Looking back for a look forward: the first tuesday year-in-review

first tuesday provides a comprehensive analysis of the 2012 economic landscape, with a keen eye to 2013 and the future.

2012 in motion

2012 was a tumultuous year for the U.S. economy and California real estate. Although there were many signs of a burgeoning real estate recovery, most were illusory.

Speculators came on the scene en masse, artificially driving up sales volume, and prices with it. End-user demand remained scarce in the marketplace. Political squabbling over the tax code, including healthcare and the mortgage interest deduction, negatively affected confidence. The specter of hyperinflation loomed large as a ghost over the convalescing economy.

first tuesday has trudged through the mire of misinformation, inflammatory political rhetoric and wrongheaded economic analysis to bring you a crystal clear picture of where we have been and where we are going.

To paraphrase the Nobel laureate physicist, Niels Bohr, predictions are very difficult to make, especially about the future. But we are from the school of thought that you must know where you came from in order to know where you are going.

So take this opportunity to look back on California real estate in 2012, and continue down an informed and thoughtful path into 2013.

It’s the demand!

When judging the progress of the real estate recovery, economists and industry consultants typically view the market through one of two lenses:

• supply-side; or
• demand-side.

During the past 30 years, real estate sales of all types of property operated from the supply-side paradigm. The supply side paradigm was a boon to the construction industry, listing agents and sellers.  Their jobs were made easier by the ever-growing availability of mortgage funds at continuously lower rates. Any entrant was assured funds. If they were willing to come to the table, a real estate deal would be closed.

Critically, all this past glory was due to the roughly 30-year period of falling interest rates, known as a seller’s market. In a seller’s market, sellers command a high price, knowing that energized buyers with easy access to ever-cheaper money will always be available to continuously sop up the housing supply.  Under the supply side paradigm, there is always a demand for housing.  List it and they will come.

However, times and conditions have changed. In a market environment of zero-bounded interest rates, high unemployment and deleveraging of negative equity home ownership, real estate supply abounds while sales volume and pricing has no underpinnings and goes nowhere.  Evidence:  little inventory and prices are quite stable for occupying homebuyers.

Though supply-side thinkers have latched on to the recently increasing sales volume and prices in California throughout 2012, it is but an illusion from which they suffer. The speculator-propelled boomlet just ending has provided a false sense of hope for some, especially for underwater homeowners.

2012 was decidedly NOT a seller’s market. The supply-side way of thinking is ill fit to the forthcoming realities. This truth will likely be in effect well into the next two or three decades of interest rate movement.

As we press-on into 2013, keep the end-user in mind. Speculators simply recycle listings, trading them as so many day-trader items. This creates phony demand and illusory pricing. Remember, there are two necessary qualities of demand:

• willingness; and
• ability.

The simple desire to purchase real estate does not count as real demand. First, end-users need jobs, and a sufficient credit score. Look for jobs to continue their slow march of growth through 2013. Real estate will follow several years hence.

Look back: It’s the demand, stupid!

What we mean by mean price

Prognosticating real estate pricing is perhaps the central preoccupation of all professionals in the industry. Methods, both spurious and sound abound, coloring the real estate analysis landscape with a multitude of possible price points.  Abstractions such as the deceptive median price of real estate sales are disservices reported to imply results that never exist.

In 2012, first tuesday developed and published what will prove to be the go-to method for determining California real estate pricing trends: the mean price trendline. We may be off around 1% annually, but not the 15% error presented by the current median price of all homes sold monthly.

As all sound economic analysis goes, this mean price trendline method for judging long term value is based on simple, fundamental rules of the market — rules which constitute the rational and enduring basis for real estate prices. The mean price trendline is, quite simply, determined by the pace of consumer inflation, as reported in the Consumer Price Index (CPI).

The reasons for tracking fundamental real estate pricing with CPI are:

• CPI affects the fundamental measure of a property’s value: its replacement cost; and

• CPI also reflects the changes in costs of other goods and services. To compensate for these increased costs, employers increase staff income in step with the CPI. As a potential homebuyer’s income increases, so to does their purchasing power which sets the limit of their capacity to borrow money.

All fluctuations above and below the mean price trendline reflect either asset price appreciation or asset price depreciation — in other words, cyclical booms and busts. In the long-term, housing prices rising beyond CPI figures will fall back to prices dictated by replacement costs (reflecting the price of the property) and personal income (the ability of the homebuyer to buy based on 31% of income for monthly mortgage payments).

California home prices rose in all three-price tiers between August and November 2012. However, prices remain down significantly from prior years, remaining close to the mean price trendline.

Looking forward through 2013 and in to 2014, expect real estate prices to drop below the mean price trendline before another modest price peak materializes. first tuesday forecasts a mild pricing peak will occur in mid- to- late 2016 as a response to increased employment and wages cut short by rising interest rates.

Look back: The mean price trendline: the home price anchor

Facts about the healthcare tax — it’s good for California real estate

One of the most contentious topics of 2012 was the expected impact of the new healthcare tax to be implemented in 2013. Outspoken opponents of the tax argued California’s wealthy were being forced to subsidize the underclass living in other states. Even more sinister, popular belief holds that sellers of California real estate will be required to pay a 3.8% surtax on the sale of their home, or that §1031 property replacement transactions would be taxed.

Well, here’s the whole truth, folks.

Effective January 1, 2013, single-filing taxpayers with an adjusted gross income (AGI) greater than $200,000 and couples filing jointly with an AGI more than $250,000 will be subject to the new 3.8% surtax on any capital gains on investment income they report exceeding a prescribed threshold.

If the capital gain realized on the sale exceeds the principal residence profit exclusion limit of $250,000 for single-filers and $500,000 for joint-filers, the amount exceeding the threshold will be taxed at 3.8% but only IF the AGI is over $250,000 for a joint filer. [Internal Revenue Code §121]

This surtax will affect only high-income taxpayers, and even then, only those rare few who will net a profit on the sale greater than $250,000. Thus, a scant 3.5% of California income tax filers are even eligible for the healthcare tax.

The final verdict?

The healthcare surtax in effect as of January 1, 2013 is good for California real estate. The government is asking a select few who cash-out on a sale to subsidize the health and well-being of those in our society with low incomes. Time and again, studies have shown and history tells that supporting the underclass, paving their way to the broad (and currently dwindling) middle class of homeowners, means a more stable and robust real estate market in the future.

Real estate has always been about quantity. The higher the sales volume, the more transactions, more wealth for more Californian’s is created. Here’s to a healthy middle class, and a healthy real estate market in the new year.

Look back: The healthcare tax: facts, not fiction

Whither the MID?

Debates surrounding the mortgage interest tax deduction (MID) typically concern one question: does it stimulate homeownership?  It doesn’t.

In 2012, first tuesday added an important question to this perennial quandary: do real estate agents market the MID as part of their real estate pitch?

We have shown time after time that the MID is a counterproductive vestige of an outdated tax code. Rather than encouraging homeownership (a particularly specious and pervasive myth), the MID:

• artificially inflates home prices;
• promotes maximum mortgage indebtedness;
• subsidizes builder and lender profits; and
• disproportionately benefits the wealthy.

Notwithstanding these regressive aspects of the deduction, the MID inexplicably remains the sacred cow of industry insiders and professionals. With this glaring contradiction at play, we wondered if buyers and agents used the hallowed MID as a marketing tool.

Our conclusions?

57% of Americans reported they had never participated in a government-run social program, according to a 2008 study by the Cornell Survey Research Institute. The participants in the survey were then asked to review a list of 21 social programs, including the MID, and to revise their responses. Upon review of the list by Cornell researchers, 94% of the group was found to have participated in at least one social program without realizing it, including the MID.

Due to the perverse and unfounded fear of being somehow prosecuted for offering unauthorized tax advice, buyer’s agents tend to shirk their duty of fully explaining their knowledge about the so-called tax benefit. No form even exists for calculating the benefits for a homebuyer.  It seems that once again, rhetoric has trumped reason, and the MID flies under the disclosure radar.

With the fiscal cliff looming, the sacred cow of the MID is ready for slaughter. We propose putting this old girl out of her misery and moving forward with real real estate sales volume and prices.

Look back: The MID truth test

Sales volume crawls along (will it continue?)

Today’s sales volume sets the stage for the future of the housing market, especially home prices 12 months forward. So how did home sales volume shape up in 2012, and what does this mean for prices in 2013?

Sales volume rose approximately 9% in 2012. However, each month experienced fluctuations in the number of homes sold.

Factors which influenced the increase included:

• a large speculator presence in the second half of the year;
• low interest rates;
• low home prices; and
• slowly improving job numbers.

Factors which restrained the increase included:

• few homebuyer-occupant buyers;
• the continued high level of underwater homeowners;
• weak homebuyer demographics; and
• tightened mortgage standards.

2013 will likely see a 5% to 10% increase in home sales volume and a slight further rise in prices. This is primarily due to slowly improving job numbers. Another modest increase will follow in 2014-2015, falling back in 2016 in reaction to rising interest rates.

The next big peak in sales volume will occur in 2019-2020 as Generation Y (Gen Y) and Baby Boomers enthusiastically hit the market in full force. A peak in pricing will follow 12 months later, fast returning prices to, well, that mean price trendline.

Look back: Home sales volume and price peaks

Zero-bounded interest rates create purchasing power

Rates have never been lower! Buy a home now before it’s too late!

This has been the lender’s cry throughout 2012. But are today’s low interest rates really worth all the hullabaloo? Yes.

first tuesday’s buyer purchasing power index measures just how much the constantly dropping rate changes in 2012 affected a buyer’s access to mortgage funds.

2012 saw a significant increase in buyer purchasing power. As interest rates decline, homebuyers are able to qualify to borrow greater principal amounts, since less of their monthly payments go toward interest. Thus, homebuyers can qualify to purchase a more expensive home — benefiting buyers and sellers (and their agents).

The 30-year fixed rate mortgage (FRM) rate decreased throughout 2012. This year ended with a 30-year FRM average of 3.33%, down from 3.9% in 2011. Meaning, the same median-income buyer (with a monthly payment of $964.10) can borrow $16,000 more at the end of 2012 than one year ago. This translates to a 7.7% increase in buyer purchasing power.

Agents beware: buyer purchasing power will decelerate through 2013, landing around zero and remaining stagnant into 2015. The 30 year past regime of ever-falling rates is at its end. Long-term rates will begin increasing around the same time the Federal Reserve (the Fed) begins raising short-term rates in 2015. This perennial increase in mortgage rates will continue over the next 20-30 years.

To get the most out of your clientele in the year to come, advise your buyers and sellers how the change in interest rates affects buyer purchasing power. Encourage buyers to act while rates are low, if they are to get the most for their money.

Look back: Buyer purchasing power determines home prices