With all the chatter about the new Fed Chair and improving global economy, a less discussed issue in the 30-year fixed-rate mortgage rate which has been rising since September 8th when it hit the lowest point since President Trump was elected.
Oddly, the Bankrate 30-year FRM rate tracked the US Treasury 10-year yield very closely since the election, but the two have diverged since early July.
(Bloomberg) — As people around the world move into cities and look for housing, one thing is clear: Most will have a hard time paying for it.
Average monthly take-home pay won’t cover the cost of buying a 1,000-square-foot residence or renting a three-bedroom home in any of the 105 metropolitan areas ranked by the Bloomberg Global City Housing Affordability Index – based on a general rule of thumb among U.S. lenders that people should spend no more than 28 percent of net income on housing costs. Only 12 cities would be considered affordable if they spend 50 percent.
Residents face many obstacles, including urban land-use regulations, underdeveloped rental markets and difficulty getting financing, according to Enrique Martínez-García, a senior research economist at the Federal Reserve Bank of Dallas who studies housing prices. Policy solutions to these problems aren’t clear, he adds.
“Not having access to credit is a challenge to develop a healthy housing market,” he said. “But opening it up too fast might be a problem as well; it might actually lead to a boom-bust episode.”
The Bloomberg index calculates the affordability of renting or buying in city centers and suburbs. Rankings are based on self-reported data, including net salary and mortgage interest rates, compiled by Numbeo.com, an online database of city and country statistics.
Since 2012, 48 cities in the Bloomberg index have become less affordable, while affordability improved in 51. (Historical data aren’t available for all 105.) In nine of the bottom 10, average net income fell, while income in eight of the top 10 cities rose as rental and mortgage costs declined.
Emerging economies currently have the least-affordable housing, led by Caracas and Kiev in Ukraine. The remaining cities among the bottom 20 include seven in Asia and six in Latin America. London is the least-affordable major city in Western Europe, with average monthly rent and mortgage payments equaling 135 percent of monthly net income.
In Rio de Janeiro, Brazil’s second-largest city, average monthly take-home pay of $640 won’t unlock a rental even on the outskirts of town, let alone provide the means to buy a house or apartment in the city center, where monthly mortgage payments approach $2,000. This contributes to multiple-income households and also may explain why more than one in five Rio residents lived in informal shantytowns called favelas in 2010, the most recent data available. Six of the 10 cities with the greatest deterioration in the past five years are in Latin America.
Seven of the top 10 most-affordable cities are in North America: four in the U.S. and three in Canada. The least-affordable metro area in the two countries is Vancouver, where an influx of foreign cash has caused a surge in home prices. New York ranked near the middle of the index.
Two of the cities with the greatest improvement are in China: Shenzhen and Guangzhou. Even so, housing demand across the country continues to outweigh supply, “despite rapid construction and the large-scale delivery of new homes” in cities including Shenzhen, according to Kate Everett-Allen, head of international residential research at real-estate consultant Knight Frank in London. That’s because of “mass urbanization” and relatively low wages, she said, adding that home prices in several cities grew at an annual rate of as much as 40 percent last year.
Four Chinese metro areas, including Hong Kong, were among the 20 least-affordable in the index.
Yes, the USA, while more affordable that the rest of the world, is suffering from low wage growth while home price growth is more rapid. In fact, the FHFA home price index is growing YoY at over 2X average hourly wage growth YoY. 6.63% versus 2.54%.
Note that home price growth started to exceed hourly wage growth in 1998, the beginning of the dreaded housing bubble that blew sky high.
The housing construction numbers for September were not great. 1-unit detached starts declined -4.60% while 5+ unit starts (multifamily) declined -6.23%.
Permits were off for 5+ unit (multifamily) at -17.43% while 1 unit permits rose 2.38% in September.
As a reminder, The Federal Reserve dropped their target rate as a result of the 2001 recession and 1-unit starts took off. Construction was so hot that The Fed had to raise their start rate to cool-off the construction bubble. Rather than cool-off the construction bubble, The Fed sent it into deep freeze.
Alas, there wasn’t a Fed Funds rate reaction during the housing bubble, but there appears to be a negative reaction to multifamily (5+ unit) starts since The Fed began jacking up their target rate.
And with an 84% implied probability of a December rate hike, we should watch starts and permits carefully over the next couple of months.
And here is the path of future rate hikes (forward curve). As Samuel L Jackson said in Jurassic Park, “Hold on to your butts.”
Currently, the standard deduction for an individual is $6,350 and $12,700 for a couple. So, the first $12,700 of mortgage interest and property taxes is essentially thrown away. On top of the standard deduction, however, a of four can also claim personal exemptions of $4,050 per person for a total of $16,200. That puts that break point at $28,700 for a family of four. Below that point, the family of four would prefer to rent since they would literally be throwing away their mortgage interest and property tax deductions (assuming that the mortgage interest deduction is $8,000 and the property tax deduction is $4,000 for illustrative purposes). So, $12,000 in mortgage interest and property tax deductions is below the standard deduction for a couple for $12,700.
Under the proposed tax reform plan, the standard deduction would be raised to $12,000 for individuals and $24,000 for a couple. At the same time personal exemptions and property tax deductions would be eliminated. This will lead to more households renting rather than owning, holding all else constant.
But President Trump’s tax reform framework calls for collapsing the current seven tax brackets into three, with marginal tax rates of 12 percent, 25 percent and 35 percent. A decline in the marginal tax bracket lowers the value of the mortgage interest deduction resulting in fewer households having an incentive to buy home.
Depending on how the marginal tax brackets are finally decided, renters (generally in the lowest marginal tax bracket) could actually see a lower tax bill (say, tax savings of $500). It becomes muddled for the middle class since the loss of itemized deductions (other than mortgage interest deductions) could actually overwhelm the lowest marginal tax rate resulting in HIGHER taxes for the middle class (say, +$500-$1,000).
There are lots of moving parts on the mortgage side, including future interest rate hikes and housing finance reform. So I hope that Congress carefully weights its options in determing the slashing of deductions in exchange for low marginal tax brackets.
But here is some food for thought. The inventory of renter occupied housing units as of Q2 2017 experienced the largest YoY plunge since the mid-2000s while owner-occupied inventory experienced the largest YoY gain since the mid-2000s.
Both New York City and Washington DC have been the slowest growing cities in terms of home prices of the Case-Shiller 20 metro index. In fact, New York City home prices are only back to where they were when The Fed started their quantitative easing (QE) program and crammed their target rate down to 0.25% in 2008.
And first-time foreclosures in The Big Apple are up 79%, according to real estate service Property Shark. The number of first-time foreclosures in NYC surged 79% year-over-year in Q3 2017 – 859 homes were scheduled, compared to 481 in Q3 2016.
WHERE are the Q3 foreclosures? Mostly around Jamaica Bay to the south and The Bronx/Pelham/East River to the north.
True, Q3 foreclosures are lower than Q2 foreclosures, but the increase relative to 2014 is striking.
New York is a judicial foreclosure state, like New Jersey, and has the second highest foreclosure inventory in the US (after New Jersey).
And the average time (days) to foreclosure in New York is still over 1,000 days (as of Q3 2016).
Here is a brief summary of Fed Chair Janet Yellen’s thoughts from yesterday courtesy of Deutsche Bank’s Peter Hooper: The Fed is on track to raise rates once more this year and three times in 2018. Yellen recognized that inflation has been running low recently, and that while there was some uncertainty around this performance, one-off factors that are not expected to persist, and which have not been associated with the performance of the broader economy, have been important. At the same time, Yellen noted that monetary policy operates with a lag and that labor market tightness will eventually push inflation up.
Inflation has been running low “recently”? Actually, “inflation” (defined as core personal consumption expenditure price growth YoY) has been below 2% since April 2012 and below 3% since July 1992. Notice that hourly wage growth for production and nonsupervisory employees has remained low as well, particularly since 2007.
Of course, home price increases have been far greater than the “inflation” rate used by The Fed. The recent FHFA Purchase-only home price index YoY (released this morning for June) has US home prices growing at 6.62% YoY while “inflation” is growing at a palty 1.40% YoY.
But nothing really seems to be working as expected by some. Expanding the M2 Money Supply was supposed to increase Real GDP, but that really hasn’t worked since the Reagan/Clinton recovery when M2 Money Supply growth dropped from over 12.5% YoY in 1983 to 0.1% YoY in April 1995 under President Clinton and Federal Reserve Chair Alan “Maestro” Greenspan. Robert Rubin was the Treasury Secretary.
Notice that M2 Money growth has almost always been higher than real GDP growth since 1995. Hence, M2 Money Velocity has mostly been declining since 1997.
What about the old model where additional Federal debt is okay as long as real GDP growth is greater than Federal debt growth? We are nearly at that point again after decades of rapid Federal debt growth with modest real GDP growth.
I am guessing that rather than raise rates next year, The Fed may be forced to expand their balance sheet … again. Giving more oxygen to the asset bubbles.