May132015

Orange County Housing Market Update: May 2015

With increasing affordability from falling mortgage rates, expect increasing sales and increasing prices until rates begin to rise.

peak_buyerEach month, I publish housing market reports for most of Southern California. The overview report covering the counties of Los Angeles, Orange, Riverside, San Bernardino, and Ventura is available to everyone in the Housing Market Reports page on this site. The individual county reports are available to registered users of this site on the Subscriber’s Reports page. Also, on weekends I publish excerpts of these reports in posts for people who want an overview without downloading the reports.

Since this is the prime season for buying and selling, I want to take a more detailed look at the local market to help everyone understand the activity we see today.

Over the last year, prices in Orange County flattened out with a modest 4.5% increase year-over-year. This is a normal and sustainable level of appreciation.

During the same timeframe, mortgage interest rates declined, which raised the rental parity value and lowered the cost of ownership. This combination of factors made houses more affordable and caused the rating to rise from a 7 to an 8.

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The increasing gap between the median and the underlying value works in favor of buyers presently. The market hit the ceiling of affordability last summer, but as mortgage interest rates declined, the market became undervalued, which is where it is today.

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Rent rose 5.1% over the last year, and rent increases show little sign of slowing, which is to be expected in an improving economy. The combination of rising rents and flattening prices also contributes to the undervalued condition in the market.

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When looking at the charts of median home prices and the cost of ownership, the more rigid ceiling of affordability is apparent. In recent months, the small gap shows the slightly undervalued condition.

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Resale prices are rising in a stable range, particularly if incomes begin to rise as the economy continues improving.

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Steadily rising rents are also indicative of a tightening market and an improving economy.

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The degree of undervaluation is more apparent in the chart below that compares the historic median to rental parity.

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Since valuations are attractive — made so by super low rates — the rating is high.

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If the market is affordable, why do prices seem so high?

Prices are high. Record low mortgage rates will do that. When the federal reserve decided to bail out the banks, their favorite tool has been the zero interest rate policy of the last several years. This allowed mortgage rates to drop as low as 3.35%, and peak housing bubble prices that made no sense in 2005 were suddenly affordable in 2015. The federal reserve hopes new buyers on stable terms will buy out the old buyers at peak prices. Surprisingly enough, it’s worked — so far.

So what happens when mortgage rates to up?

enticedThere are many possibilities, including another crash, but I consider that outcome unlikely. Lenders won’t foreclose and flood the market with REO like they did last time, so even if house prices become totally unaffordable, they will let sales decline precipitously, but they won’t foreclose and take losses.

Realistically, house prices will likely bounce around in a range near where they are now for several years as the mortgage interest rate stimulus is removed. If prices fall inventory will dry up, and prices will recover. If rates rise to fast, sales will dry up, but prices will remain where they are. It’s as if the banks bought up every house in American and said they can’t be sold for less than peak housing bubble prices. It sucks, but that’s what’s going on.

Does that mean you shouldn’t buy?

bought_in_2008We’ve had some long discussions on this site about buying when rates are high or when rates are low. If you buy when rates are high, you gain the advantage of being able to refinance when rates drop, and you’re more likely to see above-average appreciation as rates fall. However, there is a big advantage to buying when rates are low that many overlook: low rates amortize the loan faster as less of the payment is going toward interest. Low-interest rate lows build equity faster than higher rate loans, which compensates people for below-average appreciation. Plus, there is the argument that rising rates are a sign of a strong economy, so increased demand will help keep house prices up somewhat. And if inflation becomes a problem, having long-term debt at low rates is a real boon.

I’ve come to the conclusion there is no best time to buy based on mortgage interest rates. The formula of buying when rates are high and refinancing as they drop is a good one, but buying when rates are low and quickly paying down the mortgage isn’t a bad idea either.


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