The Housing Market Just Wants to Be Normal Again

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Is a topsy-turvy U.S. housing market about to settle down?

After a boom, a bust, and a heady rebound, many loan officers, real estate agents and economists I've spoken to recently are anticipating something that's eluded them for the last decade: a return to a "normal" market.

The new stability comes as a result of opposite, competing pressures. Higher interest rates and higher home prices are cooling off demand, while low inventories are straining supply, heating the market up. The forces cancel each other out, at least in part, which might be a good thing.

The interest rate on a 30-year fixed mortgage, adjusted for inflation, has risen 1.33 percentage points since May. That rate of increase is "unheard-of," Jon Shrum, a loan officer in Southern California, told me. That change would raise the monthly payment by 15.2 percent.

The first impact of that rise has been to pop the bubble in mortgage refinancing. Shrum said that interest in refinancing had evaporated almost instantly. "We've taken a major hit on that," Shrum said. Data from the Mortgage Bankers' Association shows that refinancing applications are down by half since May.

"Unlike home purchases, refinancing can respond swiftly to changes in rates," said Jed Kolko, chief economist at Trulia, an online listing site. "It's a purely financial decision, and for many borrowers, it's no longer worth it to refinance."

The impact of higher borrowing costs is less clear for buyers. If buyers anticipate further appreciation, it might not be that much of a discouragement. "If anything, the increase in interest rates will get more people into the market as people will want to beat the rise," said Mark Pullinger, Southwest regional vice president for Coldwell Banker Real Estate LLC.

Another outcome may be to drive buyers who would have otherwise taken out fixed-rate mortgages into adjustable-rate loans. The Washington Post's Jim Tankersley worries this means "America has learned nothing from the financial crisis," as payments on adjustable-rate mortgages will jump if rates continue to rise.

The sharp spike in rates has even caused some lenders to stop offering long-term fixed-rate mortgages for now. Weeks of 50-basis-point changes terrify them. "Lenders are facing significant risk because people are locking in rates and then rates jump by the time the loan is funded," said Glenn Kelman, CEO of Redfin, an online real estate brokerage.

Most said, though, that the real estate market is now strong enough to withstand rising interest rates. "It hasn’t affected our sales," Pullinger said. "Inventory has really been the more important factor."

But all acknowledged that it will take away the appetite of investors looking to flip homes for a profit, who were a record 27 percent of all home sales in 2011, according to the National Association of Realtors. It may also cool demand as buyers are surprised by higher costs.

Three signs of that: The number of listings on Redfin that receive multiple bids has dropped from 76 percent in March to 69 percent in June. Redfin also saw a 10 percent drop in bids as mortgage rates broke 4 percent. Closing ratios, which track the share of potential sales that go through, are down by 45 percentage points, said Shrum.

Adding to the impact of rates, home prices are up 14 percent since January 2012, according to the Case-Shiller Index of 20 U.S. cities. The National Association of Realtors' Housing Affordability Index has also declined 18 percent since January, a trend that's expected to continue. "Buyers are more hesitant," Kelman of Redfin said, "and this will limit the magnitude of price increases."

What this won't do is derail the housing recovery. Tight inventories will boost construction, whatever rates and prices do, many of the experts said. Adjusting for seasonality, there were only 161,000 single-family homes for sale in the U.S as of June. Inventories have begun to rise again, but nowhere near as quickly as the pickup in demand. Homes take time to build. Home completions usually lag permits by a year, according to aggregate data. At least permits may now be growing apace with future demand, Kelman said: "Three months ago, the market was limited by inventory, but that's begun to abate."

To write of a single U.S. real estate market simplifies too much. Southern California, where Shrum works, is much stronger than other regions; the Midwest is just beginning to turn around, as Federal Reserve Bank of Chicago Vice President William Testa has written. Testa built an index that tracks permits and prices in his Fed district at a county-by-county level. It just turned positive -- that is, there were more counties with improving markets than worsening ones, for the first quarter since 2006.

Other data from Redfin paint stark contrasts. A whopping 92 percent of buyers in San Francisco paid more than the asking price in June. Only 20 percent of buyers did so in Chicago. After a long period in which macroeconomic trends drove prices up or down across the country uniformly, a "patchiness" depending on the area is returning to the market, said Kelman,

Another factor sending local markets in different directions will be the share of all-cash buyers. In San Francisco, for instance, many people liquidate holdings in technology stocks to buy homes. "That makes them completely unfazed by what's happening to interest rates and the broader economy outside of their world," Kelman said.

As Kolko of Trulia sees it, the rise in mortgage rates was just what the housing market needed: "Anyone who was worried about a new home-price bubble was forming should be thrilled."

Kelman agreed. "The market had been in an unsustainable situation. We were seeing 3 or 4 percent monthly increases in price of an asset that should appreciate 2 percent per year," he said. "Cooling off doesn't mean were moving to the abyss. It just means markets have stabilized. That seems like a healthy place to be."

Housing seems to want this return to normal. More so, even, than another boom. Maybe, just maybe, the industry has learned its lesson.

(Evan Soltas is a contributor to the Ticker. Follow him on Twitter.)

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