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The FHFA House Price Index is within 5% of its peak

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Home prices are approaching peak levels

A 4.5% year-over-year gain puts the Federal Housing Finance Agency (or FHFA) House Price Index (or HPI) back at August 2005 levels. The rate of price appreciation appears to be slowing. While most indices showed the housing market bottoming out around February 2012, the FHFA House Price Index showed it bottoming out around May 2011.

Perhaps distressed sales dominated at the end of 2011. This pushed the other indices lower. As you can see from the chart, prices are within 5% of their prior peak.

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A lack of supply has been an issue for the real estate market, particularly at the lower price points. Professional investors raised a lot of money for the “REO-to-rental” trade, where hedge funds and REITs buy distressed foreclosures, renovate them, and rent them out. This has crowded out the first-time homebuyer.

Another economic challenge is the lack of labor mobility. Some places in the country have labor shortages (think the states with large drilling operations). Other places have too many workers (think the Rust Belt). Unfortunately, workers can’t move easily if they’re underwater homeowners. When these people regain home equity, they’ll sell their homes and move to where the jobs are. This will help the economy perform closer to its actual potential.

Implications for mortgage REITs

Real estate prices are big drivers of non-agency real estate investment trusts (or REITs), including CYS Investments (CYS), Newcastle Investment (NCT), and Redwood Trust (RWT). Prices aren’t as important for agency REITs such as Annaly Capital Management (NLY) and American Capital Agency (AGNC).

In fact, increases in real estate prices can be a positive for non-agency REITs. They can be negative for agency REITS. When prices rise, delinquencies drop. This trend is important because non-agency REITs face credit risk. For agency REITs that invest in government mortgages, rising real estate prices can drive prepayments, which are a drag on earnings.

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