Editor's note: This is a guest post from Ramsey Su.
Most of the commonly used real estate indicators are "interesting" but what do they actually tell you? Nationwide data such as new and existing home sales combine unrelated market conditions. For example, there is very little correlation between Detroit, Phoenix, Houston or San Diego. Mixing up all these statistics is called a “national average”, which may be useful for glossy reports but is of no practical use in real life. Furthermore, housing-related data tend to report the past and have little predictive value for the future.
In order to see what is ahead, customized indicators are often necessary. Good data is typically localized to very small markets. Sometimes these localized indicators may be applicable to other markets, often they are not. If you are interested in, say, Las Vegas, there is very little need to understand market conditions in Atlanta. Back in the subprime era, around 2005 or 2006, I devised a few indicators to track the San Diego market. I first started following the percentage of vacant listings as an indicator of excess supply. I also looked at short sale and REO prevalence as an indication of imminent market collapse. Those indicators were invaluable in trading the subprime lenders who are no longer in existence.
Real estate is far more confusing today, as a result of government and Fed intervention. Are we at a bottom? Are we well on our way to recovery or are we blowing up another bubble? Since the announcement of QE infinity back in September of 2012, the Fed has purchased $335.5 billion worth of RMBS, at an annualized rate of $872 billion. How do we measure the effects of these unprecedented "throw-money-at-it" strategies?
At the moment, I am watching two indicators which should give us a hint regarding future market conditions:
1. Mortgage Rates. This is a very easy indicator to follow. Mortgage rates are posted daily. The Mortgage Bankers Association reports weekly loan application estimates. Combining the two, we should be able to see if “QE” is successful in keeping rates low, and the effects on the mortgage market. The following chart is available daily at the Mortgage News Daily website. By the way, MND is an excellent source of industry related information from the ground level.
Mortgage rates versus applications – click image for better resolution.
I believe that if mortgage rates remain stable and fluctuate in a tight range, the stimulating effect of the low rate will be over and loan applications should fall gradually. If it they don't, then I would call it a very bullish signal. On the other hand, if rates start to go up, loan applications should drop abruptly, especially for the refinances. Once again, if the applications rise anyway, I would consider it a very bullish signal. Finally, the last scenario is for rates to fall, with or without new QE efforts from the Fed, and loan applications to drop as well. That would be so bearish that we may well see a repeat of the Lehman collapse.
2. Single family vacancy rate. This is a far more difficult indicator to follow, since no one has ever collected these data. The Federal Reserve has some type of a number in its quarterly Z.1 Flow of Funds Accounts but it is hopelessly outdated and meaningless for specific markets. I may have to rely on unquantifiable surveys or other anecdotal observations for this indicator.
Using Las Vegas as an example, during the last four months, there were 17,254 sales. Almost exactly half of those were sold to investors while just over 50% of the transactions were for cash. Vegas is a second home market, so a number of these absentee buyers may have no intention of ever renting out their purchases. However, according to Dataquick:
“There were 44 buyers in December 2012 that each purchased three or more homes, but only eight of them bought 10 or more. Combined, the eight buyers who purchased 10 or more homes in December 2012 acquired 185 homes, or about 36 percent of all homes bought by multi-home buyers. In December 2011, two purchasers bought more than 10 homes, buying a total of 38 properties.”
How many of these purchases are flips? The current market condition is simply not strong enough to make flipping profitable, especially with such high volume. Therefore, there could be over 1,000 single family homes added to the rental pool every month if this pace continues, maybe even more. How many can Las Vegas absorb? Here is the problem, there is no source for consistently reliable data so we have to rely on rough estimates, using what is available. Single family rentals may be handled by a real estate broker, a professional property manager or simply by a sign in the front yard put up by the owner. According to this Realtor's website, there are 4,782 single family homes, respectively condos for rent in Vegas, not counting apartments. That is a lot of rentals for a population of just over half a million.
Similarly, investors are purchasing about 30% of the Southern California market with cash transactions reaching 35% in December. In what is perhaps the hottest market of all, Phoenix, investors are buyers in about 37% of the sales, while cash transactions are now over 40%.
Even though the demand for single family rentals should be rising as a result of economic conditions and demographics, this demand is finite. If the price of gasoline is lower, consumers may drive more. For housing rentals, if the rent is lower, renters may rent a bigger house, but still have no reasons to rent two or three houses. In my opinion, the current demand for single family rentals is far below the current pace of conversions from owner-occupied homes to rentals. Will bulk investors cannibalize each other by lowering rent, hence not meeting their yield projections? Will bulk investors stop buying, or will they keep going as long as OPM* is available?
In summary, the combination of investor purchases and mortgage rates should continue to dictate market conditions in the immediate future. I believe both are unsustainable, but just like with the subprime bubble, it can take a while before funds are exhausted from the bulk buyers and QE is proven to be ineffective in keeping rates low. By keeping an eye on the above indicators, we should have some advance signal that should tell us if the recovery is real or a new bubble.
* for the uninitiated: “OPM” = “other people's money” [ed.]
Source: Acting Man
