Craig Frazer

This may seem counter-intuitive, but it is possible for homebuyers to be hurt if the economy improves. Of course, an improving economy has many positives for the housing market as a whole: decreasing unemployment, stabilizing household incomes and increasing consumer confidence levels. However, an improving economy also brings with it the likelihood of higher long-term interest rates.

One of the toughest jobs facing Federal Reserve Chairman Ben Bernanke is how to time any interest rate adjustments as the economy improves. Raise rates too soon and he risks killing the recovery. Wait too long and he risks significant inflationary pressures.

The interest rate conundrum also should be of concern to prospective homebuyers. Changes in interest rates can have a significant impact on a buyer’s purchasing power. To illustrate this impact, let’s do a simple “what if” case study. For purposes of this illustration, we need to define certain parameters. The first is to calculate a PITI. What is that? It is an acronym for Principal, Interest, Taxes, & Insurance. Essentially, it is your monthly house payment when you have the bank/lender escrow your annual property tax and insurance payments. Lenders use this figure to calculate certain ratios such as your payment to income ratio.

For many years (and even today) lenders have used a monthly payment to monthly gross income ratio of 28% as part of their underwriting process (there is also a total debt to income ratio of 36% but we’ll keep that for a later discussion). In essence, a mortgage lender wants to make sure a family’s monthly mortgage costs don’t exceed 28% of their gross income. The intent is to provide a safety cushion in terms of debt obligations (of course, during the sub-prime boom this safety cushion was sometimes more of a concept than an understanding standard).

So let’s take a typical purchase transaction and see the impact if interest rates begin to adjust:

Purchase Price: $250,000

Down Payment: 5% ($12,500)

Loan Amount: $237,500

Term: 360 months (30 years)

Insurance: $500 year

Property Taxes: 0.75% of value

Using these parameters with a loan interest rate of 5.25% yields a monthly house payment (PITI) of $1,502. Now if interest rates are to rise to say, 6.5% (a common interest rate just a few years ago) the monthly payment adjusts to $1,691. This is less than a $200/month change but the impact to potential buyers is significant. Remember the 28% ratio mentioned earlier. Using that ratio, a buyer would need an annual household income of approximately $64,353 under the 5.25% scenario. However, that increases to $72,482 in the 6.5% scenario. Thus, an increase of just 1.25% in the interest rate requires a nearly 13% increase in the buyer’s annual income.

Therefore, even if housing prices do not show any improvement as the economy recovers, if interest rates begin to rise, buyer’s purchasing power will begin to decline. For all those people waiting for the market to “bottom out” in terms of the overall price & interest rate environment, we may have reached the bottom in terms of overall purchasing power.

Of course, there will be those who suggest well if housing prices drop a bit more that will offset the impact. Fact is, not really. If in the example above the purchase price drops by another 5%, all things remaining the same, the buyer’s household income would still need to increase by 7% ($68,948) in order to qualify for the purchase. Home prices would need to drop another 12% from current levels for the buyer to simply break even. Given the reports of home sale activity stabilizing in many parts of the country (including here in Salt Lake and Davis County), hoping for another drop of 10-15% may be wishful thinking.

There is a lot of discussion amongst the real estate community, the banking community, consumers, and the media as to whether or not the real estate market has or will soon hit the bottom. If you think this particular blog post will answer that question, you will be sorely disappointed. However, I hope to potentially shed some light on what is really a very difficult and fluid concept

To that end, I've tried to identify what a non-bubble market would look like in terms of average price points. In our local market, data indicates that our bubble began to manifest itself between 2004 and 2005 (based on historical average sale price increases). So I went about calculating what average prices would have been assuming two different scenarios: one, housing prices matching the consumer price index (CPI) and two, utilizing a slightly higher appreciation rate to account for the differences between an overall CPI measurement versus a measurement based on less liquid durable goods.

There are several prognosticators out there suggesting the market has another 25%, 30%, 40% to drop before we hit bottom. Those "pull them out of a hat" statistics don't really appear to assist us in determining what the market is actually doing. By going through this rudimentary analysis for Davis County, I found some interesting outcomes. If we turn back the clock to 2004 and magically adjust history to eliminate the "housing bubble," we find current average sale prices in Davis County are approximately 16% above what we would've otherwise "expected" to see if housing costs matched identically to the CPI year after year. That said there is significant variation in this calculation based on sub-regions within the county.

Again turning back the clock to 2004 (is this starting to feel like an episode of LOST?) but assuming a slightly higher inflationary impact for housing due to unique housing factors, we see a smaller differential between current actual average sale prices and our projected average prices. This too varies considerably by geographic area. Regardless of which scenario we personally feel is more appropriate, it is interesting to note that just these two scenarios into three geographic areas for Davis County produces a variation range of 6% to 17%. This range is a far cry from the 25% to 40% figures bandied about in cyberspace and elsewhere

I would expect to see even more significant variation if I were to drill down to smaller and smaller geographic areas such as cities, zip codes, or even subdivisions. So although there may be geographic micro-economies where there may be an additional 25% of downward price pressure, it is also highly likely there are micro-economies that have already reached or are near pre-bubble price points. Why is this important?

Because buyers and sellers both need to understand what pricing trends are occurring in their specific location. For a buyer, if you were waiting for an additional 25% drop in a particular area that is already within 5 to 10% of predicted pre-bubble pricing you may likely miss several opportunities to purchase your preferred home based on an unrealistic expectation of further price reductions. As a seller, you may miss potential buyers by placing your property at a level that doesn't acknowledge further price deterioration may occur within your geographic area.

We must also be sure to factor in the traditional supply vs. demand dynamic in this process. If there is a sudden increase in housing inventory levels due to increased foreclosure activity or the so-called phantom or invisible inventory (sellers who have delayed putting their homes on the market due to the downturn but now are at a point where they need to list), that will impact the overall numbers. By the same token, if buyers begin to think the market has bottomed out and move into the market in numbers, it could quickly stabilize housing prices thereby decreasing any remaining downward price pressure

So it would appear the most insightful response to the question "have we hit bottom" is "it depends."

Here is the updated Layton market snapshot report for the most recent quarter. We are starting to distance ourselves from the frozen credit markets we experienced in the fourth quarter of 2008 and after the first of the year. However, the local real estate market is still a bit sluggish.

We are now starting to report more significant price point impacts as sellers are forced to adjust their pricing in order to obtain offers. As I mentioned in my fourth quarter report, the impact of elevated inventory levels and the increase in distressed properties (e.g. short sales, foreclosures) is being felt as these properties are now being sold and the price impacts being reported. The trend line continues to be downward and most analysis would indicate this trend will likely continue through at least the first half to three-quarters of 2009. The good news is we are continuing to see new inventory counts begin to decline thus slowing the pipeline of competing inventory. However, as you can see from the “Listing Inventory” section of the report, we continue to carry a high on-going inventory in all price categories.

It does appear the Fed’s ability to keep long-term interest rates moderated is helping to some extent. We are continuing to see sales activity, albeit reduced, in all price points. In fact, you might notice in the “Buyer Demand” section that average and median home sale prices in Layton increased slightly from the same period a year ago. This in spite of a 12% decrease in actual unit sale activity. This drop in unit sales is having an impact on average list prices. As the existing inventory begins to sell, I would expect the impact on average price points to be realized.

So have we hit bottom yet? That’s a question I get asked frequently and I have a standard response. “Perhaps, but we won’t really know until we can look back at one or two quarters and then definitively say ‘that was the bottom.’” I have yet to find someone who has the ability to accurately predict a bottom but a vast number of people who can report a bottom . This is just as true in the stock market as it is in the real estate market.

This spring and early summer season (May through July) will tell us a great deal about the market’s ability to reach a stabilization point. My next quarterly report will be prepared near the end of this time period and should provide an interesting view into our market’s dynamics. I hope you find this information helpful. You can also go to my website’s Communities tab and get additional market data reports for several communities in Davis County as well as global reports for both Davis and Salt Lake County

Of course, don’t hesitate to contact me with any questions you may have about this data or if there is more specific information I can provide relative to our current market conditions.

Well we finished a rather interesting first quarter (how’s that for a euphemism?). My current Farmington market snapshot report for the most recent quarter is included for your review. We are starting to distance ourselves from the frozen credit markets and corresponding near screeching halt in the realty market experienced in the fourth quarter of 2008 and after the first of the year. However, the local real estate market is still a bit sluggish.

As I mentioned in my fourth quarter report, the impact of elevated inventory levels and the increase in distressed properties (e.g. short sales, foreclosures) is being felt as these properties are now getting offers and closed and the price impacts being reported. The impact on average sale prices is now materializing as sellers are forced to adjust their pricing in order to obtain offers. The trend line continues to be downward and most analyses indicate this trend will likely continue through at least the first half to three-quarters of 2009. The good news is we are continuing to see new listed inventory counts begin to decline thus slowing the pipeline of competing inventory. However, as you can see from the “Listing Inventory” section of the report, we continue to carry a high on-going inventory in all price categories as measured by the Months Inventory calculation.

It does appear the Fed’s ability to keep long-term interest rates moderated is helping to some extent. We are continuing to see sales activity, albeit reduced, in all price point ranges. In fact, you might notice in the Buyer Demand section the average home sale price in Farmington increased a whopping 15% year over year. Well, not exactly. There were two sales over $750,000 that closed in the first quarter (one over $1,700,000) thus skewing the averages for such a small sample size. The actual pricing impact year over year is better illustrated by the 4% decline reported in the median price point.

So have we hit bottom yet? That’s a question I am asked frequently and my response is always the same. "Perhaps, but we won’t really know until we can look back at one or two quarters and then definitively say that was the bottom." I have yet to find someone who has the ability to accurately predict a bottom, but there are a vast number of people who can report a bottom. This is just as true in the stock market as it is in the real estate market. As with the stock market, the real estate market can rebound slightly and then re-test the bottom a few months later. We won’t truly know when we hit the "bottom" until we are one or two quarters removed and can definitively state "that was the bottom back there."

This spring and early summer season (May through July) will tell us a great deal about the market’s ability to reach a stabilization point. I use the term stabilization as I think "rebound" does not accurately reflect what the market reaction will likely be. My personal perspective is once we reach a more stable market (with months inventory in the six month range and average days on market declining into the 50 – 65 day range) we will likely have a relatively flat market for another 12 -18 months as consumer buying power begins to rebound.

As always, if you have any questions regarding the local market, feel free to contact me at any time.

As I was doing some research for a potential listing client, I identified some interesting trends in the data I was compiling causing me to rethink the conventional wisdom related to short sale and REO (bank foreclosure) activity. Conventional thinking suggests the declining home prices are a result of increased short sale and bank foreclosure activity. However, at least in our local market here along the Wasatch Front, I am not sure we have seen the full impact of these distressed properties on the market.

Reviewing the data for both Davis and Salt Lake counties, I noticed that, as it relates to current active listings and current under contract listings, the percentage of short sales to standard listings is relatively consistent in the 11% to 16% range. However, there is a completely different story when looking at the percentage of short sales that actually closed in the same time frame. Short sales represent less than 4% of total closed sales over the last 12 months. On the surface this appears to indicate our market hasn't fully absorbed the impact of short sales (and by extension foreclosures) as reflected in average and median sales figures published routinely in the newspapers and local news media.

Average and median sale prices year-over-year have reflected only low single-digit decreases to date. As many agents know, active listings in the current market have seen repeated price reductions as demand has diminished; due not only to the economic and financial situation but also due to seasonality. There have also been significant delays by the banks in getting short sales approved and offers accepted. Many times, offers submitted on short sales are canceled as the buyers purchase other properties while waiting for the banks to make a decision. I know of delays as long as six months to get approvals with six to eight weeks very common.

Thus, we may not have seen the so-called ”bottom” of the market as many of these short sales (and other distressed properties) have not yet been fully accounted in the markets. The next several months should provide some very telling data points, especially if the banks begin to streamline their short sale approval processes and become more effective in getting their short sale properties under contract and sold.

This information may also be understating the impact of short sales and foreclosures as agents don’t always identify the property as a short sale in the MLS.

It will be important to watch upcoming data sets to determine actual trend lines heading into the summer. The combination of federal tax credits, the recently signed grant program for new construction, and the recent reduction in interest rates due to the federal reserve program to buy Treasury securities may begin to have significant impact on the housing market over the coming months.

Stay tuned…