Afordability

Home Buyers are Bond Traders

The fixed income bond market. Likely the most unsexy of all the traders on Wall Street. Also some of the most wildly paid when the bond market is on a roll. It is an area that few casual investors really want to understand. It’s boring. Buying 10 year bonds payable by Chrysler just does’t excite. And more importantly, it confuses any newbie to the debt market.

When interest rates go down, bond prices go up. When interest rates go up, bond prices go down.

Now, why do we as Realtors care? Well, on the most basic level, we care because our 30 Year Fixed Rate mortgages that drive the US housing market are set (at least theoretically) based on federal 10 year treasury notes. But I argue that every home buyer who doesn’t pay cash is gambling in the bond market without really understanding it.

What drives price of a home? Lots of things. Scarcity is top of the list. Inventory is way down across our MSA, and thus, prices are no longer falling, and in many cases even going up.

But the other factor to influence prices is affordability. And affordability is directly impacted by interest rates.

Take a family that today has $100,000 saved to put down on a house. With a 20% downpayment, this qualifies them to purchase a $500,000 home. (Let’s set aside closing costs for the purposes of this argument.) When there was a 4.0% interest rate just a few weeks ago, this would have meant a mortgage payment of $1,909 in Principal and Interest. When the interest rate hits 5.0% — and that will be soon — that same $1,909 no longer affords a mortgage of $400,000. It affords only $355,735. This is an 8.8% reduction in buying power with only a 1% move in interest rates.

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So the question then becomes why are these home buyers bond buyers. Simple. They have a specific return they have decided they need to make an investment. And likely, that return is in the form of specific home specifications. They are looking for 4 bedrooms with a minimum of 3,000 finished square feet in a specific school district. And for months they have been looking, and they have been told by their mortgage lender that they can afford $500,000. As they continue to look for homes, however, they unknowingly are becoming priced out of the market.

But, when they find that dream home, they aren’t going to decide to spend more. They aren’t going to decided to find a cheaper house. They are going to go after this one house, but demand a drop in price commensurate with their new mortgage rate. So, they are looking to cut that $500,000 house to $455,735. Will this happen each and every time? No! Will it sometimes? Depends on the seller and their motivation. But it will happen. And that will bring down comparable sales, and that will bring down the escalating prices.

I said this as the rates were coming down. People don’t buy a house based on sale price. They buy it based on the mortgage price. People didn’t mind prices going up during the interest rate decline because they still paid less, and they felt richer. Well, here comes the reverse of that.

Title Companies v. Attorneys

Once a home is under contract, and sometimes even before, buyers will be asked if they have a settlement agent in mind to handle their closing. Some buyers opt for attorneys, others request a title company to handle the closing, primarily to avoid the attorney fees. After all, the insurance is the same after the closing, so why pay any more for the same service?title ins.jpg

Fair question.

I have in front of me a 56 page document that was just released by CRA International, a national research organization that studied the HUD-1 costs across the country and tried to determine how much extra buyers spend on attorneys instead of going straight to the title company and closing it with them.

The argument that settlement companies have made is that attorneys are expensive and unnecessary for these transactions. Without competition, attorneys would force the price of home loan settlement sky high and the consumer would be punished. The attorneys argue that in fact it is the title companies that keep prices high. They claim that title companies may charge less in the form of a “closing fee” but they more than make up for that discount in the price of the insurance policy that they offer consumers. Attorneys are able to price title policies from different companies and that brings price down.

The study looked at 839 financings that occurred in a single 12 month period, and included 366 new home purchases and 473 re-fi’s. In the case of re-fi’s, there are occasions when the lender actually performs the closing. So, in Virginia for instance, 50% of the cases studied were closed by settlement companies, ~30% by attorneys and ~20% by the lenders directly. Across the entire study 60% were closed by settlement companies, 17.4% by attorneys and 22.7% by lenders.

The empirical evidence is that the attorneys are correct that title companies charge more for their policies, but they are wrong that it always costs more overall. The study showed that in states where Attorneys handle all the closings by law and the states where settlement agents are dominant the charges are roughly equal. There does not appear to be any influence that regulations have on the costs of closing a loan. In states, such as Virginia, where consumers have a choice, the numbers that make up the total for closing costs may be different, in the end, the costs are roughly equal.

The CRA study found that “High or low closing costs appear to be at least equally – and frequently more strongly – associate with a wide range of other factors (such as details of the loan, the characteristics of the state or loan area, and the characteristics of the borrowers);” Translation: While different loans cost different amounts to close, it is based on size of loan, credit score, local taxes (GRANTOR TAX!!!) and other factors, not who the settlement agent was.

So, what does an ambiguous study tell us about how buyers should choose their settlement agent? Very little. Instead, it says that the price conscious buyer isn’t going to save money. So the question that a buyer needs to ask is, “How will I best be served?” Given that settlement companies are not allowed to act as attorneys or provide legal advice in the case of legal issues arising, my advice is to stay with a local attorney who can represent you if you need it. The cost of bringing a lawyer on board down the road is much higher than having them with you from the start.

Product Mix

Talk to a marketer and you will hear this term frequently: “Product Mix”. It refers to the breakdown of a market and precisely what is selling. This then allows companies to focus on what to manufacture. Imagine a computer company determining whether to build desktop or laptop computers. A quick look at the product mix of what is selling allows them to divert resources to the appropriate market.

Builders operate in much the same way. The problem is that a project must go to the city or county months or years before construction begins, and that can be 6 months or more before the first buyer can occupy the residence. Therefore, there is always the risk of over building a certain type of home. Below you will see a graph by quarter from 2003 to Present for the combined Charlottesville and Albemarle markets. Each line represents a product type: Detached, Attached, and Condo.

(Click on the graph for a larger image.)
YearEndWrapUp.jpg The quickest thing most folks will notice is the enormous bump that occurred in the 1st quarter of 2005 when the first condo conversions became available to the general public. The condo market was steady until it got another bump mid year 2006 and then slowed until the end of 2008 when it hit the skids.

This is a fascinating tale of what the right project was to work on then… and not now…

Builders watched as the early developers sold their stock quickly, but trends shift, and the developers who brought condos on the market at the end of 2008 were greeted with credit issues as well as an over built market.

Contrast this with attached homes which saw a bump in prevalence just as condos were slowing. While I cannot state for sure that I know what was happening, I do have a theory here. Detached homes tend to be the priciest of the three product types. Therefore, those who may not be able to afford the 3BR/2BA home on a 1/2 acre in the county look to more affordable options. Those options tend to be condos and townhouses. When credit became impossible to get on condo projects, the attached home was the only solution.

But, take a look at the last 3 quarters where detached homes have grown in popularity even while attached homes fall off sharply. This coincides with the convergence of prices across the different product types. For the first 9 months of the year in the city, the median home price of a townhouse was $242,000. But the detached home price median in the city was only $261,000. A difference of only $19,000. That’s just over $86 month in mortgage payments on an 80% loan.

So what does product mix tell us about the future market? It says that as long as the price between detached homes and their counterparts are small, the detached homes should continue to rise as a percentage of the sales. It also reiterates that we need financing to be eased in reference to condo projects.

School Districts – Where’s Hot?

Everyone wants to know what school district is the best. Of course, this baits the question, “What does ‘Best’ mean?” Some folks look at test scores, some look for diversity, others look for excellence in the sciences, and yet others look for excellence in the arts. “Best” is a fully subjective word that can apply to any and all schools in some way. It all depends on what the resident is looking for in a school.

I wanted to look at what school districts have homes that are selling the best, and so I looked not at price drops, but at the ratio of homes listed to homes sold. Seemed simple enough. And the results were not quite what I expected. I have buyers who ask for specific school districts all the time, and that request is based typically on a desire to stay in a district or it is driven by school test scores, or proximity to work, the interstate, or some recreation in which the family regularly partakes.

I’ll talk about the City first, as I found the results really interesting. (Click on the below graphs to expand.)

What I have done is created a graph of all sales in the city by elementary school district. Having only 6 schools makes this very easy to visually see what is happening here. The second pie chart shows all the active listings in the city as of today. By comparing these two charts, we can see if there are districts that contribute to more sales than they should based on the number of properties listed, or vice-versa. The first thing to note is the green section, which relates to Clark. This includes all of Belmont. While 25% of the current listings in the city are in Clark, only 19% of the sales are from this area. It follows logic to say that perhaps Belmont had its run-up during the Bubble, and is now retreating more than other areas of the city.

The flip side of that coin are Greenbrier and Jackson-Via which had 4% and 14% of the city listings respectively and yet have contributed 8% and 20% of the sales in the city thus far this year. Both of these areas are relatively affordable, with Jackson-Via’s median being only 1.5% above the median for the city. Greenbrier is priced higher (18% above the median), but still 8.5% below the pricy Venable district. Given that 71% of the houses sold this year in the city were sold for less than $325,000, this demographic seems right on target for the year.

City Sales by Elementary School

The county was equally interesting. However, with 16 elementary schools, the graphs get a little harder to read. There is however, one clear winner district this year, and one or two districts that have struggled.

On the high side, Cale Elementary is showing a lopsided number of sales compared to its listings. Again, with a median sales price below $300,000, this puts it squarely in the target for 2009 buyers. Additionally, as we have pointed out over the last year or so, homes in the urban ring have fared better than far out in the county. Cale is located on the city border to the South, and is convenient to The University as well as downtown. Neighborhoods such as Lake Reynovia and Mill Creek have managed price declines with some resistance and it appears that location, location, location may simply be playing out here.

The downside districts in Albemarle include Stone Robinson, which is home to Glenmore and the parts of the Keswick area. With the third highest median price in the county, these high end properties just aren’t having a banner year. Homes between $600,000 and a million dollars represent only 14% of the homes sold this year. Stone Robinson had 16% of the active listings. They just can’t keep up with the market. The demand is simply not there for the larger, new homes in 2009.

Albemarle County Sales by Elem School

In the wine world, we talk a lot about wines with a good QPR or Quality to Price Ratio. In 2009, we are seeing a similar flight in sales. Lower priced homes that offer convenient locations are ruling the roost. If energy prices soar again (which they certainly look like they could) this directive could become even more pronounced.

As always, I welcome comments and thoughts as well as requests for future studies. These are always interesting looking into.

Albemarle Price Per Square Foot

As requested from a reader on the Bubble Blog, I have pulled 2009 prices for detached homes in Albemarle County by month. I have to say, I don’t think there is much to see here. There have been a total of 213 closed transactions in the county of detached homes through May of this year. Based on the variability here, I would not take any stock in this meaning much at all.

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