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There Are Two Housing Markets in America

Irwin M. Stelzer

Hedge fund manager Barry Rosenstein is not a man to be fazed by the recent rise in mortgage interest rates. Nor is he one to worry that the housing market might be softening, loping the odd million off the $147 million he shelled out for an 18-acre beachfront home in the Hamptons, on New York’s Long Island Sound. So all is well in the housing market.

Not quite. Mr. Rosenstein bought in the high end of a bifurcated market, mirroring the differences in the fortunes of upper- and lower-income families. At the very top, the main problem seems to be a paucity of properties for sale: ready cash is chasing beachfront property, Greenwich estates, and high-rise condos atop Manhattan towers. At the other end of the market, first-time buyers and those hoping to move up a notch confront tight credit, higher interest rates, and prices, reducing affordability. Banks, responding to a government then pressuring them to make loans to low-income borrowers, are responding to a government now criticizing them for doing just that. They are demanding substantial down-payments and relatively robust income statements from potential buyers with stagnant incomes who, unlike Mr. Rosenstein, fear buying into a bubbly market from which several major investors are pulling back: the Blackstone Group has cut purchases of homes to be converted to rentals by 70 percent from last year’s level.

Economy watchers focus less on the prizes captured by hedge-fund billionaires and more on the broad middle and entry-level portions of the market. “A strong housing rebound is an important component of most forecasts that suggest that GDP growth will be stronger … over the next two years,” says Eric Rosengren, president of the Boston Fed. Which means that if Stan Humphries, chief economist at real estate data company Zillow is right, we have reason to worry: “Housing has become less of a drag, but I don’t think it’s going to be that engine [of growth] … and is becoming a less efficient transmission belt for the Fed” to boost the economy. That “transmission belt” is thought to work like this: low interest rates keep house and other asset prices high, which improves consumer balance sheets, encouraging them to spend, accelerating economic growth. Of course, if you don’t own a house or other assets, but do have a modest savings account, the Fed’s monetary policy works in reverse, lowering earnings on your savings account.

Here is a winnowed down version of the data over which experts on the housing market regularly pore:

  • Sales of existing homes-single-family homes and condominiums and cooperatives-make up about 90 percent of the housing market.
  • Sales of single-family homes have been flat, while sales of condos and coops have fallen.
  • Sales of new homes make up the other 10 percent of the market, but are of out-sized importance because they provide employment for construction workers. Those sales in the first quarter of this year were some 1.8 percent below last year’s first quarter, and in March were a frightening 14.5 percent below the prior month.

Prices behaved differently from sales.

  • The median price (at the mid-point of all sales) of a new home hit $290,000 in March, up 11.2 percent over the previous month and a similar percentage from the $262,000 peak reached in March of 2007 according to the Commerce Department.
  • Other indices indicate that home prices have risen somewhere between 11 percent and 13 percent in the past year.

So much for the rear-view mirror. Now to the windshield, which is fogged over with disagreements among experts. Goldman Sachs’s economists expect “a moderation in the rate of home price gains during 2014,” while their peers at Societe Generale predict that “home prices … [will] continue to appreciate rapidly and indeed show no signs of slowing.” The supply situation is no clearer. Some experts claim that the supply of existing homes for sale is at the highest level relative to sales in almost a year, others that total housing inventory is at its lowest level since 2005. Yellen told Congress, “The recent flattening out in housing activity could prove more protracted than currently expected, rather than resuming its earlier pace of recovery.” Note the appropriate sensible uncertainty reflected in the “could.”

So let me augment data with anecdotes gleaned from brokers, builders, and the trade press in hope of laying out a reasonable set of conclusions. The housing market has definitely cooled since interest rates rose by about one percentage point last year, to 4.4 percent, and prices by about 10 percent. For the average house that raises monthly mortgage payments from $934 to $1,162, or by almost a hefty 25 percent, on the typical 30-year mortgage, and increases the usual 20 percent down payment by $6,000. Although that won’t directly affect buyers who can pay cash and now constitute about 43 percent of all purchasers (other estimates vary), twice the portion of all buyers in the first quarter of 2013, it will affect others, reducing the number of serious house hunters.

Unless, of course, wages start to rise to prevent a further decrease in affordability. The Fed, increasingly worried about the housing market, believes that no such boost to demand is in sight since slack in the labor market will prevent such an increase, but its academic critics disagree. They say that not all unemployed workers and stay-at-homes are likely to re-enter the work force as the economy grows, meaning that competition for workers and hence wages will rise rapidly once growth accelerates.

Such wage increases are already hitting home builders, who complain that shortages of skilled labor are forcing them to raise wages to and often above boom-time levels. They are not confident they can pass further cost increases on in higher prices to buyers suffering from sticker shock, and are moving resources higher up the price and margin chain by including amenities such as wildly popular granite counter tops. That makes things even tougher for first-time buyers.

That means house prices are likely to continue rising, although not at the 11-13 percent rate of the past year. At the very top of the market, American all-cash buyers will continue to compete for trophy homes, and rich foreigners will continue to seek luxurious bolt-holes. At the starter end, the departure of investors buying-to-let should ease price pressures, perhaps even offsetting the passed-on cost increases, while banks’ desire to bolster their sagging profits might make credit a tad easier for first-time buyers. In the broad middle of the market, sticker shock should ease-interest rates remain low by historic standards-and buyer confidence rise as the economy continues to plod ahead. No big boom, but no sound of a bubble bursting either.

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