Home Price Appreciation: Why the West Coast Is the Front-Runner

Why House Prices Have Hit a New High

(Continued from Prior Part)

All real estate is local

The real estate recovery has been uneven, and some parts of the country are outperforming others. As you can see from the graph below, home prices in the Pacific and Mountain states have outperformed the rest of the country over the past two years. Meanwhile, the Middle Atlantic and New England states appear to have underperformed.

We’ve seen a lot of foreign buying of residential real estate, especially on the West Coast and in the Mountain states. Many Chinese investors are looking to diversify their exposure to US dollar–denominated assets. This trend has helped bid up property values in these locations.

Regulatory differences

The FHFA 1 House Price Index breaks down home price appreciation by region and by state. The Pacific States took over the lead at 7.7%, followed by the Mountain and East South Central states, with a gain of 7%.

While economic differences between the states explain some of this change, another important consideration is that some states have very borrower-friendly, or creditor-unfriendly, policies. These policies slow down price appreciation. For example, some states require a judge to approve all foreclosures.

The northeastern states of Connecticut, New York, and New Jersey have the biggest foreclosure pipelines due to a backup in the courts. These states are most likely to have vacant homes in disrepair, pulling down the values of homes in the whole neighborhood. As you can see from the above graph, New England, the Middle Atlantic, and the Rust Belt have all underperformed the other regions.

Real estate companies must watch their geographic exposure

Real estate companies, including Colony Financial (CLNY) and Northstar Realty Finance (NRF), invest in non-guaranteed MBS (mortgage-backed securities), meaning that these companies take credit risk. This separates them from agency REITs like American Capital Agency (AGNC).

Investors interested in trading in the real estate sector through an ETF could look at the iShares Mortgage Real Estate Capped ETF (REM). Separately, investors who wish to make interest rate bets directly could consider the iShares 20+ Year Treasury Bond ETF (TLT).

While being underwater doesn’t necessarily mean a borrower will stop paying—in fact, the vast majority of underwater homeowners are current on their mortgages—it does mean that the severities, or losses, rise if the lender has to foreclose.

While examining these companies, investors should determine what sort of geographical concentration they have. Diversification can certainly help.