Somewhere just after the housing bubble burst in 2008 or so, I started hearing institutional investor types considering how they could use their cash to accumulate distressed real estate assets. Funds emerged Waypoint, Colony, BlackRock, heck even John Paulson – he of the Greatest Trade Ever – flipped from shorting sub-prime to going long real estate the old-fashioned way, buying houses. At first the trade looked insane. Who would buy homes in bulk in 2009? Surely there were better places to put your cash, right?  But like all great trades, the skeptics are the ones who make it great. Now that prices have recovered so aggressively, the trades looks like a no-brainer.

How do we know when this investor opportunity is played out? When do prices rise to make it not a good deal any more?

Price to Rent Ratio

For understanding where to put your real estate dollars, we use a rule-of-thumb metric called Price to Rent ratio – Median Home Price divided by a year’s worth of rent. It looks like this:

(Median Home Price / (Median Rent * 12)) = Price to Rent Ratio

If the PtR is lower than 20 then, in a general sense, it’s a better deal to buy in a market than to rent it. (There are a lot of cases where this isn’t true, so use PtR as a tool for understanding a market, not for making investment decisions, got it?) For example a PtR of 15 means that after 15 years of paying rent, you’d have paid the whole price of the house.

In this way, Price to Rent ratio is a useful guide for investor market selection. For areas where rent is sufficiently high that the renter pays for the whole property in just 15 years, buy property and rent it! (Again, there are lots of other variables too, including price appreciation, which are not to be ignored.)

In US real estate markets, Phoenix has been the investor’s paradise. For several years, prices plummeted. Rents did not so much. So the PtR was a really strong buy signal. Furthermore, you still have massive migration into the city, so demand is real. And the investor gets the upside of a rising value of the underlying asset. Win-win.

However, as the market has recovered, home prices in Phoenix have climbed 30% off their lows. Investors are getting squeezed out by actual home buyers. All of a sudden, the PtR isn’t nearly as attractive as it was.

Phoenix, due to strong demographics and other factors, will still likely make investors good money in the coming years. But the real advantage is being arbitraged away each day.

Let’s look at other markets

Florida has climbed, but less compellingly than Phoenix.

The higher-cost California markets are not nearly as good a deal, as measured by Price to Rent Ratio

On the other hand, if we look at some Midwest markets, we see not only cheaper homes, but a weaker trend. Chicago has been the most lagging city in the housing market recovery in the past 18 months.

This set is just a high-level survey. For detailed rental market analytics, local and national, contact us. 

By now it should be clear to everyone that a multi-year home price rebound started in January of 2012. It should also be obvious to everyone that home prices in 2013 are on a tear. The rest of 2013 will remain strong, with rising home prices. The data is already in and it is very clear.

When I publish on the hot housing market, I always have some bearish readers who object to the characterization. They’re generally expecting 2014 and beyond for home prices to fall again. This bearish housing argument usually includes anecdotes about the fragility of the rental market. That investors have been driving purchase demand and now we’re flooded with rentals. Rents must fall. We decided to look at the data and see if we can spot weakness in the rental market before the headlines. Here’s what we found. (All data as of April 10, 2013)

Each week, Altos Research surveys over 1 million apartments and single family homes for rent around the country. (See here for details on our Rental Intel data products.)

Here’s a sampling of some of the big investor markets. Here we’re looking at price per square foot across all rentals, including single family homes, condos, and apartments. All data is weekly measurements.

Rents Still Rising in 2013

As you can see, the rental markets in most of the hot investor cities have not yet come under pressure. My suspicion is that this is because Rents and Home Prices both respond to new demand of accelerating household formation. Some of these new household are buyers, some are renters, but we’re all moving out from Mom’s basement.

Investor Risk

So rents are up a little bit. They’re clearly not climbing as fast a home prices. Investors, if they haven’t already, will experience Cap Rate Compression. The ratio of costs-to-income on properties is weakening. Every week, new investment purchases are a worse deal for investors.

Cap Rates in many of these markets are still quite attractive to investors. My suspicion is that these screaming deals will be gone by next year, and that’s when we’ll see if the US consumer has enough power to keep the rally going into year three.

Quit your yapping about how strong the real estate market is, Simonsen. It’s a fake rally. There is no actual demand.

That’s the bearish argument I’ve been hearing lately. I’m not buying it.

For years we’ve been watching the phenomenon of “Shadow Inventory” of potential homes that need to be sold, and looking for impact on the market. This set of underwater or distressed properties is now shrinking rapidly.  The number of homes with underwater mortgages fell by nearly two million last year. According to the Fed, home price gains of 10% will be enough to move 40% of underwater borrowers back above water. These home sellers are highly likely to buy another home in the same or comparable market, off setting new supply with new demand.

Meanwhile another phenomenon that emerged from the bubble burst has been developing, and it’s hit the market with full force. Shadow Demand. Demand for homes that went unsatisfied, primarily due to financial and economic uncertainty, that can now emerge as jobs recover and mortgages remain cheap.

Housing’s Shadow Demand

Let’s look at the source of new demand. Increased demand for housing comes from new “households.”

From 1997 through 2007, each year an average of 1.3 million new households were formed per year. Our population grows via immigration and kids maturing. These people need to  rent or buy homes, or they double up with friends and family. During the Great Recession, household formation was closer to 600,000 per year. Population growth continued at about the same pace but people didn’t move into homes of their own.  That means for the three years of 2008, 2009, 2010 we had “Shadow Demand” forming around 2 million potential homes that can’t wait to launch on their own.

In the chart above, you can see that households get formed during times of economic strength. People hide when the economy is bad.

Household formation in the five years of the housing bust was lower than any five year period since the 1960s.  This is the Shadow Demand and it’s now hitting the real estate market. These millions of potential buyers were waiting until they were financially stable and until the bargains arrived. In 2012, these conditions converged. In 2013 employment and recovery is stronger. Real estate demand is higher. 

Despite all the risks in the US and global economies, the 2012 real estate market’s demand is a function of years of pent up purchases. After years of historic lows, this demand trends seems poised for a multi-year recovery.

I’m in Washington DC to talk to the National Association of Business Economics on the state of the housing market. I ran into Lawrence Yun, the chief economist for the National Association of Realtors and he mentioned that he just raised his forecast for 2013 from 4% year over year to 7-8%. That’s pretty bullish. Yun, of course, takes a lot of flack for being an industry cheerleader rather than objective. So he should be bullish, right? I told him he’s still too low.

The logic is this: in 2012 US Housing Prices climbed between 5 and 12%, depending on which measure you choose.  The Case-Shiller Index climbed 6.8% year over year at the end of 2012. Here in 1Q 2013, all the leading indicators are stronger than they were a year ago. (For those of you just tuning in, this is the third in a series of “home prices are stronger than you think” posts from me this winter.)

Contact Altos if you want details on the our housing market data.

Note that all these measures, except for Altos, focus on the closed transactions. They are, by definition, lagging. It makes sense that, in an accelerating market, the Altos number is going to hit it’s high several months before the others do.

The always-lucid Bill McBride at CalculatedRisk saw homes prices rise in 2012 but anticipates a slowdown in 2013, though he doesn’t say why.

If you observe that home prices rose at x% last year and that the conditions (low supply, high demand) that created that rise are stronger this year, it’s reasonable that your models should indicate stronger price appreciation this year. Don’t be surprised when 2013 turns out to be another roaring year for home prices.

There’s no question about it, the operative theme of the 2013 housing market is restricted supply. Ever since the bubble burst in 2006, we’ve been hearing about the dangers of over supply, of the massive “shadow inventory” out there. Yet we’re living in a vastly different reality. There are 40% fewer homes on the market now than there have been during February in the last few years.

Mid-January typically marks the seasonal low of available housing inventory. The fewest homes are on the market after the holidays. But pretty quickly they start coming on the market to prepare for spring. Inventory gets added until the first week of July, when people start looking forward to the Autumn.

Last week we commented about the rising prices that have resulted from this restricted supply. Imagine what would happen to the price of oil if Saudi Arabia, Russia, The US, China, Iran, and Canada were all offline.  It’s a, ahem, crude analogy, because housing is less a commodity than oil. But the fact is, we’re facing unprecedented few homes available for sale.

Why is that? What happened to all this “Shadow Inventory” that was going to dump on to the market?

You can boil the low-inventory reality down to three primary factors:

Under-Construction

Since 2007, new housing starts have been anemic. The long-term average construction rates are about 1.5MM homes per year. In the last six years, we’ve averaged well under 1MM. And since 2009, the average is closer to 500,000. Meanwhile population and household formation keeps on trucking. The over-construction that happened in the bubble is a distant memory. See the chart to the right. Construction volume under the orange line are “undersupplied” conditions. The homebuilders imploded so profoundly after the bubble, that we haven’t had this few new homes being built since 1959.

Expect this trend to continue for several more years. It’s difficult to ramp up housing production quickly. And we’re a long way below normal.

The Reverse Shadow Inventory Dynamic

Rising home prices have led to fewer, not more, existing  homes coming on the market. You might call this, ironically, the “Reverse Shadow Inventory” dynamic.

When the Shadow Inventory meme emerged during the bubble, the bearish argument followed: As soon as home price tick back up, there are going to be millions of people (and banks) who want to unload. Therefore supply will rise and prices will fall again.

In actuality, it seems the psychology has been reversed: As prices have climbed, those who (still) own their underwater homes finally see light at the end of the tunnel. The longer they hold, the closer they are to recovery. Why sell now if you don’t have to? Maybe you’ll make it out alive!

Banks are acting similarly. The owners of underwater mortgages have no incentive to unload quickly. Their assets are appreciating. Furthermore, as home prices increase, fewer and fewer people are at risk of default. The Shadow is shrinking in the noon-day sunshine of rapidly re-inflating home values.

Government Policy

Finally, it is no coincidence that essentially all housing policy, all programs, laws, and incentives have been focused on stimulating demand and restricting supply. The Fed is aggressively keeping interest rates low. HARP, HAMP and related mortgage crisis programs are designed to keep people in their homes. They have been successful. Politically, it’s near impossible to institute a program that might help home buyers. For whatever reason, the bureaucrats are much more fond of home owners. That’s unlikely to change.

We’re in a hangover of short supply after the burst bubble. Low new construction, low incentive for existing homes to sell, and a government that wants people to stay put. Like a good hangover, these are long, slow, painful conditions.  We’ll ease slowly out of the fog in the next few seasonal cycles.

In January I penned an article for HousingWire magazine (paper! registration required) where I guided readers to watch for signals that the Fiscal Cliff could derail the housing recovery. A month later and the signals are strong: The Fiscal Cliff is long gone. The 2013 housing market is on fire, across the country, and the leading indicators point to home price appreciation far stronger than the 10% national jump of 2012.

Three Powerful Leading Indicators

Housing market headlines tend to focus on the traditional gauge of the market – prices of homes in completed transactions.

Fortunately, the active market of homes listed for sale is rich with signal about where prices are going in the future. Perhaps the most insightful of these is a stat we track closely: the percent of homes on the market with recent price reductions.

Contact us if for local or national details on any of these metrics

1. Percent of Homes with Price Reductions

To understand price reductions, think of your personal experience with homes for sale. In “normal” markets, a little more than a third of homes (38%, in fact, nationally is common), are listed overpriced – many intentionally, to “test the waters”.  When they don’t sell, the asking price is reduced.

In weak demand markets, price reductions climb to over 40% and even over 50% of the active inventory – meaning half the homes on the market have had to cut their asking price in the last 90 days. Conversely, in the hottest markets, price reductions may be required by only around 15% of the stock. This means that demand is so strong that homes have buyer competition and prices are rising week-over-week.

We’ve had a hot year for housing. Demand is high and inventory low, and price reductions as of February 15, 2013 are at 28% nationally. Pent up demand is buying homes more aggressively than sellers expected. This is a significantly bullish leading indicator.

2. Price of Newly Listed Properties

The pricing of newly-listed properties are a terrific signal of where a market is headed. To calculate this statistics, we snapshot prices for every property every week. Like watching the first grapes on the vine, the prices of this week’s new crop is the signal for the coming season. Why is PNL so insightful? It’s a textbook example of the “wisdom of the crowds” phenomenon. Real estate agents listing a property determine the optimal list price taking into consideration a number of factors, including everything they know about local demand levels. Those realtors, in aggregate, know exactly where to price their properties to sell. Therefore, when we observe the newly listed prices climbing, we know the Realtors are telling us something.

3. Median Days on Market

The time it takes to sell a home is a much more intuitive signal of demand than the above two leading indicators. Homes move faster when there’s more demand.

But watching Days on Market (DoM) for an area can be deceiving, for a nuanced statistical reason: most often when you hear about DoM, the number reported is an average. Averages have this nasty habit of being skewed by outliers. In this case, garbage properties that sit around the market forever skew the average DoM higher. So instead I like to look at median DoM (the middle). Median DoM reacts more quickly in recovery markets. When the good properties are going quickly, the Median DoM falls. Guess what? Across this country Median DoM is falling. Steeply.

Demand is high, supply is low. Prices are taking off. 2013 is going to crush it on home price appreciation.

If there’s one thing the (self-proclaimed) Data Geeks of Altos enjoy, it’s a challenge – particularly one issued from a client.  Today’s challenge – “What rent can I expect from my residential investment real estate?”  OK, we got that handled.

The answer was simple but not easy – the Rental Valuation Model.

Click it to calculate what your property would rent for in today’s market.

Tracking 70% of the US homes and apartments available for rent each week the RVM incorporates pricing, market times and key property characteristics in the largest housing and apartment rental database in the country.

Whether its market selection, investment decisions, loss mitigation or disposition strategy, we made RVM the MVP of everyone’s property strategy team.

You can test it for yourself here.  Let us know what you think.

(I just read a Tom Clancy novel on vacation.  Every time I read CIA, my brain translated the acronym to Comparative Information Analysis – but I digress.)

We’re really jazzed to launch Portfolio Watch – Altos’ next generation analytic platform to help residential real estate investors to know whether it’s best to “rent before selling” or to “sell before renting.”

If you face renting REO’s or investment property, you also face the challenge of acquiring solid, reliable data.  And not just rental data.  All the data.  If your Comparative Information Analysis is incomplete or just plain wrong, can you ever be truly confident in your decision?

Through the Portfolio Watch analytic platform, you can access never-before-available Rental and Listing data for all your properties in any given market.

Succinctly summarized. Easy to read and understand.   Know what’s sold.  Know what’s listed.  Know the local rental market. Know the local market dynamics.  Know what it’s likely to look like tomorrow, not just what it looked like yesterday.

It’s there, it’s in one spot and it’s at Portfolio Watch.  Take it for a test drive.

Check it out here

With personal wealth so heavily tied to real estate equity, voters answering the question “am I better off today than four years ago” may look at recent listing price trends.

From July 2011 through October 2012 we have seen a National Average increase in median values of 8.2% in 26 of the major MSA’s we track.  Entrenched Red States beat the national average in 75% of cases, stalwart Blue States in only 25% of cases.  Based on what we have, here’s what happens if we distribute the undecided states by assigning electoral votes based on whether the major metropolitan area value changes are above (Red) or below (Blue) the national average:

And the final count looks something like the table below – meaning it is still too close to call and the remaining swing states (Iowa, New Hampshire, Wisconsin, Virginia) hold the balance to the White House:

It’s fun to be the world champs – but a championship ring can come with a rich price tag.

With a view of the city streets brimming with nearly one million people attending the Giant’s victory parade, a San Francisco-based client commented “I hope they aren’t looking for rental housing.”  The San Francisco Bay Area continues to be among the strongest in the country notching better than 10% increases in median rental prices for apartments and condos in the period from July through October, 2012.  In fact, San Jose saw the highest increase across the nation in median home rental rates and was the second highest in apartment median prices.

Nationally, many of the big gains are in median rental rates are (not surprisingly) coming from high foreclosure states such as California, Florida, Nevada and Ohio.  Other areas of strength include Houston, Indianapolis, Cleveland, Minneapolis, Portland (OR) and Boston.  But Northern California seems to be leading the way in price upticks.

Here’s a fascinating Google search trend chart pointed out by a friend.

Two Google searches: the generic, “Buying a home” has been declining since the peak of the bubble. The cheap-mortgage-targeted  ”How much house can I afford?’ started spiking in early 2011, when the first signs of recovery in the non-judicial foreclosure states started emerging.

Google search trends illustrate how often (relatively) people search for a given keyword or phrase. Obviously, since the bursting of the bubble, a lot fewer people search for “buying a home”.  This shows us that recently, they’re much more interested in how much can they finance, given these super cheap interest rates.

Striking changes.

2012 has been good to the US Housing Market. In most places home prices are up, demand is up, money is super cheap, and transaction volume is up. Banks are unloading their backlog at steady but not disruptive pace. Not surprising with the improving market conditions, new delinquencies are declining rapidly. The press and traditional housing market data folks have caught on.

The biggest negative one can say about today’s housing market is that inventory is super low. Our Market Action Index, which measures demand indicators relative to active inventory (supply) to an at-a-glance answer to “How’s the market?” has turned into “Seller’s Market” territory for the first time in years in many markets.

On the downside, credit is still tight for people with bad credit. That limits the buyer pool, but I can’t say that’s a bad thing – for the long term health of the housing market. There’s a reason for lending standards – ignore them at your own peril.

So with that as a backdrop, what should we expect for the rest of 2012? Do we dare call it a “recovery”? Here’s what you need to know:

1. Home prices across the US are already up 10% year-to-date. You’re going to see five more months of “Up” headlines before the next cycle of home price declines make their way into the news.
2. Note that our earliest leading indicators – the data that leads 6 or so month out, have plateaued and are showing the end-of-year declines. Nothing scary in this data yet. Most of the rest of the year is dominated by bullish headlines.
3. In tandem with home prices, rents are climbing. I’ve described this virtuous cycle previously.

   Year to date rents (apartments and single family homes) and home prices (for just single family homes in this line) in 2012. Y axes are not zero scaled.

4. As I mentioned last week, the banks will sell into market strength, but not so much as to weaken prices in the face of these other dynamics.
5. Operation Twist continues and rates stay low. It’s difficult to tease from the data precisely how much impact the stoopid-low interest rates have on home purchases. But you can guess it’s big. The Fed is aggressively supporting housing with low-rate policy. Doesn’t look like this policy changes any time soon.
6. All of these factors combine to make real estate investing a hot market for the rest of the year. Lots of cash that has been sitting on the sidelines is now chasing a few properties with cheap financing and strong and improving yield. These are the makings of a bull market.

So there you have it. That’s the second half of 2012. Amaze your friends with your prescience.

I’ve just finished a week-long tour of some of the big financial institutions in Dallas, San Francisco, and Los Angeles with our Wall Street research partner Discern. These meetings always make me look deeply into the data because we’re faced with insightful questions from smart people and I always want to have insightful answers. I have a few blog posts bubbling as a result. Here’s the first.

This summer the defining characteristic of the US housing market is low inventory. Our Altos 10 and 20-city national composite data is a third fewer homes than last year and half of what was on the market at the ugliest points in recent memory.

This observation is generally true around the country. Sales are up, prices are up aggressively (a good 10% year-to-date), and inventory is low.

This low inventory, coupled with rising demand, is pushing home prices upward. Demand isn’t the crazy, influencing factor here. Except for the most-well financed among us, it’s still not easy to get a loan. There’s plenty of economy weakness out there. So in the spring and summer of 2012, the housing market strength is a supply-side function.

The question is Why? Why, this year, are there so few properties available? Why, when we hear so much about the “Shadow Inventory” of homes with distressed mortgages, can’t we buy them? Why, when guys like economist A. Gary Shilling think this shadow inventory will cause homes prices to tank another 20% this year, are they climbing?

Conspiracy of Banks?

The intuition of many that I talk to is that it must have to do with the banks. The banks aren’t selling. They’re afraid of tanking the market. It’s the fault of the big bad banks. But my experience says that’s not the case. The banks are actively moving the stuff on their books. They’re getting better and better at identifying and accepting reasonable deals. They’re actually selling into this strength. As they should. They’re not taking low-ball deals, which they shouldn’t, because markets are generally rising.

Staying in the Shadows

Rather, what appears to be happening is that everyone else, the consumers, those underwater borrowers who make up the vast majority of the shadow inventory, are holding out. Think about the class of people who watched their home lose 40% of its value in 2008. Those that didn’t default have now seen pretty reasonable price appreciation. In most cases it’s not back to it’s peak, but there is light at the end of the tunnel. Now is not the time, theh thinking goes, for me to sell. If I was down $100,000 and simply by holding on, I’ve recovered a decent chunk of that, I keep holding. That shadow inventory is staying in the shadows.

Regular home sellers are holding back

So Joe Sixpack feels his house has recovered a bit. He’s also a bit disillusioned with real estate in general. If he hasn’t defaulted already, he’s less inclined to throw himself into the market now. Refinancings are up so strongly, that many are paying less on the same home. People are pretty happy I made it through this mess alive.

Low inventory is the order of the day. This is consumer America catching up on a few years’ worth of equity. [sigh of relief]

What’s next? When does it turn? Stay tuned for the next post in the series. What to expect for the US housing market in the second half of 2012.

Home prices in California are stupid high, right? It must be a better deal to rent. At least in the big metros. Well not according to our friends at Movoto.com.

Movoto looked at home prices in 11 counties across the state of California and compared them to the average rents in those counties. In eight of the 11 counties, renters end up out of pocket more than buyers, sometimes a lot more.  From their press release:

• Alameda County renters pay an additional $332/month;
• Contra Costa County renters pay an additional $905;
• El Dorado County renters pay an additional $330;
• Los Angeles County renters pay an additional $174;
• Riverside County renters pay an additional $867;
• San Bernardino County renters pay an additional $507;
• San Mateo County renters pay an additional $479; and
• Yuba County renters pay an additional $248.

To complete the cost analysis, Movoto.com compared the average monthly mortgage cost and associated taxes of a 3-bedroom, single-family residence to the average monthly cost of renting an apartment. Information on the average monthly rent cost was provided by real estate data and analytic firm Altos Research, which offers the largest housing and apartment rental database in the United States.

The analysis assume a 35 percent marginal income tax rate, a 1.5 percent property tax rate, a 20% down payment and a mortgage interest rate of 4%. The analysis only compared the current cost of renting to the current monthly cost of buying and does not include the benefit of avoiding future rent increases or gaining property appreciation over the ownership period.

It’s a fascinating dynamic and something that we’ve been talking about for a while. Both home prices and rents are climbing in most of this state. It’s always a tough comparison, difficult to control for quality of dwelling and maintenance costs, etc. And of course the big assumptions are that A) you can qualify for a loan and B) that you have 20% for that downpayment. The observation, and this is true around the country, is that if you’re well financed, mortgage money is so ridiculously cheap. And that makes these “affordability” analyses look very favorably at the costs of buying a home.

Full press release here.

Altos Research Rental Intel (sm) market data info here.

Altos 20-City Composite: Days-on-market (red) is now declining with the lowest active market inventory (green) in the seven years

Altos 20-City Composite: The price of new listings (red) entering the market each week are pricing higher while existing sellers are taking few price reductions (green)

From yesterday on Calculated Risk -”House Prices & Lagged Data” -

But sometimes the lag can be much longer. Tomorrow morning the January Case-Shiller house price index will be released. This is actually a three month average for house sales recorded in November, December and January.

But remember that the purchase agreement for a house that closed in November was probably signed in September or early October. So some portion of the Case-Shiller index will be for contract prices 6 or even 7 months ago! [emphasis added]

Signed,

April

P.S. The weather’s been unseasonably warm this Spring.

P.P.S. Go to Las Vegas right now immediately and take whatever odds you can get on the Giants to win the Super Bowl.  Trust me on this.

Business Insider Pop Quiz: Which is the only housing market that showed gains in 2011 (using the Case-Shiller Home Price Index)?

Answer: Detroit

…which is what we’ve been saying for months:

Trend Chart of the Day: Detroit Home Prices on the rise? (Aug 15, 2011)

Top 3 US Housing Markets (Oct 20, 2011)

Imported from Detroit: Chryslers & Housing Strength (Oct 25, 2011)

“Geez, it’s almost there. If we could just get another 851,489 houses for sale in the market, we’ll have it juuuuuust right…”

We released our February National Housing Report yesterday – “US Home Prices Already Climbing in February,” in which we highlight the role of declining active market housing inventory in this year’s home price stabilization.

Ironically, Jonathan Miller (author of Matrix Blog) wrote on Monday – “The Decline In Inventory Right Now is NOT a Good Sign.” Jonathan and I disagree on this point, which we delightfully and civilly discussed via email this morning.

Here’s the way I see it: It wasn’t long ago that the world was worried about millions and millions of foreclosed homes hitting the open market and crashing home prices another 30%.  Now we’re worried there’s not enough supply. Huh?

The problem with the housing market in the first place was too much supply at bubble prices and demand levels. Because housing supply is difficult to destroy or spoil (Greenspan’s suggestion to burn down houses and rotting REOs aside…), I’d much rather be in a place with very low supply – even a shortage in terms of “homes for sale relative to demand” – that causes prices to rise in the short-to-intermediate term. Trying to fine tune the “right” supply level is very dangerous.

Plus, other factors are influencing active market inventory:

1. Short Sales: Some of the “lowness” in the active market inventory is due to the shadow/distressed inventory which will leak out this year via the continued short sale push from the GSEs and banks. These institutions have very large NPV functions and are concluding that a short sale at today’s price > 6-36 month foreclosure process in many cases.  This will nag home prices to the dismay of non-distressed home sellers, but it’s a realistic way to handle the problem.  Much better than foreclosing on another 6-10mln people behind on their mortgage. You can’t have it all…

2. REO-to-Rental: Bulk REOs on the GSE/bank balance sheets are converting to rental housing with recent program announcements from Freddie Mac, Fannie Mae, the FHFA, and Bernanke.  This means that this subset of inventory won’t hit the active listings in the short-to-intermediate run. Investors buy and convert these properties to rental. Eventually when home prices rebound significantly, investors may attempt to re-sell into the market, especially if price-to-rent ratios make it economically sensible for renters to enter or re-enter the marketplace, but that is 5-7 years down the road.

3. Supply & Demand: One can use either an upward-sloping supply curve or a vertical/no slope supply curve to depict active market inventory.  An upward sloping housing supply curve says that as prices rise, the quantity supplied along a fixed supply curve will also rise. However, in this scenario, prices will also drop because a rise in supply creates a surplus gap at a given quantity demanded along a fixed demand curve.

The good news is that the opposite also happens – when prices fall, the quantity supplied falls along the fixed upward-sloping supply curve, as home sellers and firms withdraw or stay out of the market. This is the argument that Jonathan makes as to why supply that is “too low” is a bad sign for the market – low supply is due to low prices.

But… if that happens for a prolonged period, then a shortage develops in the market which causes prices to rise. This is what we’re seeing now. Then, home sellers and firms will re-enter the market as suppliers when they see prices stabilize and rise.  Part of this supply re-entering will be home owners on the underwater mortgage margin.  They’re current on their mortgage so they don’t qualify for a short sale or modification in most cases. They want to sell but can’t sell because they are LTV=101 to 120 and don’t have the cash on hand to bring to closing.  If the market pops 5-10% because of a supply shortage, then it becomes feasible to enter the market.

(Personally, I assume  a vertical/no slope supply curve and a fixed demand curve. On the supply side, there are a discrete number of homes for sale at any one point in time, and there is a baseline number per year with seasonal fluctuations that enable the supply curve to move more nimbly back and forth. Principally, demand curves are fixed and are very hard to shift, though the market is seeing the demand curve shift downwards with a preference change to rentership – both by choice and by force – as the homeownership rate falls back into the mid-to-low 60%, and heads lower every quarter.)

In either an upward sloping supply curve or vertical supply curve, the supply curve moves  back and forth on expected future prices (i.e. market conditions) and the number of firms (i.e. individuals, homebuilders). When these market suppliers sees a sustained recovery and expect future prices to rise, then a chunk of sellers enter the market and homebuilders start building homes.

It’s dangerous and Keynesian (worse) to think that anyone can decide the “correct” amount of active inventory, particularly when using history as a guide.  Looking backwards too much for too long got us here in the first place.  I’m not advocating a free-for-all in the housing market – it’s way too screwed to extract the government programs now.  And it seems that HARP II might actually be working.

I do think that the market is responding appropriately right now with low supply and I’d really like to see the current situation play out in 2012 before a bunch of politicians or lobby groups decides on the optimal housing supply that should be available to buyers.

“Or maybe it should be 853,109 more homes…”

Lots of headlines around the web today about what the Facebook IPO means to Silicon Valley real estate. They all get it wrong. The short answer is that the Facebook IPO will have essentially no impact on the Silicon Valley housing market. Why? Because the market is already hot and has weathered the housing crisis better than maybe anywhere else, driven by infinitesimal supply and *tons* of other successful wealth creating companies of the last 10 years.

Take for example, Apple. In 2006, Apple’s market cap was about $35B. Now it’s $450B. That’s 400% of the wealth created potentially to be added by Facebook. Here’s another: VMWare. Here’s a company, based in Palo Alto, that created $40B in equity wealth since 2008. Here’s how local home prices have acted since then.

Home prices in four central Silicon Valley towns. 2005-2012

No surprise, this is an expensive part of the world to live in. Guess what? Facebook doesn’t make it moreso. What’s more interesting than perpetually high prices, in my opinion, are perpetually low inventories.

Inventory of homes for sale in Palo Alto, Los Altos, Mountain View, and Menlo Park, California 2005-2012

There are just over 100 homes for sale in these four towns. That’s it. (Why this is true is a topic for another post). If there are 5000 people vying for 100 homes, adding another 1000 millionaires from Facebook, while awesome and wonderful, doesn’t add any marginal demand to the local housing market.

The bottom line is that Silicon Valley consistently creates big stock wealth (thank god) and it consistently has few homes for sale. Home prices have held up quite fine since the bubble burst. They will continue to do fine. But Facebook is not a significant outlier event for homes in this market.

For better or worse.

Last week I highlighted the bullish signal that the price of newly listed homes after the first of the year were ticking up. This week I have another hint of good news. Rents.

In addition to the active housing market, Altos Research now tracks the active rental market. Our set of 750,000 – 1 million rental units a month is the largest set available anywhere. And it’s powerful.

US Rental Prices, weekly sample, single family homes and apartments for rent. Sample size is approximately 600,000 per week.

This chart illustrates rents across our Altos 20-City Composite and 10-City Composite as of January 27, 2012 so it’s a national view. This data is a blend of both single family homes and apartments on the market.  The weekly upticks in rents is one of the signs we’re using to underpin our mildly bullish home price scenario for 2012. The argument goes like this:

1. Rents are rising because mortgages are harder to get and because the conventional wisdom that “owning always wins” is diminishing.  Percent of American households who own their homes has fallen to 65%. It’ll likely keep falling to closer to 60% over the next few years. This bodes well for rents.
2. As rents rise, home prices fall, and mortgage money remains unnaturally cheap, we’ve reached the point where investors see growing returns on investment properties. There’s a well-funded investor pool who can take advantage. They’re buying.
3. As rents rise, those non-investor home buyers see more opportunity buying vs. renting. As long as they can get a mortgage, there are relative opportunities.

So rising rents help provide a floor to home prices. Keep an eye on this space for more as Q1 2012 progress.

We track hundreds of local housing market stats here, but one of my favorite (because you can’t find it anywhere else, and because it’s so insightful) is the Median Price of Newly Listed Properties.

It turns out that if you watch the prices of the properties that enter the market each week, you can get a real sense for the quality of the demand in a local market.

Also notable is that the spring housing market starts the second week of January. Like clockwork.

Realtors, it turns out, in aggregate are quite sensitive to where homes should be priced. They tend to price homes very close to where they’ll sell. When they’re sensing healthy demand, they price more aggressively. When they sense weakness, they’ll price lower so the property will move. They’re pretty clever, those Realtors. Here’s what they’re telling us today:

Median price of new listings. Single Family Properties across 20 major US metro markets. Source: Altos Research

The data-point we’re looking at is at the far right side of the red line, that’s the weekly number, for January 13, 2012. Notice every 2nd week of January we get an uptick. This year is a nice strong move above the recent trendline (that’s the green). This move, while admittedly only one data point, is the very first signal of the new year.

It’s not aggressively bullish, mind you. But it implies US home price stability through the first quarter. And that’s encouraging.

Stay tuned.