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.
QE, CREDIT AND THE FINANCIALIZATION OF EVERYTHING
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 terms.
Financial markets are great and useful things, but they are not the answer to all problems.
(The opinions expressed here are those of the author, a columnist for Reuters.)
(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 firstname.lastname@example.org and find more columns at blogs.reuters.com/james-saft)
(Editing by Dan Grebler)