Home prices broach peak levels
The recent 6% year-over-year gain for house prices has put the FHFA[1. Federal Housing Finance Agency] House Price Index about 2% past its April 2007 levels. Strangely, the financial press largely ignored this event. While most indexes show the housing market bottoming out around February 2012, the FHFA House Price Index shows it bottoming out around May 2011. Perhaps distressed sales dominated at the end of 2011, pushing the other indexes lower. As you can see from the following chart, prices are nearly back to their prior peak.
Real estate prices are beginning to flatten because wages haven’t kept up with real estate prices since the downturn. Historically, real estate prices and incomes have correlated closely. After the real estate market bottomed out, professional investor demand pushed up prices, but wages didn’t move. This made more home price appreciation difficult.
For most families, homes comprise the lion’s share of net worth. While most middle-class families would like a raise as well, home price appreciation is the next best thing. Many homeowners are finding that they can now do a cash-out refinance on their homes and use the cash to pay off higher interest rate credit card debt. This lowers monthly payments and gives the homeowner more disposable income to fund consumption.
Implications for mortgage REITs
The big agency REITs like American Capital Agency (AGNC), Annaly Capital (NLY), and MFA Financial (MFA) invest in mortgage-backed securities that the government guarantees. But that doesn’t mean that these companies don’t care about real estate prices.
As home prices rise, homeowners who were previously underwater gain the ability to refinance. This increases prepayment speeds. Since they’re underwater, many homeowners hold 2006-vintage and 2007-vintage mortgage-back securities that have high coupons and low prepayment rates. As home prices appreciate, these loans will pay off as borrowers are able to refinance.
If you’re interested in making directional bets on interest rates, you can consider the iShares 20+ Year Treasury Bond ETF (TLT). Investors interested in trading the real estate sector as a whole could look at the iShares Mortgage Real Estate Capped ETF (REM).
In the next part of this series, we’ll look at how home price appreciation varies by state. We’ll see how this impacts investors.