There is little doubt that growing wealth and income inequality is a reality in the United States. Even in California we can see this microcosm unfold dramatically. You have people being pushed inland from coastal areas and those near employment hubs have seen housing values reach near peak levels. What we are also seeing is that access to debt is the key measure of success in this economy. For example, the bubble favorite of interest only loans is back but with a different flavor. Banks like Wells Fargo, Bank of America, and Union Bank are back at it underwriting interest only loans to wealthier clients. The big difference is that you need to have money to play in this current market. Banks are holding onto these loans in their own portfolios. Not a bad way to earn money in a low rate environment. So this hits at the heart of the issue where Fed policy has largely aided those least needing it in a modern day feudal banking network. For example, you can buy a $1,000,000 home today with a 3 year interest only mortgage and carry a principal and interest payment of $1,562 per month. Impossible? Welcome to the modern banking system where low rates are accessible to those who least need it.
Making homes unaffordable to younger Americans is more problematic than simply altering the living habits of upcoming generations. Housing formation in the United States is entering uncharted territory based on demographic shifts and also the new reality that younger Americans will be less affluent than their parents. This is why we have millions of younger Americans living at home with parents. Some may not view this as an issue but in the past, construction was a big part of GDP and you will have a hard time justifying new housing construction if people are simply living at home or are only able to afford a rental. The student debt crisis goes hand and hand with the unaffordable nature of housing for young Americans. It also doesn’t help that Wall Street is crowding out regular buyers in the market. With a growing population and investors eating up the low supply of housing, many young Americans are essentially in the position to move back home or to rent. Buying is a remote possibility for many Americans and this has put a clamp on new housing formation.
While the stock market can turn on a dime with the agility of a cheetah, the housing market has the nimbleness of the Titanic. That is why the slowdown that started in the summer of 2013 is actually now resulting in on the ground changes for buyers and sellers. The stock market has taken a bit of a reversal early in 2014. This is important for housing since much of the hot money is coming from excess funds from Wall Street and investors chasing yields like hungry hippos. The euphoria of a stock market juiced on Quantitative Easing has leaked into many areas outside of stocks including real estate once again. Yet the resulting re-inflation was largely based on investors cramping out regular home buyers. Regular buyers unlike the last bubble, are the last folks to the party. That is, the last bubble was because of too many regular buyers over stretching with toxic mortgage junk (and prime mortgages with weak income due diligence) while this cycle is because of Wall Street using easy money from uncle Fed. This is why the rise in adjustable rate mortgages (ARMs) and jumbo mortgages so late in the game tells you that families are simply unable to compete with big money and once again, are stretching out their budgets for as much as they can get. Many even with low rates cannot compete so they have taken the next alternative in the form of renting. One thesis I think largely being missed is that the real estate market has caught a ride on the coattails of the non-stop stock rise since 2009. Four years of stocks only going up with QE as a backstop have conditioned people to believing that stocks and real estate only go in one direction. What happens when the juice no longer holds the same kick as before?
One of the major signs of a tipping point in real estate includes rising inventory, falling sales, and a resistance to higher home prices. California has reached this level. Affordability is a major challenge with only one out of three families able to afford the median priced home in the state. What is interesting is that for regular home buyers, the modest rise in interest rates essentially slammed the breaks on the price rise momentum. Home prices in California have remained in a tight range since June of 2013. Sales have fallen and the year is starting off with a nice little return of inventory to the market. This is good news for potential buyers assuming they even have incomes to support current home prices (which the affordability measures show they cannot without added leverage). Investors continue to be major players here but they have showed some slight pullback as the easy gains are now harder to find. Beyond the coast, California has plenty of land to build but we see building permits at near all-time lows. Is California built out?
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