CASH COURSE IN HOUSING ECONOMICS / THE WALL STREET JOURNAL

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Updated March 1, 2013, 3:28 p.m. ET

Cash Course in Housing Economics

By JUSTIN LAHART

 

 

It is true that the Federal Reserve's efforts to get the economy going have helped spark a recovery in housing. Just not in quite the way it intended. Both home sales and prices have been on the rise over the past year, offering relief at a time when the U.S. has been fighting through a sluggish recovery at home and financial uncertainty overseas. Housing's gains have also provided evidence that the Fed's extraordinary efforts to put the economy back on its feet are having an impact.

But a cursory look at the data shows that there is something unusual going on.

Even though overall home sales are now back to 2007 levels, mortgage activity isn't. In the fourth quarter, mortgage originations aimed at purchasing a home came to $123 billion, according to the Mortgage Bankers Association, compared with $226 billion five years earlier. Rates are extremely low, and the Fed is buying oodles of mortgage-backed securities, but banks are still reticent about lending money to home buyers.

The explanation for why home sales have recovered despite lackluster mortgage origination is that a lot of homes are getting bought in all-cash deals these days. Across 55 large metropolitan areas that it follows, DataQuick MDA.T -0.35%found that 36% of homes sold last year were purchased without mortgage financing, compared with 15% in 2007. In some of the old hotbeds of speculation, the number of homes getting purchased for cash is eye-catchingly high: In the Miami area, for example, there were 72,459 cash sales last year, against 19,625 five years earlier.

Some of those cash sales come from people who aim to live in what they bought, of course, but a great many of them were to investors looking for homes to rent out. Indeed, what was essentially a mom-and-pop activity a few years ago—buying distressed-price homes, fixing them up and renting them out—has turned into a big business, with investment firms like Blackstone Group BX -0.63% and, more recently, foreign-led groups jumping into the fray.

A big reason why: The extremely low long-term interest rates that the Fed has helped engineer through its bond and mortgage purchases have made many investors desperate for yield. That has made the stream of income they can generate through rental homes enticing. So while the Fed's intent was to get housing going by making mortgages more easily available to would-be buyers, much of its actual success has come as a result of the yield-seeking behavior—or reach for yield—it has inculcated among investors.

Given the role that investors' house-flipping played in the inflation of the housing bubble, there is something disconcerting about investor involvement having such a pronounced effect on the market now. An important difference is that today's activity isn't being driven by investors buying homes with subprime mortgages in hopes of selling to a greater fool, but by investors who are looking to generate better returns on their cash than they can get elsewhere.

But though it is cheering that today's activity doesn't have the speculative characteristics of a bubble, there is still a question of how long the economics of what housing investors are doing is going to make sense.

Home prices are now on the rise, and with so many houses getting converted to rentals, rent increases aren't keeping up. That has begun to make rent-to-price ratios—housing yields—a little less attractive. If the trend continues, and if an improving economy prompts the Fed to let long-term interest-rates rise, the reason for the reach for yield goes away.

Christopher Mayer, a Columbia Business School economist, further worries that some housing investors have underestimated the cost of maintaining stand-alone homes, and may soon find that they aren't generating as much income from their rentals as they had anticipated.

The natural response would be to sell, which would probably be a pretty nice trade for investors who bought at the bottom. For the more recent comers, some of which would have hundreds of homes to unload, it could be a bit more trying.