For those of you who are worried about home prices, I don’t like what I am seeing in the bond market.
The ten year bond yield has increased by almost half a percent in the past 2 weeks, from 3.88% to 4.32% today. That’s worth 12-15% on home prices.
We saw this movie on the way up; now we may see a little on the way down. Home prices have increased by more than 50% over the past 3 years, driven primarily by lower mortgage rates. Mortgage are bundled and sold by the container load in the bond market, where they price off Treasuries.
The right way to think about home prices is like a bond, as the securitized value, or present value, of the stream of housing services they will provide in the future. Buyers in the commercial property market go through this analysis explicitly, using estimates of future rents to determine expected cet cash flow each year in the future. A proxy for residential housing is expected rental yields.
Worth noting. More construction and completions means more houses relative to people and incomes. It lowers expected rental yields, therefore depresses the value of existing properties.
Bond guys do this work all the time. Stock analysts don’t do it but should do it. Home buyers should do it too.
The duration of the S&P 500 at today’s interest rate levels is 26 years. that means it will take 26 years for the owner of the S&P 500 to “earn” half the present value of the index if he collected all the free cash flow. That means a 100 basis point rise in the after-tax cost of capital for the index would reduce its value by 25%.
The duration of the housing stock is not far off. It is shorter to the degree that rental values grow more slowly than cash flow, and longer to the extent that the cost of capital for housing is somewhat lower than for equities due to the yummy tax breaks on housing. On net, I would use roughly the same number.
That’s why a half percent move in the bond yield worries me. It equals about 13% on home prices.
Don’t get crazy and sell your house. But don’t stand in line to buy one either. This housing boom is just about over.
JR
We know all about the current real estate trend to over inflate the prices of sub-average homes just because the market allows it. We poke fun at this current craze at: http://www.ridiculousrealestat.com
Thanks to this, prices are higher than ever and the average person can’t afford an average home.
I think people are over analyzing the housing market. I bought my first house in 1983 with a 12.875% mortgage. Rates fell, then rose again, then fell. In 1987 rates went up 3 whole percentage points. Then fell until 1994 when they rose two points. Rates then fell until 2000 when they rose a point and half. Real estate prices overall have gradually risen throughout this period, save for some specific regional downturns from time to time. If I was to worry, I would chose the SE coastal area, Florida and the Gulf Coast. The past 35 years have been pretty calm from a climatic perspective. If storm activity is on the rise, there is a heck of lot of new real estate in those areas that is right in the path of a Category 5 or greater storm.
You did good on FOX.
Thanks Jim, Neil Cavuto is a very nice man and his show is a pleasure to work.