The CoreLogic index of real estate prices increased 12.2% year-over-year in May, the largest year-over-year increase since the days of the housing bubble.
The CoreLogic Home Price Index
The CoreLogic index is a widely followed index of real estate values. Unlike the other major indices, like Case-Schiller or Radar Logic, CoreLogic separates distressed sales from non-distressed sales. Non-distressed sales are more indicative of the core market in general. Note: Corelogic recently bought the Case-Schiller indices, so we’ll see if they change their methodology.
Real estate values are big drivers of consumer confidence and spending, and, therefore, have an enormous effect on the economy. The phenomenon of “underwater” home owners, or those who owe more than their mortgage is worth, has been a major drag on economic growth. Underwater home owners are reluctant to spend and cannot relocate to where jobs are. Real estate and mortgage professionals watch the real estate indices closely.
Real estate prices are also a big driver of credit availability in the economy. Mortgages and loans secured by real estate are major risk areas for banks. When real estate prices are falling, banks become conservative and reserve funds for losses. Conversely, increasing real estate prices make the collateral worth more than the loan, which encourages them to lend more.
Twelve consecutive months of year-over-year gains
The 12.2% year-over-year gain was the highest since February of 2006. Both distressed sales and non-distressed sales rose by similar amounts. The consensus is growing that prices bottomed in February of last year. The rebound has been strongest in the western states, primarily California, Nevada, and Arizona. That said, of the 100 distinct markets that CoreLogic measures, 97 showed year-over-year gains. This shows that the recovery is not limited to a few visible markets, but is broad-based. Only two states – Delaware and Alabama – reported month-over-month declines.
The theme of the real estate market for the past year has been tight inventory. Professional investors (hedge funds, private equity firms) have raised capital to purchase single family homes and rent them. This has been driven by auctions from the Federal Government, primarily the FDIC and FHA. These entities have been auctioning off billions of dollars worth of real estate and required investors to hold them for a period of three years. This has had the effect of taking supply off the market (or at least the perception of supply) which has helped the real estate market find some support. These professional investors are competing for properties with first time home buyers, which is making the starter home a scarce commodity.
Implications for mortgage REITs
Real estate prices are big drivers of non-agency REITs, such as Two Harbors (TWO), PennyMac (PMT) or Walter Investment Management (WAC). When prices are rising, delinquencies drop, which helps servicers and those who invest in non-agency (non government-guaranteed) mortgage backed securities. It also helps reduce stress on the financial system, which makes securitization easier and lowers the cost of borrowing. Finally, those REITs with large legacy portfolios of securities from the bubble years are able to stop taking mark-to market write downs and may revalue their securities upwards. Since REITs must pay out most of their earnings as dividends, higher earnings means higher cash flows to the investor. While agency REITs, like Annaly (NLY) or American Capital (AGNC), do not bear credit risk, they are affected by rising home prices as it increases prepayment speeds.
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