Tuesday, January 28, 2014

California house price bubble ends as Forecasted

Seven months ago prices in the three California cities of Case Shiller 20 city index grew at an annual rate of 38%.  This month they grew at 11%, the same rate as the other 17 cities in the index.  In the 2013 reporting period, the California cities grew 60% faster than the index. This surge rendered the 2013 forecasts obsolete in two months.  These cities: Los Angeles, San Diego and San Francisco represent 27% of the 20 city index so a sharp change will have an outsized impact on the total index. In 2014, a sharp decline in these cities will make this year’s forecasts as obsolete as they have been in the last three years.

The following graph illustrates the monthly price changes in the three California cities and the remaining 17 cities compared to the 20 city index.  To understand the forces acting on house prices you need to understand when the event occurred.  The January 28 report covers preliminary house prices for November closings the bulk of which were negotiated in September. My 2014 Forecast prepared last month had the 17 cities starting to decline with the California cities declining at a more rapid rate with both groups at a 10 % growth this period.  A risky forecast, but the only miss was that both groups declined to 11% this month.  

The actual price changes illustrated in the graph cannot be driven by stronger macroeconomic indicators.  Historically regional housing bubbles contract to the level where they started adjusted for inflation. In this case changes to government programs triggered a price surge.  The rush to buy before prices got higher ended in April and investors and others left the market. It is an example of Fed Governor Jeremy Stein’s concern about reaching for yield. California prices in 2012 and 2013 were a mini bubble.  The other 17 cities exhibited a similar pattern, but not as extreme. The one indicator that does move housing prices is mortgage rates. In June the rates began to move up but this increased prices as buyers rushed to lock in lower rates driving prices in the 17 cities up.  Now prices have begun to fall in reaction to the higher rates.

The Case Shiller 20 index highlights the surging prices in expensive markets. Media coverage of the hot markets leads to higher price expectations in other markets. The more expensive markets showed a greater response to FHA loan limits, house purchase credit and other programs.  The California market has a long history of booms and busts.  Buyers remember the peak and believe that these prices will return.  With some good news the price stampede will begin. The 20 cities are diverse.  I look at them by grouping them into cities that perform similarly. Four of these cities did not see much increase in the bubble.  The price trend of each city correlates to the extent of the price increase in the bubble and personal income. Outside the 20 cities prices are much more stable. The following table illustrates the projected 2014 prices.
David Blitzer of S&P Case Shiller announced that the year over year growth for this month was 13.7%. He said “While housing will make further contributions to the economy in 2014, the pace of price gains is likely to slow during the year," That is an understatement. The year over year is held up by the large gains in early months that mask the current fall in price growth. Next month the yearly number will decline to 12.4, but the annual growth rate that month is forecast to be 7%. 




Tuesday, January 7, 2014

2014 House Price Forecast Risk





In 2013, the Case Shiller 20 city index grew 13.6% and grew 22% in its 3 California cities. In that light, a fourth quarter Zillow survey of 110 economists forecasting a 2014 gain of 4.3% appears low.  Forecasts for 2013 were far too low but, for 2014 they are too optimistic. Prices in California are falling rapidly and those for the case Shiller will turn negative.  Price growth in 2014 will be zero with declines in the second half of 5%
The 2013 forecasts were obsolete in two months because the three California cities (Los Angeles, San Francisco, and San Diego)   grew unexpectedly. These three cities represent 27% of the Case Shiller so a sharp rise will have an outsized impact on the total index. In 2014, a sharp decline in these cities will make these forecasts obsolete. 
The following graph illustrates the monthly price changes in the three California cities and the remaining 17 cities compared to the 20 city index.  To understand the forces acting on house prices you need to understand when the event occurred.  The December 31 report covers preliminary house prices for October closings the bulk of which were negotiated in August.   

The first thing you notice is the rapid price swings  from negative to 38% in California and then a sharp drop by April. Prices like that cannot be driven by stronger macroeconomic indicators. The rush to buy before prices got higher ended in April and investors and others left the market. It is an example of Fed Governor Jeremy Stein’s concern about reaching for yield. The prices in 2012 and 2013 were a mini bubble that is in the process of deflating.  The other 17 cities exhibited a similar pattern, but not as extreme. The one indicator that does move housing prices is mortgage rates. In June the rates began to move up but this increased prices as buyers rushed to lock in lower rates driving prices in the 17 cities up.  Now prices will fall.
The graph contains linear trend lines from January deals. Extrapolation of these lines will lead to an average price increase of 5% in 2014.  However, some adjustments are needed for a realistic projection. The prices increase in the 17 cites since June will begin to decline to the levels these cities saw in the last half of 2011.  The sharp drop in March and April in California occurred because all three cities had declined. Since April Los Angeles was steady but the prices in the other two cities declined. Price data from the California Association of Realtors, which is not as accurate as Case Shiller but more timely, indicates that Los Angeles prices are declining rapidly. This scenario is illustrated in the following graph.
The average rate for the 20 cities in the last half of 2014 is a negative 5%.   
The Case Shiller 20 index highlights the surging prices in expensive markets. Media coverage of the hot markets leads to higher price expectations in other markets. The more expensive markets showed a greater response to FHA loan limits, house purchase credit and other programs.  The California market has a long history of booms and busts.  Buyers remember the peak and believe that these prices will return.  With some good news the price stampede will begin. The 20 cities are diverse I look at them by grouping them into cities that perform similarly. Four of these cities did not see much increase in the bubble.  The price trend of each city correlates to the extent of the price increase in the bubble and personal income.

The following Chart illustrates the relationship of Case Shiller 20 city and national to housing outside the Case Shiller cities (called Heartland). It represents 75% of the housing stock and is drastically lower priced. 




  The table below illustrates the Actual price trends in the first three quarters of the year compared to the 2014 forecast.
   

House Price Change at Annual rates





Actual                         Forecast

First 3 Qtr.. 2013  Ave. 2014 Last Half 2014
Case Shiller 14% 0% -5%
Heartland 5% 4% 4%
National 9% 2% 0%





The U.S. has a history of city price bubbles. They take a long time to expand and a long time to contract.  The price at the end of the contraction is equal to the price beginning adjusted for inflation. The federal government programs to lower interest rate and provide FHA loans at low down payments, have kept prices well above the sustainable level in cites that expanded rapidly in the bubble. With higher inters rates and restrictions on low down payments the prices of many markets will decline while other cities will do well.