Collateral Analytics – December 2012 – Market Update
We have been pointing out for the past year that most of the fundamental factors for a recovery in home sales activity and prices were falling into place. However, the residential real estate market has always had a strong psychological component driven by consumer sentiment which can be tracked by a number of surveys which include consumer confidence as well as whether it is a good time to buy a home. This should not be surprising since a home is a “big-ticket” purchase and a buyer generally needs to feel confident about the outlook for both the overall economy and his own job before making such a commitment. These swings in sentiment toward the real estate market result in the tendency for home prices to oscillate above and below what we like to think of as an intrinsic value for each market. During periods of great exuberance, these swings can carry prices far above sustainable values as we saw during the most recent bubble period. Similarly, during times of extreme pessimism, these swings can move prices significantly below intrinsic values as we have seen in the past several years.
One of the primary drivers of intrinsic value in our home price forecast models in employment. Figure 1 shows the strong correlation back to the early 1970s of annual percent changes of single family home price and total employment for the Sacramento CBSA.
The actual values of these two series over the same time period are shown in Figure 2. Displaying these on the same chart with two axes is a good way of seeing the longer term oscillatory behavior of home prices above and below a proxy for intrinsic home values. It is also a good way to see how much prices overshot during the 2004 to 2006 bubble period as well as the overshooting on the downside since 2009. In addition, this chart provides some idea how much Sacramento prices need to rise at the present time just to revert back to more fundamentally based values.
The strong psychological component of home price movements is one of the reasons why home prices tend to exhibit a lot of momentum on both the upside and downside of the real estate cycle. The technical term for this is “serial correlation” and, in lay terms, means that when home prices are rising, home buyers assume that they will keep rising and when prices are declining, home buyers assume that they will continue declining. This should not be too surprising since housing impacts the rest of the economy in many ways. For example, rising home prices lift not only consumer but also business confidence. They also increase homeowner net worth and encourages those buyers who have been sitting on the fence to purchase. These new buyers lead to higher turnover rates which lead to higher prices. This reinforces the existing trend and leads to the above mentioned momentum.
CBSA Winners and Losers
Each month Home Value Forecast ranks the single family home markets in the top 200 CBSAs to highlight the best and worst metros with regard to a number of leading real estate market based indicators.
The ranking system is purely objective and is based on directional trends. Each indicator is given a score based on whether the trend is positive, negative, or neutral for that series. For example, a declining trend in active listings would be positive as will be an increasing trend in average price. A composite score for each CBSA is calculated by summing the directional scores of each of its indicators. From the universe of the top 200 CBSAs, we highlight each month the CBSAs which have the highest and lowest composite scores.
The tables below show the individual market indicators which are being used to rank the CBSAs along with the most recent values and the percent changes. We have color-coded each of the indicators to help visualize whether it is moving in a positive (green) or negative (red) direction.
Top 10 CBSAs
The top ranked metros in the current month represent a cross section of U.S. real estate markets. Three of the top ranked CBSAs are located in Texas while another three are in Southern California. The former are markets which really did not exhibit bubble conditions during the nationwide run up and, thus, did not need to experience a meaningful price correction. The California markets fall into the category of markets which did overshoot on the downside and, thus, are attracting homebuyers looking to take advantage of very favorable prices. New additions to the Top 10 list this month include the Minneapolis and Salt Lake City CBSAs. Note that all the indicators in the Top 10 list are colored green which means that they are universally exhibiting positive trends. One thing that all these markets have in common is that they all have experienced significant declines in active listing counts over the past year. This has led to most of these currently having tight markets based on their Months of Inventory Remaining values.
Bottom 10 CBSAs
The bottom ranked metros also represent and interesting mix with four being in the greater New York-New Jersey-Connecticut area. There are also four in the Southeast with new additions to the Bottom 10 the month being the Little Rock and Knoxville CBSAs. As seen in the table, most have double-digit Months of Inventory Remaining. However, our top and bottom ranked CBSAs are ranked on a relative basis. Thus, even the ones in the Bottom 10 list are showing a fair percentage of positive (green) trends. This is quite different from last year when the majority of the Bottom 10 markets had most (or all) of their indicators trending negative and colored red.
Our Market Condition thematic maps are a good way to visualize the differences in the top and bottom ranked metros. Figure 3 below shows the single family rankings for the Santa Ana-Anaheim-Irvive, CA area while Figure 4 shows the same for the Newark-Union, NJ CBSA.
In this month’s Outliers, we highlight the Santa Ana-Anaheim-Irvine, CA CBSA (Orange County), which is currently in the list of the Top 10 metros. The Orange County CBSA did experience a sharp decline in home prices since its peak in early 2007, much like that of other markets in California as well as other western states such as Arizona, and Nevada. As seen in the ranking table above, all of its important market indicators for the Orange County CBSA are showing positive trends on a year-over-year basis including declining inventory, lower Inventory Remaining, declining market times and lower distressed sales activity to name a few.
Within the Orange County CBSA there are numerous sub-markets. On a Zip code level, one of particular interest is Zip code 92660, Newport Beach, CA.
Figure 5: CBSA – Santa Ana-Anaheim-Irvine | ZIP 92660, Newport Beach, CA
As seen in Figure 5, single family home prices in this Zip code have held up better than in the overall Orange County metro since the market peak. In addition, as seen in Figure 5, our home price forecast models call for this Zip code to perform quite a bit better than the overall CBSA over the next several years.
There are a number of reasons for the historical and forecasted outperformance of this Zip code which include the fact that this is a very desirable area with limited developable land. In addition, homebuyers in this Zip code have historically been better capitalized and, thus, better able to weather declines in home prices. The average loan-to-value (LTV) ratio in Zip 92660 has historically been below 70 percent compared to approximately 75 to 80 percent for the overall Santa Ana-Anaheim-Irvine, CA CBSA.