Unconventional Cash To Conventional Mortgages: News from Hutchens Investment Management

CONCORD, N.H. - Sept. 5, 2013 - PRLog -- Over the past two years we have discussed the role of a recovery in housing and accelerating economic growth. Throughout this period economists and housing analysts have vacillated from double-dip to bubble while in reality housing bottomed and is firmly in the recovery stage. In fairness to the “experts” who were wrong with their forecasts, the recovery has not been normal, but that may be changing. Pivotal has been Fed policy lowering mortgage rates and holding them at historically low levels.

European, South American and Chinese investors, sensing value in US housing as their own economies faltered, brought cash and found the US a desirable location and housing a secure investment with potential high returns. (About 63% of foreign purchases are cash.) US institutional investors share of home purchases grew from an estimated 15% to 26% from 2010 through mid-2012. While the Administration policies failed to halt the housing depression, it was the unconventional cash from private sources purchasing foreclosed and distressed homes in Florida and the West Coast that created the bottom for the overcorrection. Chinese investors, typically not bottom fishers, rose from 5% to 12% of the foreign total with purchases in primarily in California and Texas.

According to Goldman Sachs, recent cash purchases accounted for 57% of all residential homes sales compared with 19% in the peak housing year 2005. This percentage seems high as cash purchases are declining. RealtyTrac estimates all-cash purchases at 40% in July, down from 53% in March. Also in July it is estimated that investors were 19.7% of homes purchased, the lowest level since September 2012. Typically 70% of investors pay cash. As the unconventional all-cash buyers’ role in the housing recovery diminishes and affordability further restricts first- time buyers, what will replace this reduced demand for housing? The housing bears claim that this slackening in demand will limit the growth in home sales and stifle the housing recovery. We do not agree. Assuming that the unconventional cash flowing into housing has begun to slow, we would look to the conventional buyer, the existing homeowner, to step up.

The tide has begun to change. The early entrants, driven by foreclosures and low prices, have slowed their home purchases. Inventories of distressed homes have declined and prices risen. The entry level home buyer, more absent than normal, is withdrawing further as the pool of qualified first-time homebuyers shrinks as house prices and mortgage rates rise. Mortgage lending is only getting slightly more aggressive as banks and lending agencies are hampered by the Dodd-Frank legislation.

Under the radar of most housing analysts has been the dramatic rise in housing affordability. The sizeable positive gap between the median family income and qualifying income (affordability index) of existing homebuyers assures viability. Another reason for optimism is
the sharp decline in underwater mortgages. As of June 2013, a Zillow analysis estimates that 12.2 million or 23.8% of homeowners owe more than their home is worth. This compares with 15.7 million or 31.4% underwater as of March 2012. The report forecasts a further decline of 1.9 million homeowners turning net positive in the coming year, lowering the underwater percentage to 20.9%.

Much has been written on the slowdown in housing, however while there is volatility in the month to month data, the trend clearly remains positive. The monthly downturn in new home sales reported by the Census Bureau is the indicator being citied for a slowdown. For July, these sales were 394,000, this is 13.4% below the revised June level but 6.8% above July 2012. Existing home sales were 5.39 million, an increase of 6.5% above June and 17.4% above year- ago levels. Both series had a 5.1 month inventory in July, low by historical averages, but up from the 4.0 month supply in January 2013. But this is well-below the 6.3 month supply a year ago. New home sales account for less than 7% of total home sales and while disconcerting, the July data does not alter the trend.

In conclusion, housing is in the early stages of transition. Investors, both domestic and foreign, will remain but be of declining relative importance as the market reverts back to more traditional buyers - - the existing homeowners. We anticipate growth slowing in the above the trend increases in the number of homes sold. The market for distressed and foreclosed homes is rapidly clearing and with it, the cash investors. A return to more moderate price increases below double-digit will characterize the transition.

Our investment policy remains positive on equities. A laundry list of potential market destabilizing political uncertainties remain as we approach the seasonally weak fall months. Among these are; Syria, Fed Policy changes and the selection of a new Chairman, budget and debt limits, and the implementation of the Affordable Care Act.

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens