The housing market is definitely softening. Sales are slowing down, price reductions are increasing, and affordability has decreased dramatically because of spiking interest rates. The problem with relying with artificial stimulus is that the market becomes conditioned to easy money. A recent survey found that only 1 out of 3 Californians had the means to purchase a home, down from 49 percent one year ago. The big change has come from spiking prices, weak wage growth, and of course a 100 basis point increase in interest rates. So it should come as no surprise that inventory is up and more sellers are facing the need to reduce prices. This QE experiment has ‘worked’ but now bigger action is needed to keep the gig going. The Fed owns the mortgage market but with a job report that appears to be solid on the surface, the Fed is now having more pressure to taper. Of course looking at the evidence there will be no taper but perception is the name of the game. One thing is certain and that is, it looks like a tipping point is here.

Price reductions soar

One of the biggest indicators of a tipping point is when sellers need to reduce prices. That is now in full motion:

Source: Redfin

1 in 4 sellers are now forced to reduce their asking price (the highest in three years). This is a dramatic reversal when only early this year, sellers were getting nearly everything they wanted. Agents were recommending contingent free offers and bids over asking. You may have even had the recommendation to provide a personalized PowerPoint on the awesomeness of your family. Today, the market is different. Very different. Of course, tipping points don’t happen overnight. Since the summer mortgage rates rose by 100 basis points. The Fed has made a big bet on low rates and even with $85 billion a month in MBS buying rates and a balance sheet of nearly $4 trillion rates still went up.

Price drops are also happening in the expensive state of California:

Source: Redfin

In 2007 similar trends hit before prices started softening: more price reductions, more inventory, and shifting buyer sentiment.

The unaffordable state

Two major things happened this year to tip the scales in this manic housing market. The first one had to do with the big rise in rates but the other had to do with the crazy like increases in home prices given the lack of inventory. Inventory is now rising, home prices are softening, and we hit a lower bound on interest rates (which has gutted the refi market). When only 1/3 of Californians can afford homes, you need an abnormal amount of investor buying to make up for the rest of sales:

“(MortgageNewsDaily) Home buyers needed to earn a minimum annual income of $89,170 to qualify for the purchase of a $433,940 statewide median-priced, existing single-family home in the third quarter of 2013. The monthly payment, including taxes and insurance on a 30-year fixed-rate loan, would be $2,230, assuming a 20 percent down payment and an effective composite interest rate of 4.36 percent. A year earlier it required an annual income of $65,828 to purchase a median priced home of $339,930 in California with an interest rate of 3.64 percent.”

This is the problem when you rely on artificial low rates and rigged markets:

A California household to maintain the affordability of last year would have needed a $24,000 increase in household income just to purchase the median priced home (and this assumes they have a 20 percent down payment of close to $100,000). Even professional households making $100,000 a year have a tough time saving $100,000 because they end up blowing most of their money on rent, cars, and all other sorts of gimmicks that are popular in California. This is why everyone goes bananas when they even mention requiring a 10 percent down payment (when 20 percent was typical a generation ago).

California is addicted to boom and bust real estate cycles. The last few years were a definite boom. So why are we to expect a suddenly “normal” market? We’ve had a couple of solid years and now a tipping point appears to be formulating. What can accelerate this move is if investors suddenly decide to pull back from the market. This level of investor buying is not normal:

This chart only goes out to 2011 but it is useful for historical reference. Absentee buying peaked at 32 percent early this year. Last month it was at 26 percent for SoCal so it is certainly moving lower but still incredibly high. A good portion of this market was buying because prices were going up. Like a Catch-22, will there be interest if prices are moving lower? Cash buyers have been the wild card since 2009. With higher rates and a blistering stock market, hot money may not be so interested in real estate especially if it is harder to squeak out gains. The fact that only 1/3 Californians can afford a home tells you an adjustment is on the way. To what extent? We will shortly find out.

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