Economic Recovery

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.


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.

The City By Month

For about two years now, I have been creating reports on various neighborhoods throughout the city and subdivisions in Albemarle County. One of the things I have done is to look at homes by the price per square foot, hoping to minimize as much as possible any bias toward the product mix of homes being sold. Last year, big homes were selling, this year, it is the entry level homes that are selling. (When I can get time on my PC and do a histogram in Excel I will. Apple number crunching bites.) One of the things I haven’t done, until now, is to look at the entire city of Charlottesville as a single unit in the same manner.

At first, when I looked at this graph, I was shocked. I thought for sure the market had moved more than the graph appears to demonstrate. Then I calculated out the percentage shifts and realized that actually the market is about where most people thought. In general, pricing in the City is down. And, as known, the pricing is, at best, erratic and, at times, somewhat irrational. The most obvious part of this graph is a quick look at Days On the Market (DOM). We have known that it was going up, and this sure makes that obvious. I had originally figured that I would need to do two scales, one for DOM, and one for Price per S.F. But alas, the DOM actually exceeded the Price / S.F. at one point.

The graph below is fairly straight forward. I have pulled every detached home that has sold since January 1, 2005 in the city of Charlottesville. I then calculated the Price / S.F. for each home and then pulled the average $/SF and average DOM for every month since January, 2005. The results were then graphed.

City_Monthly.jpg When you look at the green line ($/SF) it looks fairly flat, but in reality, that is just the scale. In fact, I looked at the rise and fall over every three month period during the 05-09 years, and found 5 periods that the price showed over 10% drops during 3 months. There were also nine corresponding positive periods in which the prices rose more than 10% over a three month period. Again, erratic behavior.

But as you look at the line over time, you see the trend downward. From the peak in April, 2006 to current month, we find a price adjustment of roughly 10.5%.

I would have guessed a larger devaluation of the market overall, but if you look back three months to March, 2009 the price was showing values 38% below today’s prices. Obviously, the city has not gone up nearly 40% in three months. Instead, what you are seeing is a light month of transactions where a single deal can dramatically change the average.

So where should this line trend in the next few months? I would be surprised if we see what looks like a positive trend continue much more. I think the city has found a good number of sales in lower priced properties for the entry level buyer. At the time of this writing, there are 85 properties under contract in the City. While this is not similar to 2005, it is a fair number of transactions occurring.

I have addressed this numerous times in other posts, but I continue to shout it, because it matters so much: The big “What If” for the city is the unemployment rate. We are still at the top of the state for our numbers, but the rates are no longer as good as they once were. We are way up. The most recent Bureau of Labor Statistics shows Charlottesville as the healthiest MSA in the state with civilian unemployment rates of 5.5%, but that is a far cry from one year ago when we were at 2.5%. This is going to play a major role at how many homebuyers are in the market. No one buys a home when they are afraid of losing all their income. So, we need to keep an eye on it. The BLS numbers project April to be lower than March, but most analysts are projecting the US rate to rise through the end of 2009.

Looking Forward, Hopeful

Originally Published January 19, 2009

I have been working on my 4th quarter numbers for several weeks now. I haven’t gotten as far as I would have liked. Perhaps because they aren’t great, and I’m not looking forward to hitting the final calculation button and getting the jolt of what I believe, but can’t yet back up with numbers. That fear of “Not meeting expectations” is part of it. I know its going to be bad, but what if it is worse than I thought? I was looking for some economic data to bring some brightness to the outlook. Hard to find. But I did find myself on the Gallup Poll web site looking for something.

I have said in past postings that I think that tomorrow is important in so many ways. There is the obvious of the first African-American President. But I think more than what people are talking about, is what people are feeling, a sense of hope. I just looked at the Gallup Polls, and noticed that President Bush is leaving office with a Net Approval rating worse than any president since WWII with the single exception of Richard Nixon. On the flip side, Obama’s transition team has an approval rating of 83%, more than 20 points higher than George W. Bush received during his transition.

But, let us hope that tomorrow will be a day of hope for the Country. A hope in the future of our economy. A hope in the future of our employment numbers, GDP, and more. As we look at our local real estate market, can we be surprised at the stagnation when the current Consumer Confidence number is a whopping 4% positive / 77% negative and 79% of Americans believe that the Economy is getting worse?

Let us hope a new president represents a different tact, a different view, and if nothing else, youthful exuberance. One can only imagine how battered a president must be after dealing with this economy and Iraq and more for 8 years.

I am going to get back to my numbers, but I do have faith that the consumer confidence will begin to come back, employment numbers should stabilize, and slowly but surely, we can begin to dig our way out. It is going to take more than a bailout to do it.

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