The Case Shiller 20 city index is 11.3% above last year. Prices in the latest month grew only slightly less at an annualized rate of 9.5%. However, 9 months ago prices were growing at 24% annually up from 3% growth in January 2012. The 11.3% annual number occurred because growth was high in early 2013. Year to year growth is a misleading statistic. The trend of house prices indicates that prices will start declining in second quarter closings.
To understand House prices, you need to understand seasonally adjusted monthly data and when the events occurred. The February 25, Case Shiller report, covers preliminary house prices for December closings the bulk of which were negotiated in October - three months before the Cold January and February. Prices have fallen most rapidly in California which has been warmer than normal. This does not mean that the cold weather will not depress prices. It probably will, but this will not show up for four months.
The following graph illustrates the monthly price changes in the three California cities and the remaining 17 cities in the 20 city index.
Changes illustrated in the graph cannot be explained by macroeconomic indicators. In this case, changes to government programs triggered a price surge. The rush to buy before prices got higher ended in April 2013 as 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.
My 2014 Forecast prepared in December had the 17 cities starting to decline with the California cities declining at a more rapid rate. The 17 cities growth rate began to decline as forecast. The California cities are higher because San Francisco prices bounced up. These prices are trending down but move erratically.
Prices increase if the inventory of homes for sale is low and fall when inventories are high. Low inventory means the seller has more leverage in that local market. However housing does not follow the normal rules of supply and demand because 90% of sales are of existing homes. In the bulk of the cases, a seller will end up as a buyer in another transaction. The price trends drive sales because it indicates that housing is a better investment. If house prices are falling, move up buyers and renters looking to buy, put off purchases. So lower prices and greater affordability lower sales in volatile markets. Historically regional housing bubbles contract to the level where they started adjusted for inflation. In stable markets houses have a lower investment value and bubbles do not happen.
The following table illustrates the projected 2014 prices.
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.