Today, the National Association of Realtors’ pending homes sales data, representing June’s homes entering contract, showed a decline of .04%. Analysts expected a smaller decline of .01%. The Decline is being blamed on a combination of low inventory (can’t go under contract if you’re not on the market) and the dramatic full 1% increase in interest rates since May. And while the pending number still represents a near 11% increase from June of 2012, it is consistent with what every Realtor I know is saying about the market, and that is that it is slowing down.
Slowing down is an interesting term because it sounds negative, though it is not necessarily so. What I mean is, yes the market is slowing some, but it couldn’t keep skyrocketing indefinitely without some kind of respite. So a slowdown about now is actually welcome news. A bubble we don’t want. That said, here’s what I think is the reasoning for the decline in pending numbers.
First and foremost is the interest rate increase. In our area of the Conejo Valley, along the Ventura/Los Angeles County line, the 1% increase in long term mortgage rates represents about a $500 a month increase in payment based on a conforming loan amount of $417,000. That’s a lot of money to just about everyone and to my thinking, the clear catalyst for the slowdown in new contracts. The current pool of buyers is pretty shell shocked by this rise from 3.5% to 4.5%. That said, in a few months a new pool of buyers will exist and to them a 4.5% rate will sound good having never had a chance to buy at 3.5%. It’s interesting when I talk to people in finance and investing, about the rise and the cause/reasoning behind it. My personal belief is that Fed Chairman Bernanke blew it by making a statement about the eventuality of rising rates, without accompanying that statement with tangible action. In other words, he came out and stated that if the unemployment should get down to 6.5% and the economy continued to show strength, then sometime in 2014 the Fed would begin ratcheting back their stimulus policy known as QE III, of buying $83B a month in mortgage backed securities (MBS). Ratcheting back isn’t even raising the Fed Funds rate (the rate the Fed charges banks to borrow), it’s just scaling back the Fed’s printing of money and using that money to buy mortgages. I argue that the failure to take action along with this statement means he shot a volley across the bow of bond traders and they then turned tail and ran but without hitting any target, Bernanke wasted a valuable bullet. When bond traders run, they dump bonds and the rates rise as they did. Yet the Fed did nothing. So effectively Bernanke caused a rise in rates in anticipation of action, rather than because of action. The obvious problem is that when he actually takes action, rates are going to go up even more. I would argue that had he done something at the same time of his statement, the effect would have been the same. After all, rates went up over 30%. How much more would they have gone up had he done something? Probably not at all would be my guess.
When I recently expressed this line of reasoning to someone, they said to me, “Maybe that’s what Bernanke wanted to have happen and you just don’t understand; he is the smartest guy in the room you know…” While a possibility, I doubt it. Especially given how much back peddling and damage control he and the other Fed presidents been doing ever since. Frankly it’s his own fault because he has pledged a policy of transparency as a departure from the policies of his predecessor, Alan Greenspan. You may recall that Greenspan used what Wall Street observers like to call, “Greenspeak” as a method to signal to the markets what the Fed was planning on doing without specifically declaring so. The uncertainty and disagreement that ensued was something Bernanke has said he wants to avoid. Here’s the problem with that: markets need a certain degree of uncertainty to function or else traders can’t make any money. By giving the bond traders a warning about things to come, they reacted to the eventuality rather than the present day reality.
Regardless, on this we can agree: interest rates went up and that slowed things down. But there’s more going on here than just an increase in rates, namely prices have gone up a lot in the past 6 months. By most accounts, home prices have risen around 18% in the past 12 months and maybe by as much as 10-15% since the first of the year. Clearly this appreciation is unsustainable and a slowdown inevitable. In fact I am seeing that many sellers are pricing their homes too high which has the effect of keeping those homes on the market longer, increasing inventory and requiring more sellers to reduce price. Moreover, historically summer inventory increases anyway, so that means there are a couple of forces at work here pushing our inventory higher. Further, the rise in values has finally allowed many sellers to get out from under water, increasing mobility (the ability to sell) giving us some more homes for sale. Thus we have more inventory due to more sellers, seasonal trends and longer marketing times as a result of overreaching sellers.
The Question is what does that portend for the near term? If I were to guess I would say that prices are going to soften a little. Moreover I would argue that the lions’ share of the appreciation (or recouping of losses from the dramatic crash we experienced) has already taken place. That’s not to say the market is never going to rise again, nor that it is going to go back down, but it does mean that the market is flattening and its meteoric rise leveling. Clearly this should be a healthy thing. So whether this was Bernanke’s goal or not, his actions have caused the real estate market to pause and take a breath; appreciation to slow and the cost of buying when using financing to increase. Only time will tell if this turns into a soft landing or a crash landing, either way, it’s going to be a little bit bumpy for a while.