WHAT’S WRONG WITH THIS PICTURE?

Greg McCarry, Westerra Homes

Imagine a conversation where someone is describing a market where rents are rising, home

prices are low, interest rates are below 4%, home inventory is shrinking, housing affordability

is at a record high, new purchases are up 22% over last year and prices are starting to rise.

What would you say? Take a look at these indicators:

-42.65% Year over year (as of May) decline in Seattle area for sale home inventory

-28% Decline in available inventory in 22 counties covered by NWMLS

22% Increase in Washington pending sales in 22 counties covered by NWMLS

5.9% Nationwide increase in pending sales for month of May

12.8% Average increase in prices since January 2012 in 22 counties covered by

NWMLS

3.66% National average 30 Year Mortgage Rate

2.1 Million Pent up demand for homes estimated by Nat’l Assn of Home Builders

4% Annual rate of increase in rents

183 Housing Affordability Index. A family earning the median income has

183% needed to qualify for a median-priced home assuming 20% down.

19.8% Nationwide increase in New Home sales over last year

Conditions for buying homes including a record high affordability index, low prices, and rock

bottom interest rates may represent a once-in-a lifetime opportunity for a home purchase.

However, the combination of increasing rental demand, rising investor cash purchases and

declining home inventories are creating competitive conditions for those buyers getting into

the market for homes and for those sitting on the sidelines thinking the chance to buy will

still get better.

All markets are local and these conditions don’t exist everywhere…like our own Clallam

County market. For Clallam County homebuilders, the gap between cost to build and the

median price is still too wide to unleash even a normal rate of new home construction.

Generally, buyers are willing to pay a 7 to 10% premium for a brand new home over a resale.

However, with an average price of $190,000 for a 1,700 square foot home and cost to build

(sales price) of $250,000 there is gap of 25%. We still have to narrow that gap by at least

another 15%.

Fortunately, the markets that ultimately send customers to our area are steadily improving

including the 4 counties on the I-5 corridor. Those include King, Snohomish, Pierce and

Thurston. Here is a snapshot of year to year activity in those markets for pending sales

activity. Pending sales are newly written purchase agreements for the month. From January

through May of 2012, there has been steady improvement in the numbers. See the chart

below.

Source: Northwest Multiple Listing ServiceNumber of Homes For Sale vs. Sold vs.

There is another real issue for prospective home buyers. That is the fact that consumers are

focused on home prices but ignoring the real cost which is the monthly payment. For

example, even if prices fall another 10% but rates go up just another 1% then it would cost

more in the monthly payment. Say you want to buy a home that costs $250,000 with 20%

down. You would need to borrow $200,000 with a current rate of 3.75% giving a monthly

payment of $926. Now let’s say the prices fall another 10% and the same house is now priced

at $225,000 with 20% down. The new loan amount drops to $180,000. HOWEVER, if rates

rise just 1% to 4.75% the new payment is $938…it goes up! If prices DON’T fall any further

and rates go up 1% then the payment is $1,043. At the $250,000 price range, a 1% change in

interest rates cost $22,000 in borrowing power.

Another factor is that many housing units representing a pent up demand for 2.1 million

homes (houses and apartments). That’s because many young people have moved back home

after college or people combining households to save money. The key for unlocking the pent

up demand is a better job environment.

I do believe we will see improvements in the homebuilding sector in Clallam County as our

external markets continue to improve, driving demand our way, and an improving job market

unleashing the pent up demand to a market that features relatively low inventories at

favorable prices and terrific interest rate that create a home buying environment that

represents the best opportunities we may see in our lifetimes.

Pended (Mar. 2011 - May. 2012)

In addition to the new vs. resale price gap, appraisals and financing continue to be

challenging barriers to a local real estate recovery. Bottom line, new home building in

Clallam County is not out of the woods yet but the regional and national trends help to push

improvements our way.

Housing Affordability Index

Measures the degree to which a typical family can afford the monthly mortgage payments on a typical

home.

Value of 100 means that a family with the median income has exactly enough income to qualify for a

mortgage on a median-priced home. An index above 100 signifies that family earning the median

income has more than enough income to qualify for a mortgage loan on a median-priced home,

assuming a 20 percent down payment. For example, a composite housing affordability index (COMPHAI)

of 120.0 means a family earning the median family income has 120% of the income necessary to qualify

for a conventional loan covering 80 percent of a median-priced existing single-family home. An increase

in the COMPHAI then shows that this family is more able to afford the median priced home.

Here is a chart showing housing affordability. This is an indicator of how much a median income family

earns relative to the cost of a median priced home. This chart is showing a very dramatic increase in

housing affordability due to lower home prices and dramatically lower interest rates and personal

income improvement. The median income household has 195% of the income needed to buy a median

priced home. So why are buyers delaying? It is still the low levels of confidence, lack of ability to meet

new down payment requirements and tight credit standards. But this remarkable catalyst stands ready

to charge the market as lending conditions improve and confidence returns. This period is a rare lifetime

opportunity to capture the advantages of current market conditions before the general market realizes

it. The buy low sell high theory is at play now if you have the guts to ignore the herd.

http://research.stlouisfed.org/fred2/series/COMPHAI/

NATIONAL MARKET

Earlier pressure on home prices has given way to an improving trend. The seasonally adjusted

Case-Shiller 20-City Home Price Index rose another 0.7% (-1.9% y/y) during April. That

repeated its March rise, revised up from 0.1%. The narrower 10 City Composite Home Price

Index also rose 0.7% (-2.2% y/y) for the second month.

Prices in most markets improved m/m during April, notably in Phoenix, San Francisco, Tampa,

Washington D.C., Minneapolis, Miami and Los Angeles. Losing momentum were prices in

Detroit, New York and Boston.

S&P Case-Shiller Home Price Index (SA, %) Apr Mar Feb Apr

Y/Y 2011 2010 2009

20 City Composite Index 0.7 0.7 0.1 -1.9% -3.9 1.3 -13.3

Regional Indicators

Atlanta 0.8 -0.3 -2.0 -17.0 -7.0 -2.4 -11.6

Boston -0.1 0.8 -0.1 0.1 -2.0 1.9 -4.9

Chicago 0.5 -1.1 -0.7 -5.5 -6.8 -3.7 -14.2

Cleveland 0.6 0.8 -0.1 -1.3 -4.3 0.7 -4.8

Dallas 0.5 1.4 0.6 2.9 -2.4 0.1 -2.3

Denver 0.4 1.1 0.3 2.8 -2.1 0.9 -2.8

S&P Case-Shiller Home Price Index (SA, %) Apr Mar Feb Apr

Y/Y 2011 2010 2009

Detroit -2.1 -1.2 0.3 1.4 -0.0 -3.4 -21.3

Las Vegas 0.9 0.6 0.2 -5.9 -6.5 -7.7 -29.8

Los Angeles 1.1 0.5 0.1 -3.6 -3.4 5.3 -15.4

Miami 1.2 1.9 1.4 3.2 -4.9 -2.1 -22.0

Minneapolis 1.3 0.8 1.3 3.9 -8.2 3.2 -15.7

New York -0.1 -0.2 -0.5 -3.7 -3.1 -1.5 -9.8

Phoenix 2.3 2.7 2.3 8.6 -7.3 -0.3 -28.0

Portland 0.7 0.1 0.6 -0.9 -7.2 -3.2 -12.8

San Diego 0.7 0.4 0.6 -1.8 -4.4 7.3 -13.3

San Francisco 1.5 1.0 1.2 -1.4 -4.9 9.3 -18.4

Seattle 0.6 2.0 -0.4 -0.9 -6.6 -3.6 -14.3

Tampa 1.4 1.3 0.9 0.8 -6.6 -4.0 -18.8

Washington, D.C. 1.4 1.8 -0.5 1.6 -0.4 4.7 -10.8

Inventory Declines

Rank Metro

For Sale Inventory, % Change

May 2012 vs May 2011

1 Oakland, CA -56.60% 2 Fresno, CA -48.76% 3 Bakersfield, CA -48.59% 4 Phoenix-Mesa, AZ -44.71% 5 Seattle-Bellevue, WA -42.65% 6 San Jose, CA -40.80%

7 Tampa-St. Petersburg, FL -39.76%

8 Stockton-Lodi, CA -39.25% 9 Atlanta, GA -39.19% 10 San Francisco, CA -38.90% Source: Realtor.com

With a slowly improving trend in housing starts and improvements in the balance of supply as the charts

show above there is also improvement in the outlook for the future as shows in the financial markets.

The next chart shows what the Wall Street investment community is thinking.

The chart above is the performance of the XHB. This is the exchange traded index fund on the

homebuilders. Notice that the XHB value in October 2011 was at a little over $13 per share. Just 5

months later (March 2012) the price is closing in on $22. That’s a 60% return in less than half a year.

This chart reflects the belief on Wall Street that the bottom is already behind us. On the one hand, the

earlier charts are showing historical information. On the other hand, the chart of the XHB is Wall

Street’s glimpse into the future and it is showing amazing confidence that the future looks good.

One of the problems in today’s real estate market is the continued fear that is pervasive. What if the

real estate prices continue to go down if I buy today? The problem is that no one can know precisely

when that is. One thing is clear, when we all can see it then, by definition, it has already happened.

Next we’ll see about advantages in buying power that is available for today’s home buyer. With the

combination of affordability, as shown earlier, and the buying power offered by low interest rates the

current conditions take a lot of risk out of buying now.

The next chart is an example of how much money you can “rent” from a bank based upon a fixed

monthly cost. In this case we’ll use $1,146 as the month “rent” paid to the bank for a loan. The chart

shows what happens to a buyer’s ability to rent money at various interest rates.

BUYING POWER

4% 4.50% 5% 5.50% 6% 6.50% 7%

Price $300,000 $300,000 $300,000 $300,000 $300,000 $300,000 $300,000

Loan $240,000 $226,175 $213,500 $202,000 $191,000 $181,300 $172,250

Down Pmt $60,000 $73,825 $86,500 $98,000 $109,000 $118,700 $127,500

Mon Pmt $1,146 $1,146 $1,146 $1,146 $1,146 $1,146 $1,146

At a 4% interest rate and with a 20% down payment, a home priced at $300,000 requires a $60,000 down payment. The home loan is $240,000 with a monthly principal and interest payment of $1,146. This graph shows the buying power of a $1,146 payment as rates increase. The loan amount declines and the down payment requirement increases. What this means is that if one can borrow at 4% today but decides to wait due to a fear prices are still falling, then decides to buy later and rates increase to 5%, then the buyer loses $26,500 in buying power. Therefore, real estate prices would have to fall almost 10% further to lose the advantage of today’s interest rates. The question is whether this is a high risk or low risk bet.

$0

$50,000

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4% 5% 6% 7%

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