With one foot on the gas and the other on the brake, housing sales are slowing, and maybe that’s a good thing.

The 2013 Portland housing market has given us the most spectacular ride in nearly a decade.  We’ve seen double-digit gains across the whole spectrum, and while we’re still enjoying nice price appreciation and steady sales, there’s relief in the voices and words of experts who have become worried that unabated growth could cause another bubble to start forming under the market.   Now, moving into the fall, we see persistent demand for low inventories (the gas) being dampened by a moderate rise in interest rates (the brake).  The rise in interest rates, coupled with what a Realtor-friend called “buyer fatigue” has helped slow the pace.  The effect has been a modest decline in sales prices over the past two months – we hit the 2013 market high in July – and a very modest increase in housing inventory.    Mind you, rates are not high: we closed last week with the benchmark 30-year rate stuck between 4.125 and 4.25 percent, a figure that’s only a point higher than last winter’s record lows.  It’s just that, well, an uptick in the rate has helped moderate the market’s meteoric rise.

Where will interest rates go?  At the moment low interest rates are the beneficiary of the Fed’s quantitate easing program, which is in turn coupled to the economic recovery.  While debate rages in Washington and on Wall Street, it appears to your correspondents that quantative easing will remain in place until the Fed sees signs the protracted recovery is (finally) fully underway.  In our view, interest rates will remain attractive as long as unemployment levels remain relatively high, wages show few signs of growth, and consumers remain wary about over-extending themselves.

Two emerging trends will affect the real estate picture in 2014.  The first, a happy trend, is coupled to economic recovery: “new household formation.”  Over the five-year period during and after the 2007–09 recession, the number of households established in America plummeted by about 800,000 a year from the annual average of 1.35 million household formations from 2000 to 2006, said Andrew Paciorek, an economist at the Federal Reserve Board of Governors.   When a person establishes a residence, whether it’s an apartment or a house or another dwelling, that person is forming a household. Mainly because of high unemployment and a weak labor market that held down income, the rate of household formation collapsed nearly 60 percent during the recession and subsequent recovery.   Unemployed college graduates and families who lost their homes to foreclosure moved back in with their parents or siblings or formed co-op living arrangements with other folks forced out of the housing market.  Along with population growth, a healthier employment situation should push household formations up to about 1.5 to 1.6 million a year over the next several years, according to Paciorek’s forecast model. The numbers of formations could exceed the pre-recession trend because of pent-up demand for households from those who did not set up homes during the recessionary dip.   The impact of growing numbers of new households will put pressure on inventories, which will further stimulate price growth.

Strong demand from investors and builders in the first time home buyer market is a second, more troubling trend.  Institutional investors –defined as investors who buy more than 10 properties a year – have been buying up properties for the past two years at an impressive and growing rate.  According to RealtyTrac, which has been following the trend since 2011, intuitional investors accounted for a record-high 14 percent of all sales nationwide in September.  Lured by the promise of strong rents they’ve been out-competing first-time buyers and after minor repair are renting them, or fixing them up nicely and re-selling (flipping) them for profit.

And you’ve probably seen the new housing boom in your own neighborhood: from north Portland all the way into Lake Oswego and as far as you can see to the east and the west, builders are putting in new homes on the site of former, smaller homes and vacant lots.  With the surge in prices, and unmet demand, builders have been in direct completion with buyers all year, and most of them, like the institutional investors, are armed with cash.  The first-time-buyer housing stock has been affected to the greatest degree: builders and developers see as much potential in the smallest / least-maintained house on the street as first-time buyers, but the potential they see is conversion: turning the house into a rental, or flipping it, or tearing it down and replacing it with one or two or even three expensive new homes.  The investor / builder trend will persist through 2014 and well beyond, and while its effect on the first-time buyer market may be troublesome, we need to keep in mind that new home starts and adequate housing are important building blocks in the overall economic recovery.

The gas, the brake, and the road ahead.  Our housing hot rod works like this: it has just one pedal operating both the gas and the brake.  The harder we shove on the gas, the more we bear on the brake.  Low inventories are the gas for the housing market, and high interest rates are the brake.   New household formation and builder / investor demand – signs of economic recovery – add octane to the gas, so go ahead and let’s put the pedal to the metal.  Whoops!  Signs of economic recovery will cause the fed to pull back on quantative easing and cause interest rates to rise.  Rising interest rates will put the brakes on buyer demand and slow runaway growth, hopefully without putting our car in the ditch.  The desirable outcome of this cycle of demand – rate hike – easing – growth – demand – rate hike – easing – growth will be a gradual increase in home prices and inventories over the course of the next two or three or four years until we have full economic – and housing – recovery.