Getting Graphic is a semi-sort-of-irregular collection of our favorite BIG real estate-related chart(s).

Source: Barrons

I read an article in Barron’s this weekend written by the chief U.S. economist at High Frequency Economics, of whom (grammar?) Dow Jones likes to rely on that was pretty cool. Ian provides some sobering insight about the national housing market in these two charts that are pretty powerful. Of course, anyone that can invert a data point to make a point is ok in my book.

Mortgage rates are low, yet the number of sales continue to drop. Inventory levels are high. He makes the argument that real (not nominal) mortgage rates, calculated by deducting the rate of home price growth from actual (nominal) mortgage rates are actually high right now, explaining the low level of demand.

The key problem now is not the level of nominal mortgage rates, which are not particularly high by the standards of the past decade. Instead, buyers are backing off because the real mortgage rate has rocketed and continues to rise. At the peak of the boom, people essentially were being paid to buy a home. The average 30-year fixed mortgage rate in 2005 was a tax-deductible 5.9%. The Office of Federal Housing Enterprise Oversight says that home prices rose 10.7% that year.

As long as buyers expected prices to keep rising, the implied real mortgage rate — home-price increase minus mortgage-interest rate — was minus 4.8%. This was an enormous incentive to borrow heavily to buy real estate. Result: a bubble.

But recently, the average 30-year mortgage rate was 6.5%, so with home prices up just 3%, real mortgage rates are now 3.5%. And with most potential buyers well aware of the huge excess supply of homes, there’s no reason to expect prices to rebound soon. A reasonable person might expect them to fall further, boosting the real mortgage rate further.

Here’s Bob Hagerty’s monthly inventory piece in the WSJ [free] providing more detail on rising inventory levels throughout the US based on ZipRealty data. June inventory is up 2.5% from May overall in the 18 markets covered.

Hence the notion that the national housing market probably has a few years to go before things stabilize.


5 Responses to “[Getting Graphic] Mortgage Rate-Inventory Stew: Separating Real From Nominal”

  1. Lovely graphs, I agree, especially inverted.

    But the use of national stats is only valid if both elements of the national stats (number of sales + real mortgage rates) are in synch in local markets. Thus, you would expect to see local markets with high price appreciation have more sales than local markets with stagnant or falling prices. Logical, yes, but impossible to tell based on this chart.

    If local markets are all over the place (some performing as expected, some off one way, some off the other), you may simply be seeing the effect of averaging.

    Hasn’t Jonathan Miller on Matrix carped about the (over) use of national housing stats before?

    (BTW, I think that grammar point is “… ON whom Dow Jones likes to rely …”)

  2. peter says:

    manhattan is just fine now. I think change is in the air for nyc real estate. We can not stay immune to huge macro events taking place every where else in this country. S&P finally says subprime is mostly junk Marketwatch – July 10, 2007 12:51 PM ET WASHINGTON (MarketWatch) – Standard & Poor’s just drove a huge harpoon into the heart of the mortgage credit bubble and it’s going to take a long time to clean up the mess once the beast finally dies.

    S&P, one of the three main credit-rating agencies that served as enablers of the subprime mortgage boom, announced Tuesday that it would lower its ratings on 612 bonds, a small portion of the mortgage-backed securities it had given its seal of approval to. See full story.

    But the bigger news is that S&P isn’t going along with the charade any more. S&P said it would change its methodology for ratings hundreds of billions of dollars in residential mortgage-backed securities.

    And it would review its ratings on hundreds of billions of dollars in the more complex collateralized debt obligations based on those subprime loans.

    A lot of debt will be downgraded to junk status. A lot of that debt will have to be sold at fire-sale prices. A lot of pension funds and hedge funds that once thrived on the high returns they could get from investing in subprime junk will now lose a lot of money.

    S&P’s announcement is a death warrant for the subprime industry. No longer will mortgage brokers be able to help buyers lie their way into a home. Fewer stressed homeowners will be able to refinance their mortgage, thus extending and exacerbating the housing bust.

    “We do not foresee the poor performance abating,” S&P said. Prices will fall, and foreclosures will rise. More mortgage fraud will be uncovered as the tide goes out.

    And hedge funds will have to find another way to beat the market, if they survive this blow, that is.

    Rex Nutting, Washington Bureau chief

  3. Jason says:

    Actually, the “real” mortgage rate is the mortgage rate minus the EXPECTED rate of home price growth. The logic is that if people expect a high return (i.e. 10%) on their investment, they’d be willing to pay a much higher mortgage rate (i.e. 8%); than if the expected return is only 2%. Usually people’s expectations are based on recent trends, so there’s some lag. That’s from the investment point of view. From the “having a place to live” point of view, it’s more of an affordability or cash flow issue — that is, when the LEVEL of home prices (and to some extent mortgage rates) is high relative to income (as it still is), then that will hamper home sales. One big reason why Manhattan is so prone to big booms & big busts is that a lot of the income comes from Wall Street (bonuses), which makes affordability more volatile than elsewhere. And apartment prices tend to have even bigger swings than income due to speculation & credit cycles. As someone noted above, Wall Street has been doing pretty well . . . so far.

  4. Sandy – hey, its a theory. Don’t kill the messenger. 😉

    Thanks Jason, so its not really a usable metric because the expected growth rate is really up to the individual investor. I suppose, via a survey you could drum up the expectations for sales price growth OR, you can keep an eye on , my alter ego these days.

  5. PK says:

    Jason, agree on your point that investment in housing is based on EXPECTED return i.e the real mortgage rate but I submit that it is not a in or out situation. Other big factors in the decision to invest are relative return rate i.e. real mortgage vs real return from other equal/near-equal risky ventures. Of course risk perception is colored by past experiences. So where as the chart is good as a directional, it is not a true performance metric.