budget cuts.  That fear is missing in Phoenix where its aggressive housing investors pushed prices 8% above prediction. Excluding these two cities, the correlation raises to 91%.  
The graph below illustrates how close the actual is to the regression projection. 


Investors buying houses to rent to profit from house appreciation drive price increases. They base their investment on how far prices fell from the 2006 peak.  As Investors push up the prices the inventory declines which also drives prices higher. These factors explain the reemergence of bubbles. The high priced cities are likely to decline.  First, because they always do.  American has a history of housing cycles.  A city that is expensive will slowly lose business to lower cost regions causing a slow grinding decline that goes on for years.  This process continues even as the economy grows. The investor performance in the future will not look as good as it does now.
Case Shiller 20 city prices in February grew at an analyzed rate 16%, compared to November growth of 8.5%.  Prices have grown at a faster rate in each of the last four months.  Rapid growth in an overpriced is a bubble not a recovery. Half of the Case Shiller cities are driving the growth.  The most important fact in developing a price forecast for 2013 is when the price increases will stop accelerating.  There are tentative signs that prices will level off but they have yet to do so.
The regions outside the Case Shiller 20 called “Heartland” represent the bulk of the U.S. housing market.  This market accounted for 75% of housing sales in the last year but it got less than 5% of the attention. Why? It’s boring. House prices are one third that of the Case Shiller average and one fifth of the California average. Inventories are high.  They did not experience a big gain in the housing bubble and the house prices average 15% below the inflation adjusted price at the start of the bubble in 1997, while Case Shiller cities are 30% above.  Prices in these regions are slowly but steadily recovering.
The Fed believes that low interest rates will push prices up which will increase house construction and raise employment. The flaw with that approach is that, if it were easy to permit new houses in expensive cities, these cities would not have become expensive.  The short term gains from low interest rate are not worth the long term pain.