About the Author
Patrick Pulatie is the CEO of LFI Analytics. He can be reached at 925-522-0371, or 925-238-1221 for further information. www.LFI-Analytics.com, firstname.lastname@example.org.
Day after day, week after week, and month after month, there are media reports concerning the status of housing in the US. Depending upon the source, housing values are increasing, or decreasing. Home sales are increasing, or decreasing. The Housing recovery has started, stalled, or in a state of further decline. Does anyone really know what is going on? Who can you trust?
At this time, no one knows with any certainty what is going to happen. The economy, governmental regulation, lending issues, foreclosure issues, borrower qualifications and other issues are all contributing to the uncertainty in the housing market. Until such time as these issues begin to be resolved, recovery cannot begin. But, taking the different data points that exist in the continuing reports, some general assumptions can be made.
Correlating the data, a picture of the health of the housing market can begin to be painted and a very loose timeline of what to be expected to occur can be developed. This article is intended to try and take the data and show how to connect the dots. To understand what is happening in the local area, the reader must use specific information within their area, so as to get a general idea of what can be expected in that particular area. Remember, real estate is local, local, local.
Our first consideration must be the number of homes that are in foreclosure. Dependent upon the report, there are approximately 6.5 million loans that are currently delinquent. A large part of these loans are delinquent by only 30 days, but once a home goes into delinquency by 30 days, there is only 10% likelihood of the homeowner catching up on the payment. Therefore, let’s assume that 6 million homes will be foreclosed upon of this current batch.
Various estimates place REO properties at over 600,000. These are properties owned by the banks from foreclosure. Some have been listed on MLS, but most are not listed.
The number of actual homes purchased per year is unknown. Corelogic places the number at approximately 3 million homes to be purchased this year. The National Association of Realtors predicts approximately 5 million homes will be purchased. The problem is that NAR’s numbers appear to be significantly overstated, and it’s reported that they will be coming out with a new methodology to determine monthly and yearly sales. Corelogic uses different data methods and most observers believe those numbers to be more in line with what is occurring. So we shall use that data point.
Approximately 33% of all sales are on foreclosed homes. (This number varies from month to month, and may be considered low by many, but I don’t engage in “”blue sky” thinking.) That would suggest that one million foreclosures per year are being bought. If we consider that there are all total about 6.5 million properties that have either been foreclosed on or going to be foreclosed on based upon today’s numbers, it will take over 6 years to clear this inventory, and that is provided that no other homes go into default and gets foreclosed upon, which is unrealistic to accept. (Note: Laurie Goodman of Amherst Securities has suggested at 10.8 million homes are at risk. If so, that would mean that there would be 11 years to clear foreclosure inventory.) However, this is only one factor.
The next factor to consider is that 28% of the homes with loans in the U.S. are underwater. Assuming that all delinquent homes are underwater, which represents 10% of the homes in the country, there are 18% non delinquent homes left in the country that are underwater. How many of these will eventually default we do not know, but there will be a considerable amount. This has to be factored into the timeline to end foreclosure sales, but it is impossible to predict.
Case-Schiller has been the most accurate in determining how far property values will fall. At this time, they suggest that home values had fallen 33% on average Nationwide. They predict up to 17% more drop in values can realistically occur. How will this affect those that are under water is unknown, but again, reasonable assumptions would indicate it will lead to more defaults. This will also lead to further homes becoming underwater.
(Note: one must be extremely careful when reviewing stats concerning increasing home values. When the values are taken and calculated, it is based upon an average of the sales for each area. The problem that exists is that homes are not homogenous. In many areas, larger homes are selling it greatly reduced values and smaller homes are selling but not in proportion to the size of the larger homes. So if a higher number of larger home sold at a greatly reduced value, it would make it appear that home values were increasing again when it was not necessarily so. Apple to apple comparisons are not being made.)
Next, we must factor in the issue of lending. At this time, 95% of all lending is done through government agencies buying loans from the originators. The agencies lead with over 60% of the purchases. The purchase guidelines are based upon standards in effect in 2010 and allow for loan to values greater than 80%. Loans not meeting agency standards are subject to FHA or VA programs. The vast majority of FHA purchases are at 95% or greater loan to value.
The new QRM standards significantly tighten agency purchases. Loan to value will be capped at 80% for purchase money, and 70 to 75% for refinances. Debt ratios are reduced substantially from 45% down to 38% Back-End ratios.
The end result of the tightening of credit standards means that fewer people will qualify for loans, and will remove many people from the market. As the pool of qualified buyers shrinks, demand for homes will lessen, and prices will necessarily have to come down, so as to bring qualified buyers back into the market.
Of course, FHA is not affected by these changes. However, FHA loans above 95% loan to value result in an approximate 16.6% default rate. So FHA is not in a position to pick up the slack.
Securitization of loans in the private market is still nonexistent. In each of the past two years there has been one securitized offering, and it came through Redwood Trust. The offering was of the best loans available, non-QRM, with loan amounts generally greater than 700,000. No other offerings have been made.
Securitization was suffering from a lack of trust by investors as to the quality of the loans. Until methods are developed that can accurately determine quantitatively the quality of an individual loan, securitization will still be lackluster at the very least. (See the LFI Analytics LDR Score for potential resolution of this issue.)
Interest Rates and the Deficit and National Debt are much too important to ignore. Interest rates have been kept artificially low by the Federal Reserve Board. Even then, with rates at the lowest we have ever seen, lending is still stalled.
At some point in time, within the next couple of years, interest rates will have to increase. This is even more likely as the debt and deficit continue to spiral out of control (the current and all budget deals being discussed do little to ameliorate this situation). Purchasers of U.S. debt will begin to demand higher interest rates for the risk. Buyers of Fannie Mae and Freddie Mac loans will also demand higher rates of return.
This can only be bad for the lending industry and housing industry as a whole. And if as interest rates rise, buyers are again priced out of the market, and home values must fall to bring them back into the market.
Debt reduction commissions have recommended that one manner to increase income to cover debt would be in eliminating the mortgage deduction. The affect of any such action would immediately crash the housing market. For many, the deduction is the single most important reason to buy a home. Eliminate the deduction, you eliminate purchases, and the result is and another round of decreasing home values.
Additionally, homeowners rely upon the check that they received from the IRS after payment of taxes. Without this additional income, many families’ would be subject to to additional financial strain and this could end up in loss of home through either foreclosure or a forced sale.
Will it happen? We don’t know… but it is being seriously discussed.
Affordability of homes is a key issue as well. Since the 1990s, the income of the U.S. worker has not been increasing, or if so, it has not been enough to keep up with inflation. The percentage of people who are able to afford homes has been increasing with the falling home values. At this time, it is estimated that maybe 33% of people can actually afford homes. This would indicate that home values must fall further. If the economy worsens, people get paid less, or unemployment increases, home affordability will worsen.
Currently, it is estimated that the Housing Supply in the U.S. is overbuilt between 2-3.5 million units. From 400-500 thousand units are being built each year in the U.S. at this time. New family creation is estimated to be 400-500 thousand per year. What this means is that new family creation is not going to alleviate housing issues.
The baby boom generation is now retiring and will do so in greater numbers. As they retire, they typically want to downsize to smaller homes in increasing numbers. This frees up equity in the home for their retirement years. With the increasing amount of homes underwater, this makes it more difficult for downsizing to occur.
Additionally, the aging of the population of the baby boom generation will result in a greater home surplus as the years go on due to increasing numbers of boomer deaths. This will be an increasing issue in future years.
We must consider in the equation “pent up seller demand” and the “move up Buyer”. Years down the road as the market begins to recover, prices are not going to immediately increase. That is because there is a vast amount of “wannabe Sellers” who are waiting for a point in time where they can sell and move up into larger homes. As these homeowners place their homes on the market, the numbers of those wanting to sell and move up will keep prices from increasing measurably for a period of time.
Finally, it is not reasonable to expect that we will see 10% to 20% appreciation again. Typically home prices have increased 2 to 3% per year, usually following inflationary trends. Unless hyperinflation occurs, 2 to 3% reasonable to expect. If hyperinflation occurs, then lending will be an even greater issue, and we are in even more trouble than we are now.
At a 2-3% yearly increase, it will take decades to reach what were home values at the height of the market. Likely, it will never reach those heights.
In summary, the forces that will exert pressure on the housing market for many years to come are numerous and relentless. It is easy to infer that the foreclosure crisis and the inventory clearance of just foreclosed properties could exist for up to 10 years, and likely longer.
The economic and the demographic issues that will come to the forefront as years pass will be many and long-lasting. These issues will present further challenges that must be addressed and solved.
The problem for economic issues is that housing has traditionally led the way out of recession. But in this case, housing is the cause of the recession, and until housing issues can be resolved, it cannot take the lead.
The government has been engaged in methods to resolved housing issues, by keeping interest rates low, and by offering different programs to assist homeowners in foreclosure to retain their homes, or to get out from under the homes. So far, the results have been less than stellar. Nothing looks promising.
Where we go from here is anyone’s guess. The issues must be looked at through “new eyes”, with new perspectives, attempting to find solutions in both the short term, and in the long term. These answers will not be easy to find, nor will they often be without pain to some or all parties involved. But the pain will certainly be less if all eyes are open to the reality.