The Wall Street Journal

31 July 2013

Rising Mortgage Rates, Potential for More Supply Threaten Pace of Gains Shown in Two Indexes

Home prices during the first half of 2013 posted their largest gain since the housing boom peaked seven years ago, but rising mortgage rates and the potential for more supply could eventually slow the run-up.

Nationally, home values rose by 5.8% in June from one year ago, according to Zillow Inc., the real-estate website, the largest gain since 2006. So far this year, prices are up 2.7%, the strongest year-to-date gain in June since 2005.

A separate and widely watched index released Tuesday showed that home prices in 20 major U.S. cities rose by 12.2% in May from one year earlier. The Standard & Poor’s/Case-Shiller index shows that home prices are now down from their 2006 peak by 24.4%, compared with a peak-to-trough decline of 35.1% in March 2012. Prices in two cities, Dallas and Denver, reached an all-time high, surpassing peaks set in 2007 and 2006, respectively.

The speed with which prices have risen over the past year has taken many economists by surprise. Gains have been fueled by record-low mortgage rates, a slowly improving economy that has released pent-up demand and strong appetites from investors converting homes into rentals.

Some economists say the Case-Shiller index could overstate the magnitude of recent price increases because of how it counts foreclosures. Because foreclosures may be in greater disrepair than traditional homes, they tend to sell at a discount. As the share of distressed-property sales rises, as it did beginning in 2007, price falls can be magnified in markets with lots of foreclosures; later, when the share of distressed sales falls, as it has over the past year, prices appear to rebound faster. The Zillow index, by contrast, doesn’t include foreclosed properties, minimizing potential volatility from this shift in the sales mix.

For now, inventories remain tight in a majority of the nation’s major housing markets. The Wall Street Journal’s survey of quarterly housing-market conditions in 28 metro areas found that Phoenix, Seattle, Denver, and Sacramento, Calif., had less than a 2.5-month supply of homes for sale at the current sales pace. Dallas, Los Angeles, San Diego, Washington, D.C., and Orlando, Fla., had less than three months of supply, according to data compiled by John Burns Real Estate Consulting in Irvine, Calif.

Typically, real-estate agents consider a balanced market to have a six-month supply. Nationally, the supply of existing homes for sale stood at five months at the end of June, according to the National Association Realtors.

One question is whether recent price gains can be sustained amid mortgage rates that have jumped a full percentage point since May. Rising rates are most likely to squeeze prices in more expensive markets across coastal California and in cities such as New York and Boston.

“We expect prices to slow in the second half of the year,” said Doug Duncan, chief economist at mortgage-finance firm Fannie Mae. He said seasonal factors—sales tend to slow after July—could be as much to blame as higher interest rates.

Rising home prices could also encourage more homeowners like Geoff Stanton to test the market. Within four days of listing his three-bedroom home in Hudson, Mass., Mr. Stanton had two full-price offers for his home, which sold in May for $306,000. While that’s down sharply from the $376,000 that he paid for the house in 2007, Mr. Stanton was pleased because he had nearly sold the home for $290,000 last year.

Last year’s sale fell through when the buyer had trouble getting a mortgage, and the 37-year-old insurance agent rented out the home for a year. “The extra money—that was worth renting for the year,” he said.

In a sign of how tight inventories have grown, the National Association for Realtors began running a national television ad three weeks ago encouraging homeowners to consider selling. “Buyers are in the market, but there’s a shortage of homes for sale,” says a narrator. “If you’ve been thinking about selling, now may be the right time.”

There are signs inventory declines will ease as price gains increase. In Sacramento, Calif., the number of homes for sale in June stood 7.5% above the level of a year ago, while inventories in Atlanta rose 9.7%. Both cities have witnessed large declines in homes available for sale as investors have scooped up large numbers of cheap properties.

In Orange County, Calif., inventories have risen 68% since March, standing roughly unchanged from year-ago levels and reversing what had been a large year-over-year drop. Steven Thomas, a local housing analyst, says buyers are growing frustrated because sellers are getting greedy. “There is a drought of properly priced homes,” he wrote in a recent report. Reports of rising prices “have enticed a herd of homeowners to come on the market who all have thrown discretion out the door.”

Angela Creech, a real-estate agent with Redfin in Irvine, Calif., says she has refused more listings in the past month because sellers are asking too much. “There are more really unrealistic sellers,” she said.

Prices increased in all 26 of the nation’s largest housing markets tracked by Zillow. In June, prices rose 29.5% in Sacramento, 29.4% in Las Vegas, and 25.5% in San Francisco. The smallest gains were reported in Chicago (0.2%), St. Louis (0.4%), and Philadelphia (0.9%).

The Journal’s survey also found continued declines in the share of loans that were in foreclosure. In San Francisco, just 4.3% of all mortgages at the end of May were delinquent or in foreclosure, down from a high of 10.4% three years ago, according to Lender Processing Services. Other cities with low levels of bad mortgage debt include Minneapolis, Denver, San Diego, Phoenix and Sacramento.

States where banks are required to process foreclosures by going to court still lag behind. More than 15% of loans were delinquent or in foreclosure in the Florida cities Jacksonville, Orlando, Tampa, and Miami.