Talking About a Housing Revolution: Predictions for the Sector

The Beatles song comes to mind when I consider what the bottom of the housing market and recovery will look like.

June 28, 2009 -- DETROIT, MI – Recent housing reports brought apparently good news on housing as it was reported that Housing Starts in May jumped 17.2% and Building Permits jumped 4% in April. Also, the National Association of Realtors [NAR] reported that Existing Home Sales, the Pending Home Sales Index and New Home Sales were all up in recent months.

According to Lawrence Yun, chief economist for NAR, "We are at or near bottom in terms of sales."

So, it’s a great time to put that home of yours on the market that you desperately want to sell? Not even close.

One month of good news doesn’t mean the housing crisis is over. On top of that, it’s spring – a time when home sales invariably go up after winter. Look at the following graph, the same thing happens just about every year:

As for the housing starts and building permit numbers – it’s amazing how these numbers were skewed to look good. The numbers reported by NAR and the media compared May of 2009 numbers to April of 2009. If one references the source of these numbers, the U.S. Census Bureau website, the May numbers for 2009 when compared to 2008 are actually down – by 45.2% for Housing Starts and 47.0% for Building Permits. How does that qualify as good news?

It was also reported by NAR that May home sales were up 2.4% over April. Yet again, when compared to May of 2008, sales were actually off 3.6%. Not really good news as it doesn’t show we’ve reached a bottom yet.

THE REAL STORY

Looking at the big picture, it’s obvious that the housing market is not out of the woods yet. The FNMA/FHLMC foreclosure moratorium from Thanksgiving through March (waiting for Obama’s housing plan) created an artificial shortage of foreclosed properties on the market. Not surprisingly, April foreclosure filings set a record.

Last week, California announced its own 90 day moratorium on foreclosures which will further hide the true extent of the housing problems in that state. Michigan recently passed legislation that will have a similar, albeit more limited, effect. Several other states have passed or are considering doing the same.

All the Adjustable Rate Mortgages [ARM] that borrowers took out at the peak of the housing market, so they could afford to buy or cash out of their homes, are starting to reset in record numbers and will continue to do so for the next two years. The ugliest situation is for those with “Option ARMS” also known as “Pick a Payment” plans, but technically called “Negative Amortizing” ARMs. Anything with the word “negative” in it is usually not good. In the case of these products, they were originally designed for sophisticated borrowers that understood how they worked and the inherent dangers. Only two lenders, WAMU (WM) and World Savings (WB), initially offered them. At the height of the housing boom, many more banks jumped on the bandwagon to offer them and pushed mortgage brokers to sell them to their clients by offering insane commissions. Of course, many unscrupulous brokers, few understanding the product themselves, pushed these loans onto borrowers that didn’t take the time to understand anything but the artificially low payment. Now, many of these borrowers will see their payments increase by 50% or even double. Many won’t be able to afford the payment shock and will eventually be added to the foreclose statistics.

There’s also the issue of a “Shadow Inventory” of homes. How many of you see vacant homes in your neighborhoods that aren’t for sale? Many of these are foreclosures where the lender is just sitting on the home instead of trying to sell it at a loss. There’s also the inventory of homes where owners aren’t making payments, but haven’t been foreclosed on yet, despite being well past the point where they should’ve been. Several sources have estimated this shadow inventory at 600,000 homes. Now do you understand why banks were forced to take TARP funds?

Real estate investors are also contributing to the problem. I know of many that are struggling with rentals where the rents don’t cover their payments. Many of them will eventually throw in the towel as their reserves run dry or the value of the rental falls to where it just doesn’t make sense to keep throwing good money after bad.

Finally, we have the unemployment situation. May’s unemployment figure hit 9.4%, the highest since 1983. June’s number is expected to hit 9.6%. Since the recession begin in December 2007, we’ve lost 6 million jobs. These numbers are bad, but actually are worse if you include all the workers that have had to settle for part-time jobs or are making less than half of what they used to. Housing won’t stabilize until unemployment does. Even then, there’ll be a lagging effect as households paydown debt, replenish reserves and proceed cautiously.

PUTTING IT ALL IN PERSPECTIVE

The highly touted, and over referenced, Case-Shiller Index predicted that housing prices would fall 10-20% this year. As of May, the median price of a home is off 16.8% from last year. Faced with these numbers and all this information, what would you do if you were in charge of our government? Would you let housing free-fall and probably put the country into a Great Depression II? Or would you use every financial tool at your disposal to soften the landing, wherever that may be?

Obviously, the current administration has chosen the soft-landing option and is pulling out all the stops to make it happen:

The real reason for the Thanksgiving to March foreclosure moratorium was to come up with a plan to force banks to modify mortgages and slow the flow of foreclosures hitting the market and driving down prices. Obama’s administration had to do something dramatic after the disaster of Bush’s “Hope for Homeowners” plan that resulted in only 50 or so homeowners being helped. TARP funds were probably used as “bribes” to get banks to go along with the new plan.

Ben Bernanke is doing his best to keep mortgage rates low. Not only does this encourage home buying, it also encourages people to refinance to lower their payments and not let them go to foreclosure. After a brief spike to 6%, when Wall Street bluffed the Fed, rates are back to the mid 5’s, still historically low.

FNMA/FHLMC, now under government control, currently allow homeowners to refinance up to 105% of their home’s value so they can lower their monthly payment. Again, this was done to keep people in their homes through lower monthly payments. I expect to see the 105% increased to at least 115%, or done away with altogether, as housing prices have fallen faster than expected and the number of homeowners qualifying for a 105% refinance are much lower than the original target.

The $8,000 tax credit to buy a home has generated quite a bit of home buying activity as intended. I predicted a couple of months ago that the tax credit program would probably be extended past its December 2009 deadline. There’s now talk in Congress about not only extending the program, but increasing the tax credit to $15,000 and opening it up to anyone that buys a home. It’ll be interesting to see what they do with the income restrictions as the current plan has propped up the lower end of the housing market, but left the rest of the market struggling.

PREDICTIONS

So far, the housing market is down over 30% from its 2006 highs.

The government is doing its best to prop up our housing market, but it’s expected to fall further. How far is anyone’s guess, as one can’t predict it any better than one can predict where the stock market is going. I don’t think we’ll see housing bottom until late 2010 at the earliest. That being said, I think the pace of the decrease will slow after this winter.

I also think that we won’t see a rebound for quite some time and it won’t be the rebound that many are hoping for. We won’t see double digit appreciation of housing for decades, if ever again. Nationally, we’ll see very slow anemic appreciation as homebuyers will be extremely cautious after this crisis.

There will be a rebound bounce in areas where prices dropped ridiculously low. Detroit immediately comes to mind. The median price of a home in Detroit (the actual city) stands at $6,000 as of today. As long as one buys in a decent area of the city, that price could easily double, triple, even quadruple once unemployment improves. A house at $24,000 is still quite a bargain, especially when it would cost at least $80,000 to build a new one. The southern Florida condo market is another place that might have a double digit rebound as prices there are quite low due to over building. Understand that any double digit rebound in areas like these will be a quick, one-time thing as values bounce back from their oversold positions. Then they’ll follow the national trend of anemic appreciation.

It could take a generation (25 years) for nationwide home values to return to the peaks of this decade.

THE HOUSING REVOLUTION

We’re also going to see residual effects from this crisis, much the same as we saw after the Great Depression. People that lived through the scarcity of those years tended to be savers and hoarders, not throwing anything away. Going forward, I think we’ll see a large increase in the number of people that never buy another home. After going through the trauma of getting foreclosed on or watching their parents, family, neighbors and/or friends go through it, they’ll choose to be lifetime renters. That’s good news for real estate investors as many of these people will still want to raise their families in houses, not apartments.

I also think we’re seeing the end of the “McMansions” and sprawling suburbia. Inland California was overbuilt, in the middle of nowhere (that’s why it was cheap to develop) and is now turning out near vacant ghost towns due to all the foreclosures. Values have already dropped over 50% in many of these areas and show no signs of slowing yet. Why? It’s too far to commute to work. Eventually population growth will fill these towns back up, but that could take a decade or more.

Millennial’s, those born after 1980, are flocking to urban landscapes and smaller homes. They don’t want to be house poor or commute more than minutes to work, preferably via mass transit. As gas and energy prices rise when the world economy recovers, more of us will be forced to address these same issues. This will eventually be good news for decaying urban areas and those that invest there ahead of the curve.

People will also stop looking at their homes as a source of wealth. Homes will be seen less as “castles” and more as just places to live. Europe and Asia are already like this. People there don’t socialize in their homes as much as we do (most are too small), they meet at cafes, restaurants, parks, etc.

SHOULD YOU BUY NOW?

No one can predict the bottom of the housing market. So, if you’re in the market for a home, you should buy something that fits your budget, that you think is a good deal, when you think you’re ready for the monthly liability. Notice I didn’t say a great deal or a steal of a deal. Too many people still fall into the trap of following the herd lining up for the sensationalism the media peddles to get our attention. They want to hit the jackpot with the deal of a lifetime on a home. Well, keep in mind that very few hit the jackpot in Las Vegas and even fewer win the lottery. It’s usually better to play it safe and follow you head than gamble your future away by listening to others.

Buy a home you can afford now that fits your lifestyle. Don’t stretch to afford something and put yourself in a tenuous financial situation. You also don’t need to be keeping up with the Jones’ and getting in over your head by doing so.

Homes should be bought that fit one’s monthly budget. I can’t believe all the homebuyers I talk to that have never sat down and put together a monthly budget to figure out what they can afford for a monthly housing payment. They expect ME to tell THEM what they can afford! I’d be very appreciative if this was because they trusted me, but it’s actually due to laziness. Don’t they realize that they’re looking at buying a foreclosure where the previous owner probably made this same mistake?

Consider how long you plan to live in a home before deciding whether to buy it. Don’t count on buying something and being able to break even if you sell it 2 years from now. You’ll probably need 5 years or so to be able to do that.

Overall, homes are now more affordable than they’ve been in over a decade. Foreclosures have created unique opportunities for many to get solid deals on homes. Throw in the current $8,000 tax credit (with talk of it going to $15k soon) and this could be the time for many to buy a home. Not for everyone, but for many.

If all of this is a bit much to take in and analyze, find professionals that can assist you. Run from those that are pushy. They should ask a lot of questions and rarely tell you what to do, but rather help you find your own answers.

Comments

[Tom E.:]

Good insight on people being gun-shy on buying a home in the future.

Jun 29 07:15 AM

[Houston:]

The key to the bottom in most markets is...at what price can investors purchase a home and get postive or break even cash flow from the rental? How long will that rental market and coash flow hold up as more and more rentals are put on the market.

Shadow inventory, alt-a loans and everything else all secondary to that consideration.

Jun 29 07:59 AM

[Tim Plaehn:]

The long term trend is the U.S. population has and will form about 1.5 million new households every year. Homebuilders are adding new housing at a rate of 500k per year. The longer the permits and starts rates stay low the more positive it is for housing prices in the future.

In May both Florida and California reported median price increases for existing homes. One month is not a trend, but if it happens for a couple of months buyers will become more confident to make a purchase.

Banks are holding on to the shadow inventory to wait for the trends listed above to take effect. If they can refrain from dumping too much housing into the market, pricing should continue to firm up.

Jun 29 09:20 AM

[Vito Boscaino:]

I generally agree with everything that you said. I believe you hit on the key unknown factor, the question being exactly how big is the "Shadow Inventory" gorilla standing in the corner. With new foreclosures increasing in number month-by-month, added to the deferred foreclosure inventory that has not been processed into the marketplace, plua the "Normal" seller withheld inventory when added to the impending increase in foreclosures due to the recent job losses and upcoming rate resets, the cumulative number of potential empty homes that could hit the market over the next eighteen months could be staggering. Until there is some transparency and visibility to the size and expected timing of the flow of these properties into the market - I think that many buyers and investors are going to wait this game out. That implies to me that the late 2010 timing for the bottom of the market might be realistic, or it may be early. I certainly do not see a bottom any sooner than late 2010.

Vito Boscaino
Managing Partner
North High Realty, LLC
Dublin, Ohio
www.ServingColumbus.com

Jun 29 09:51 AM

[Stephen Kanitz:]

Postponing house purchase means postponing Mortgage Interest Tax Deductions, which for some brackets means a 30% to 42% tax deduction. I did not see this "opportunity cost" factored in your analysis.

Jun 29 10:09 AM

[Mad Hedge F...:]

If I had a quarter for every time the bottom was called I wouldn't have to write this lusy newsletter. Since I have been pelted daily with predictions that residential real estate has bottomed for the last 18 months, like hail in a Midwestern summer thunderstorm, I feel a public duty to tell you that is just not the case. Now that the state and federal moratoriums are off, foreclosures are accelerating. There are over a million Option ARM and Alt-A loan resets about to hit the fan. Since many owners will not see positive equity in their homes in their lifetimes, banks are seeing more walk always. The run up in mortgage rates from 4.5% to 5.5% has yet to hit the market. Some 18 million homeowners divert 50% of their incomes to pay for housing, double the 25% that is considered healthy, and many of them are losing jobs. While the volume of units sold has rebounded, the action is dominated by speculators, flippers, and bottom feeders bidding for properties at 10-40 cents on the dollar, not exactly a sign of health. Call me when Ozzie & Harriet Nelson come back to the market. I listen to industry insiders call the bottom of the Japanese real estate market for 15 years, until they finally died, and the market is still a fraction of its 1990 high. I thing we are closer to the bottom than the top in terms of price, but closer to the top than the bottom in terms of time. You can take that to the bank.

Jun 29 10:34 AM

[ThePhoenix:]

Walk away factor needs to be considered since this is starting to surge:

Assume: Homeowner owes $400,000.00 on a home that is now worth $200,000.00. The loan of $400,000.00 has an interest rate of 6.5% The homeowner has reached out to their lender and is now offered a loan modification for an interest rate of 4.5%. This scenario achieves the following:

Current mortgage: $400,000.00 @ 6.5% = $2,528.27 per month.
Modified mortgage: $400,000.00 @ 4.5% = $2,026.74 per month.

Savings of ~$500.00 per month. On the surface, saving $500.00 per month sounds like a good deal, but is it?

Since the asset is worth only $200,000.00, consider the various interest rates for a term of 30 years:

6.5% rate gives a payment of $1,264.14.

8.5% rate gives a payment of $1,537.83.

12.0% rate gives a payment of $2,057.23, similar to modified payment proposed.

15% rate gives a payment of $2,528.89, similar to current mortgage payment.

In effect, the current lender is asking you pay a cash flow to them on $200,000.00 with the modified loan at 12% or at the current monthly payment at 15%. This assumes that you pay your mortgage for a total of 30 years. Paying a mortgage at those rates makes no sense.

Accepting Loan Modification Cash Flow Analysis ($200,000.00 value):

30 years with a payment of $2,026.74 yielding 11.933% for a total of payments of $729,626.40.

30 years with a payoff at 10 years with a payment of $2,026.74 requires a $319,532.34 payoff yielding 14.933% for a total of payments of $562,741.14.

30 years with a payoff at 5 years with a payment of $2,026.74 requires a $363,972.30 payoff yielding 21.616% for a total of payments of $485,576.70.

This analysis is important. It would be rare that a consumer will actually go longer than 10 years with a modified loan and realistically it will end up being refinanced or the property sold somewhere between 5 to 10 years. That would mean the consumer will end up paying somewhere between 15% to almost 22%.

However, if the homeowner becomes a renter, consider this cash flow analysis:

Renting for various periods:


Renting for 10 years with rent for years 1-3 at $1,600.00 at years 4-6 at $1,750.00 at years 7-10 at $1,850.00 would be a total of payments of $213,000.00.

Renting for 5 years with rent for years 1-3 at $1,600.00 at years 4-5 at $1,750.00 would be a total of payments of $99,600.00.

Of course, none of this assumes any increase in value for the underlying property being owned. Any increase in value over the next 5-10 years is highly speculative and even a 5% increase per year still does not impact the 10 years projection in any real favorable ways.

As consumers grasp this concept, the results could be dramatic.

Jun 29 11:46 AM

[hanumanhojo:]

I think the main cause of the revolution in housing is that jobs simply aren't stable. Who can expect to stay in the same area for 30 years? If you can't, why even bother buying? It is a vestige of an era gone bye.

Jun 29 01:00 PM

[Cold Reality:]

What about the tax implications of the shift from mortgage payments to rent?


On Jun 29 11:46 AM ThePhoenix wrote:

> Walk away factor needs to be considered since this is starting to
> surge:
>
> Assume: Homeowner owes $400,000.00 on a home that is now worth $200,000.00.
> The loan of $400,000.00 has an interest rate of 6.5% The homeowner
> has reached out to their lender and is now offered a loan modification
> for an interest rate of 4.5%. This scenario achieves the following:
>
>
> Current mortgage: $400,000.00 @ 6.5% = $2,528.27 per month.
> Modified mortgage: $400,000.00 @ 4.5% = $2,026.74 per month.
>
> Savings of ~$500.00 per month. On the surface, saving $500.00 per
> month sounds like a good deal, but is it?
>
> Since the asset is worth only $200,000.00, consider the various interest
> rates for a term of 30 years:
>
> 6.5% rate gives a payment of $1,264.14.
>
> 8.5% rate gives a payment of $1,537.83.
>
> 12.0% rate gives a payment of $2,057.23, similar to modified payment
> proposed.
>
> 15% rate gives a payment of $2,528.89, similar to current mortgage
> payment.
>
> In effect, the current lender is asking you pay a cash flow to them
> on $200,000.00 with the modified loan at 12% or at the current monthly
> payment at 15%. This assumes that you pay your mortgage for a total
> of 30 years. Paying a mortgage at those rates makes no sense.
>
> Accepting Loan Modification Cash Flow Analysis ($200,000.00 value):
>
>
> 30 years with a payment of $2,026.74 yielding 11.933% for a total
> of payments of $729,626.40.
>
> 30 years with a payoff at 10 years with a payment of $2,026.74 requires
> a $319,532.34 payoff yielding 14.933% for a total of payments of
> $562,741.14.
>
> 30 years with a payoff at 5 years with a payment of $2,026.74 requires
> a $363,972.30 payoff yielding 21.616% for a total of payments of
> $485,576.70.
>
> This analysis is important. It would be rare that a consumer will
> actually go longer than 10 years with a modified loan and realistically
> it will end up being refinanced or the property sold somewhere between
> 5 to 10 years. That would mean the consumer will end up paying somewhere
> between 15% to almost 22%.
>
> However, if the homeowner becomes a renter, consider this cash flow
> analysis:
>
> Renting for various periods:
>
>
> Renting for 10 years with rent for years 1-3 at $1,600.00 at years
> 4-6 at $1,750.00 at years 7-10 at $1,850.00 would be a total of payments
> of $213,000.00.
>
> Renting for 5 years with rent for years 1-3 at $1,600.00 at years
> 4-5 at $1,750.00 would be a total of payments of $99,600.00.
>
> Of course, none of this assumes any increase in value for the underlying
> property being owned. Any increase in value over the next 5-10 years
> is highly speculative and even a 5% increase per year still does
> not impact the 10 years projection in any real favorable ways.<br/>
>
> As consumers grasp this concept, the results could be dramatic.

Jun 29 01:24 PM

[ThePhoenix:]

I would love to see someone overlay the tax implications to the analysis. I also have not heard anyone explain the tax implications of engaging in a loan modification on a 400k loan that has only a 200k value. According to IRS pub 936, any secured debt you use to refinance home acquisition debt is treated as home acquisition debt. However, the new debt will qualify as home acquisition debt only up to the amount of the balance of the old mortgage principal just before the refinancing. Any additional debt not used to buy, build, or substantially improve a qualified home is not home acquisition debt, but may qualify as home equity debt. This limit is 100k if it was for home improvement.

While a blind eye has been turned on this provision and consumers have been actively taking the deduction, it is not proper. Anyone care to provide real numbers?


On Jun 29 01:24 PM Cold Reality wrote:

> What about the tax implications of the shift from mortgage payments
> to rent?

Jun 29 03:26 PM

[JPDX:]

I don't understand how you can say nobody can predict the market, then right below that start making predictions. This always annoys me. You even give solid numbers. Your ideas are great, but wrong, America will not be like Europe, we forget when the media starts talking about something else. People will stop saving when things turn around, and get back into debt because we live in a world where we covet crap. Our culture will not change to what you say it should change to in your analysis. As far as where the bottom will be, that is regional and even neighborhood based. Stop looking at the US market, who cares! I could care less about the national trend because it does not really mean anything to a homebuyer buying one house in one little place in this diverse country.

Jun 30 01:59 AM

[Ted Hurlbut:]

I wholeheartedly agree that the idea of 'house-as-investment' has been seriously undercut, and that there's a whole segment of the population that will never again be prepared to accept the risks of mortgaged homeownership. This dampening of demand may already be contributing to further declines in the housing market, as the structure of housing ownership evolves.

Jul 01 02:59 PM