Big problems ahead for housing; but innovative solutions could change the game.
There are four worrisome lines converging on the housing market today, that should concern both consumers and brokers.
The first is a red line from CoreLogic’s chart of housing prices from September 2013. The headline reads: House Prices up 12.4% Year-over-year in July
Shouldn’t we celebrate rising prices? Actually, no. To put it in perspective, do you cheer when gasoline rises 30-cents year over year? For most people, housing and gasoline represent monthly costs; rising prices affect their household budget over long periods of time. Price jumps for buyers reduce their purchasing power. Even sellers – who rejoice at higher sale prices – soon frown at the higher cost of replacement after. Some people argue that underwater owners benefit from rising prices, reaching break-even with their mortgage: But break-even isn’t the same as recovering equity from down-payments – and many people need that money to buy their next (and rising cost) house.
Thus, higher priced homes mean higher-costs to household budgets. Mortgage payments come from household wages, our second worrisome line on a chart from ZeroHedge:
Costlier houses will take a little bit more from the little bit less people earn these days. For now, the housing market isn’t too worried: a solid 50% of U.S. sales in 2013 have been all cash. But it’s unlikely to last, as the Fed tapers its bond-buying, and mops-up the excess cash that investors have been throwing into housing markets in NV, AZ, FL, NY and CA. Already, reality has returned to many markets where investors pushed up prices, then scared themselves away. That leaves only ordinary consumers behind, most of whom will need a mortgage.
Which brings us to our third line, the 12-month trajectory of mortgages rates by Freddie Mac:
The cost to finance is also rising sharply. Even though rates remain lower during the last bubble in real terms, wages were also higher then. This creates two challenges: Move-up buyers will pay more for less, and first time home buyers will sit on the sidelines for some time longer. The percentage of first time home buyers has already already fallen to 34%, the lowest in the last three years. Much of the decline is attributed to soaring personal debt due to college tuitions, as well as job scarcity. But it’s the source of financing they traditionally rely upon that is worrisome. FHA.
In November of 2012 (almost a year ago) FHA announced it had exhausted its reserves. It might need a bailout, but in the meantime, it took action: raising credit score requirements, minimum down-payments and insurance premiums that represent costs which first-time buyers can hardly absorb (see wage graph above). As long as the FHA insurance fund remains below its Congressionally-mandated minimum of 2% these costs will persist or worsen, further constricting the next round of buyers.
What to do?
Given these trend lines, what should the housing industry do? Even with a nod to the usual caveats (housing markets are local; economies are local; my market is different) housing professionals should make plans to navigate these likely persistent trends as soon as possible. Here are three ideas:
1. Start new conversations with consumers, and much earlier. It’s time to start educating consumers about the total housing proposition – not just interest rates, historically low costs, reduced closing or brokerage fees or traditional rent-vs-buy formulas. Consumers need advisors who understand the entire cost of housing in a household budget. Real estate professionals must get comfortable talking about topics that consumers read about every day: The consumer price index, wage trends, unemployment, and even local tax burdens that affect their clients’ ability to act. They also need to start these conversations much earlier: Reposition seller thinking in the total marketplace, which isn’t just “the comparison” to homes for sale, but the overall cost-environment for likely buyers. Likewise, engage future first-time buyers around issues like credit, debt, and wages long before they make critical decisions in life, such as college or renting. Brokers will feel uncomfortable taking positions on these topics to begin with, but the future consumer needs – and will demand – a more comprehensive approach from their broker.
2. Diversify brokerage offerings. We’ve said it before, but it bears repeating: Most of the red lines pose problems for residential housing, but that’s not the entire housing market. Brokers must diversify, fast. The obvious choice is rentals: both helping people rent, and investing in rental units themselves. Owning rentals might require creating a rental management division, which could offer paid services to the all-cash small investors who are mopping up the market right now. And there are other segments that represent primary income streams: Retail and commercial leasing, consulting to small builders, concierge services for busy consumers, and so on. It’s time for brokers to create deeper “department store” strategies for their business, rather than just a large stable of one-trick ponies.
3. Innovate on the cost structure. As the costs of the housing transaction goes up, while wages are falling, brokers need a plan to protect how they get paid. It’s time to break the traditional one-time commission model. Such fees actually affect the broker’s own market: directly reducing the remaining proceeds their seller has to buy their replacement home. With little or no equity (or short equity) today, downward pressure on commissions will increase, unless brokers innovate on how they get paid. Experiments with monthly-payment plans could reduce closing costs while creating long-term streams of revenue. Exploring “membership clubs” that exchange subscription-income for single closing fees over time, and insurance-style policies that build up over year and culminate in a purchase or sale, and even tax-deferred savings like consumers use to save for college – all offer ideas to keep the brokerage business healthy while releasing consumer equity into the marketplace.
Like any period, the housing market is experiencing a Dickens moment: It’s potentially the best of times, while dangerously close to the worst of times. If real estate brokers want to change the trend lines, they might consider some of these ways to innovate within their business lines.