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Why House Prices Have Hit a New Record

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Prices continue to climb

In December 2015, the FHFA (Federal Housing Finance Agency) reported that house prices grew 0.4% month-over-month, rising by 5.2% year-over-year. Prices are now higher than their April 2007 peak, meaning the losses from the Great Recession have been recouped. Real estate values drive consumer confidence and spending. In fact, asset price appreciation was a big driver of consumption during the bubble years, masking wage stagnation.

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Now that people are having a difficult time funding consumption through equity expansion, a dialog about the lack of wage growth has begun. One of the unstated purposes of quantitative easing was to raise asset prices to spur spending. We’re finally beginning to see the beginnings of wage inflation in the average hourly earnings numbers, which should make these home price levels sustainable.

What makes the FHFA House Price Index different?

The FHFA’s House Price Index differs from other house price indexes, including those from Case-Shiller and Radar Logic, in that the FHFA House Price Index only looks at houses with mortgages guaranteed by Fannie Mae and Freddie Mac.

This difference means that home prices are below the conforming threshold of $417,000. It also means that the borrower has a mortgage that eliminates cash-only transactions. This eliminates a lot of the bidding war transactions we’ve seen in the hot markets. Finally, the FHFA House Price Index eliminates jumbos, making it more of a central tendency index.

The FHFA House Price Index is the first major house price index to get back to its prior highs. Other indexes, including Case-Shiller, show that we are still about 10% below peak levels.

Implications for REITs and real estate companies

Rising real estate prices are good for the real estate securities owned by real estate companies like Colony Financial (CLNY) and Northstar Realty Finance (NRF). These companies aren’t like Annaly Capital (NLY) or American Capital Agency (AGNC), as the latter two primarily invest in agency, or government-insured, mortgage-backed securities. Instead, they take the credit risk, and if the borrower defaults, they’re stuck with the collateral.

Investors interested in trading the real estate sector via an ETF could look at the iShares Mortgage Real Estate Capped ETF (REM). If you want to isolate interest rate risk, you can consider the iShares 20+ Year Treasury Bond ETF (TLT).

In the next part of this series, we’ll look at how housing prices are now approaching peak levels and what that means.

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