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Who Benefits from Climbing Home Prices?

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Prices continue to climb

In May 2016, the FHFA (Federal Housing Finance Agency) reported that house prices rose by 0.2% month-over-month and 5.6% year-over-year. April’s gain of 0.2% was revised upward to 0.3%. This means that home prices have eclipsed their April 2007 peak and are now hitting new highs.

The tight real estate market is driving prices higher. The latest Existing Home Sales report shows available inventory at 4.6 months and a market that’s tilted heavily in favor of sellers. A balanced market is considered to be around 6.5 months’ worth of inventory. In some markets such as San Diego, the inventory is about two months. The number of pending home sales is higher than the number of homes available for sale. This is an almost unheard of state of affairs.

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What makes the FHFA House Price Index different?

The FHFA House Price Index differs from other house price indexes like those from Case-Shiller and Radar Logic. The FHFA 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 hot markets. Finally, the index eliminates jumbos, which makes 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’s, show that we’re still about 11% below peak levels.

Implications for REITs and real estate companies

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

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

In the next part of this series, we’ll look at housing prices compared to their bubble peak levels.

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