Bubble market or solid economic fundamentals: Lessons we can learn from the Canadians

by Dan Krell © 2010

Bubble housing markets occur when real estate markets, either local or regional, are overvalued. The cause of bubble markets is often debated, as has been hotly argued in recent times, to be the cause of speculation and/or credit policies.

There are several real estate markets that have rebounded much faster than most such that they are in danger of becoming bubble markets. Some economists rank the real estate markets in China, Australia, and Canada as having the highest risk of becoming the next busted bubble market. Because of Canada’s close proximity and similar real estate market, we’re compelled to take a closer look.

Canada’s equivalent to the Federal Reserve Bank is called the Bank of Canada (www.bank-banque-canada.ca) and much like the Fed, the Bank of Canada is a central bank that offers advice on monetary policy. The Deputy Director of the Bank of Canada, Timothy Lane, PhD, offered his analysis on the current situation that is occurring in Canada’s real estate market in a speech given on his behalf on January 11th, 2010.

Although Dr. Lane’s speech was delivered by an advisor, in what may seem like a déjà-vu to Americans, there was somewhat of a denial of a bubble market. The Deputy Director maintained that fundamentals of the Canadian market are intact, such that recent increases in home prices are not unusual for supply and demand economics. As Canadian housing starts are below the target to meet population growth requirements, the Deputy Director made clear that inventories were diminishing as well.

Although Dr. Lane’s opinion is that housing bubbles are fueled by credit expansion, and that recent growth in the Canadian housing market is due to low interest rates and pent up demand. Mr. Lane pointed out that the Canadian housing market was not as turbulent as the market in the United States because Canadian home price appreciation was not as steep. The resulting turbulence manifested in sharp declines in American housing, while Canadian housing fared much better.

Similarities between the current Canadian housing market and the U.S. market prior to the global recession includes: historically low mortgage interest rates, reduced inventory, and increased real estate speculation. The role of increased real estate speculation is of interest because it is not only the domestic investors fueling the Canadian market, but foreign investor looking for large gains.

However, fundamental differences also exist between the markets. Dr. Lane pointed out that the Canadian mortgage system is inherently different than its counterpart in the U.S. Canadian mortgage guidelines are written primarily by mortgage insurers because mortgage insurance is compulsory for mortgages with less than a 20% down payment. Additionally, about 70% of Canadian mortgages are held by the lending institution (rather than becoming securitized) forcing the lender to make more responsible lending decisions.

Deputy Director Lane’s summation was that the Canadian housing market requires “vigilance, but not alarm.” However, they may not have much choice but to ride out market disturbances because any intervention may stall the recovering Canadian economy in a global recessionary environment.

Time will tell whether the Canadian real estate market is a bubble waiting to burst, or just a manifestation of solid economic principles. Either way, we will learn whether prudent mortgage policies can play a part in mitigating future real estate bubbles here in the U.S.

This article is not intended to provide nor should it be relied upon for legal and financial advice. This article was originally published in the Montgomery County Sentinel the week of March 8, 2010. Using this article without permission is a violation of copyright laws. Copyright © 2010 Dan Krell

Will an expected housing shortage cause another bubble market?

by Dan Krell © 2010

housing shortageLast week’s statements by Brian Wesbury may have startled the real estate industry. The chief economist for First Trust Advisers stated in an interview with Steve Forbes that the United States is headed for a housing shortage in 2011 (“Housing Shortage Coming In 2011” by Alexandra Zendrian, Forbes.com; 2/15/2010).

Mr. Wesbury’s dire prediction is predicated on housing statistics that indicate that the United States needs to add an annual average of 1.5 million homes to stay on par with population growth. The fact that housing starts and completions in the last two years have only been a fraction of the 1.5 million home target may be an indicator of a housing shortage. Even though the foreclosure crisis has added many homes to the market, the number of homes being built is significantly deficient in maintaining a reasonable pace with the population growth, according to Wesbury.

The last time people spoke of a housing shortage was in 2004, when monthly peek single family inventory for Montgomery County never exceeded 2,000 units and absorption rates of single family homes approached 80% during winter months (as reported in the 2005 Year in Review by the Greater Capital Association of Realtors). The following year, winter inventory soared and housing absorption rates did not exceed 40%. The result was a bubbling real estate market that exhibited an appreciation of 18% of single family home prices in Montgomery County from November 2004 to November 2005, even though inventory increased from 1,692 to 3,100 units for the same time period.

Cole Kendall, of Understanding Markets LLC (understandingthemarket.com), explains that the annual addition of 1.5 million homes is a benchmark that is widely used by economists to predict housing trends. The benchmark is based on a decade of demographic and economic data.

The problem is that since 2008, the Country’s economy and demography may have changed significantly, such that predictions based on historical data may be flawed. In fact, in 2008 Mr. Kendall was emphatic that over building occurred during the housing bubble. He stated that housing starts must remain low just to catch up with diminished demand, “It is impossible to know how many houses there should be in the U.S. at any time, but we can say that the gap between demographic demand and the supply of homes has been getting smaller.”

The national and local economy is vastly different today than it was earlier this dhousing shortageecade; so even if the demand for housing once again equaled the levels that existed in 2004, any resulting market gains may be expressed differently. Currently, unemployment and stricter lending policies are only a couple of changed factors that have significantly impacted the housing market in recent years. Compared to a time when many home buyers did not even need to prove they had a job (much less an income) to qualify for a mortgage, today’s lending environment is such that a home buyer not only needs to provide evidence of employment and income, they need a higher down payment as well as evidence of financial reserves to make their case for a mortgage.

There is no doubt that the housing supply is being reduced because of decreased demand. The result may not be a housing shortage, but more likely it is the manifestation of economic forces seeking equilibrium.

This article is not intended to provide nor should it be relied upon for legal and financial advice. This article was originally published in the Montgomery County Sentinel the week of February 22, 2010. Using this article without permission is a violation of copyright laws. Copyright © 2010 Dan Krell

A two pronged stopgap for real estate

by Dan Krell © 2009

Last week was indeed historic for events in Washington, DC. However, two important developments that directly affect real estate should be highlighted. You may have already heard that the home buyer tax credit was extended and expanded. However, you may not have heard that Fannie Mae announced another program to assist home owners facing foreclosure.

On Friday November 6th, the President signed HR 3548 into law which extends the home buyer tax credit through next year; home buyers must have a ratified contract for a principle residence (up to a purchase price of $800,000) by April 30th 2010 and close by June 30th 2010. A tax credit up to $8,000 will continue for first time home buyers who purchase their home before the sunset date; other home buyers who purchase their home before the deadline may be eligible to receive a tax credit up to $6,500. Home buyer income limits have also been increased to $125,000 for individuals and $225,000 for those filing joint returns (prorated amounts may be available for those who earn more than the stated limits). For additional qualifying information, please refer to the guidelines posted by the IRS (www.irs.gov/newsroom/article/0,,id=206293,00.html).

Additional good news came last week from the mortgage giant Fannie Mae, which issued a press release announcing the “Deed for lease” program. The “Deed for Lease” program is designed to assist struggling home owners to stay in their homes by allowing them to pay “market” rent. The program requires home owners facing foreclosure to give the home to their lender via a “deed in lieu of foreclosure” (also known as a friendly foreclosure).

The rental period for the “Deed for lease” program may be up to twelve months. The program may also be available for investment properties that are currently occupied by tenants. A rental application fee of $75 per unit is required. If the home is occupied by tenants who want to stay in the home, those tenants must cooperate with the property manager through the process. Any disruption of the process may result in disqualification from the program. Once initiated, the home owner may not be eligible for the ”Cash for Keys” program (a relocation assistance program for those who are forced to leave their homes). Eligibility requirements and further assistance can be obtained from your Fannie Mae servicer (www.efanniemae.com/sf/servicing/d4l/).

This two prong approach may stem further eroding residential real estate values, which may be due to foreclosures, by increasing demand while reducing inventory. Providing incentives to all home buyers will add additional home buying activity, while allowing home owners facing foreclosure stay in their homes may decrease the negative events associated with foreclosure, such as: lowering the number of displaced home owners who are forced to move, reducing the number of vacant homes; and decreasing the inventory of distressed properties that have the potential to lower neighborhood values.

Alone, programs such as these have drawn criticism pointing out statistics indicating that the money is wasted. However, increasing demand through incentives, while decreasing distressed property inventory may be the combination needed to hold off further eroding home values while strengthening the overall economy. Time will tell if the one-two punch is successful and if there is a need for further expansion of one or both of sides of the equation.

This column is not intended to provide nor should it be relied upon for legal and financial advice. This article was originally published in the Montgomery County Sentinel the week of November 9, 2009. Copyright © 2009 Dan Krell

Senate passes home buyer tax credit legislation; but is the credit over rated?

Yesterday (November 4th), the Senate passed legislation to extend and expand the home buyer tax credit. The $8,000 first time home buyer tax credit continues; AND adding a “move up” buyer tax credit of $6,500 (both to sunset April 30, 2010). The new legislation is certainly going to continue helping first time home buyers, as well as helping many move up home buyers who are struggling with their own liquidity. http://isakson.senate.gov/press/2009/110409hbtc.htm

Surely, many home buyers will take advantage of the tax credit to assist them in condemnedtheir purchases. Although there is a direct and immediate effect of the home buyer credit, many continue to debate its affects. The following articles offer interesting commentary and insight as to why the home buyer tax credit may be poor policy:

“The home-buyer tax credit: Throwing good money after bad”
By Simon Johnson and James Kwak

“Why the Home Buyer Tax Credit Is a Bad Idea”
By Tim Iacono

“Extending and Expanding the Homebuyer Tax Credit Is a Bad Idea”
Ted Gayer, Co-Director, Economic Studies
The Brookings Institution

“Home-Buyer Credit Tempts Tax Cheats”

Market stabilization or evidence of a two tier market?

by Dan Krell &copy 2009

A tale of two markets

As signs of economic stabilization are being reported throughout the world, markets begin to show signs of activity. Global housing markets have also reported increased activity and signs of a stabilizing real estate market.

Julia Werdigier recently reported in a recent New York Times article (British Real Estate Market Seems to Be Thawing a Bit, August 4, 2009) that British home prices have increased 1.3% since the beginning of the year. Although this is still quite a difference from the almost 15% slide in UK home prices since 2007, it is sure a welcome statistic as the British expect home prices to end positively.

In China, ShaignhighDaily.com (August 11, 2009) reported that home prices across seventy Chinese cities increased one percent from the same time last year. Additionally, Chinese home prices have increased for five consecutive months after a six month slide.

Here in the United States, the National Association of Realtors (NAR) recently reported that the number of pending home sales continue to increase (a five month increase). This successive increase is the first since 2003. Signed real estate contracts increased 3.6% in June from May’s Pending Home Sales Index (PHSI) of 91.3 and 6.7% from June 2008’s PHSI of 88.7 (August 4, 2009).

Additionally, the S&P/Case-Shiller Home Price Index (StandardandPoors.com) showed signs of relief of downward pressure; however, home prices are reported to be at 2003 levels. Freddie Mac reported that its Conventional Mortgage Home Price Index (CMHPI) fell 5.3% in the first quarter of 2009 compared to the 18.4% decline in the fourth quarter of 2008.

NAR Chief Economist, Lawrence Yun, was quoted in the NAR press release as attributing increased activity to “historically low mortgage interest rates, affordable home prices and large selection are encouraging buyers who’ve been on the sidelines. Activity has been consistently much stronger for lower priced homes…” Dr. Yun also stated that many first time home buyers are acting to meet the November 30th deadline to qualify for an $8,000 tax credit.

Although the data may seem encouraging, the numbers may be telling the story of an emerging “two tier “market. A two tier market is a description used when prices vary significantly for seemingly similar homes; a closer look reveals that well kept and updated home owner resales fetch a higher price than the poorer condition distressed properties.

Because home owner resales typically peek in spring and summer months, we can expect the number of home owner resale listing to decrease as winter approaches. Combined with another expected wave of home foreclosures (from resetting adjustable rate mortgages and option arms), recent real estate market gains may be temporary.

Even the venerated Alan Greenspan recently warned on the August 2nd airing of “This Week With George Stephanopoulos” (ABC.com) that there may be a “second wave down” in home prices; stating that the real estate market has stabilized temporarily, and real estate data is very difficult to measure because the data is regional.

Much like last summer’s real estate market blip (where the NAR reported a five month high in home sales for July 2008), we may be headed into another downward winter market. However, any downturn will be temporary and further indication of a two tier market as home owner resales increase next spring and summer.

This column is not intended to provide nor should it be relied upon for legal and financial advice. This article was originally published in the Montgomery County Sentinel the week of August 10, 2009. Copyright © 2009 Dan Krell.

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