Last month we discussed bubble talk in the housing market and noted that the Case Schiller index for San Diego showed that prices are 30% below their 2006 peak and that mortgage rates (at 4%) were 40% below the 6.7% rate in June of 2006. Let’s do the math and see what that translates to.
In 2006, 456 Main Street, San Diego (hypothetical property) cost $650,000 and putting 20% down ($130,000) to a $520,000 mortgage at 6.7% yielded a monthly mortgage cost of $3,337 per month. The retail buyer sees that home costing $130,000 (down) and $3,337 per month. Today, according to Case Schiller, 456 Main Street, San Diego costs $455,000, $91,000 down, and $1,732 per month. Mathematically, we could say that now the same house costs only 52% (1,732/3,337) per month of what it did in 2006 and takes only 70% (91/130) in terms of down payment.
Good data, good math, but not apples to apples. In 2006, the psychology was very different. Anyone could and did buy homes and they didn’t put 20% down. Many put virtually nothing down and they didn’t pay 6.7% on mortgages either. They took teaser loans and liar loans. The teaser loans were something like 2% for a year or so, and that made qualifying easy – even if they told the truth. Liar loans were those that were called “stated income” loans. Basically, hordes of unscrupulous mortgage brokers told their borrowers what they needed to “state” their income was in order to qualify for the loan they needed to purchase the home they wanted. The point is that the Case Schiller data does not include the variations of the financial markets between then and now. 2006 values were not sustainable and were caused by stupid practices and policies.
Case Schiller has long been held as a very good index for comparison purposes. The reason it has been regarded so is that it compares 456 Main Street to 456 Main Street all across the country. If 456 Main Street sold for $650,000 in 2006 and then it sold for $455,000 in 2013, Case Schiller computes that change.
The press is all over Case Schiller and headlines run rampant when new data comes out:
Los Angeles Times July 30, 2013
“Home Prices up Sharply in U.S. Cities in May, Case-Schiller Index Says”
UT San Diego – Lily Leung -July 30, 2013
“Home Prices up 17% from Year Ago”
But are they really? Remember that Case Schiller records same house sales. In a stable market, this is a good way to measure, but we have not had a stable market for quite a few years. Case Schiller is picking up every flipper sold as data.
Example: 456 Main Street sold in 2006 for $650,000 on a liar loan with a variable teaser rate of 2%. The teaser rate ran out in 2008 so the payment went up. The Liar couldn’t make the new payment and the world was in chaos so the Liar was able to not make payments for 2 years before the bank finally foreclosed. The bank sold it in late 2010 for $300,000 because it was beat to crap and one of our rehabbers then spent $60,000 in renovation and $20,000 in financing and another $25,000 in transaction fees and sold it in early 2011 for $450,000. Case Schiller would have recorded a 54% drop from 2006 to 2010 and then a 50% increase from 2010 to 2011. Another way to look at it is that the home was in good shape when sold in 2006 and it was also in similar condition when sold in 2011.
The takeaway here is that sensational press reports of huge price increases are skewed by the fixer flipper market. Despite the headlines, we are still 31% below the peak and we still have better financing.
I am not suggesting that we go back to the peak. I am suggesting that the Case Schiller index is currently overstating the real estate market. It will take a fair amount of time to get to 2006 levels and that time will depend on jobs and government policies going forward, but because today’s buyers are not liars and teaser loans don’t yet exist, there is very little reason to believe that the market will drop or is in bubble territory. Buyer today are putting money down, have credit, and are able to pay their mortgages as long as they have a job. Additionally, we do not have nearly the supply of housing online as we did in 2006. My prognosis is that we have a stable to improving market for at least another year.