God bless the internet! Zillow.com (NASDAQ:Z), a Seattle-based real estate website offering home values and rents estimates nationally, IPO'ed on July 20th and saw its value instantly triple to $1 billion - without having ever turned a profit. This is, however, more a sign of the strength of the technology sector than the real estate one.
First, some numbers: at 66%, the rate of homeownership is at its lowest level since 1998. 22.7% of homeowners - or 11 millions of them - are 'underwater' (meaning that they have a mortgage that is more than the current value of their home). Existing home sales reached a 7 months low in June (third straight monthly drop) and 40% of second mortgages are underwater. Home prices are near recession lows. In some hard-hit markets, such as Nevada, Arizona and Florida, homes have lost half of their values since their July 2006 peak. 63% of homeowners in Nevada currently owe their banks more than their real estate is worth.
The slow pace of the recovery has multiple causes. However, there are also some bright points for the U.S. housing market.
Joblessness and tight lending are the two most important drags the housing market is currently facing. High unemployment is keeping potential buyers from acquiring real estate or from obtaining a loan to do so. Unless the economy recovers and creates enough jobs to lower the unemployment rate, real estate will not appreciate.
Lending has never really loosened up since the 2007 credit crunch, and banks are still hoarding cash. Recent new capital requirements add an incentive for them to keep capital, as does the economic outlook that has been uncertain since the beginning of the financial crisis, and which has become even more so this summer.
The country went from extremely loose lending standards during the real estate bubble - with some borrowers obtaining loans without documenting their income and being approved for loans of over 100% of the value of the homes they were purchasing - to extremely tight ones. Requirements to qualify a borrower for a loan are numerous today. 27% of loan applications were turned down by the nation's 10 largest mortgage lenders in 2010. While this has kept property prices down, it has also led to the prominence of all-cash buyers: in Miami in April 2011, 63% of home sales occurred without a mortgage being used. In our current environment, 'cash is king.'
Another key factor keeping banks from lending more freely are the U.S. government's efforts to force banks to repurchase bad loans and fine lenders for foreclosure practices deemed unethical and/or illegal. The housing crash has created a flood of lawsuits.
On the one hand, the federal government is trying to recoup losses it incurred mostly through Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) (which buy mortgages from issuers in order to securitize them - in effect promoting homeownership and lowering interest rates for borrowers - and which where taken over by the U.S. in 2008). It is trying to prove misconduct from loan issuers during the housing bubble, alleging that they sold Fannie Mae and Freddie Mac loans that did not conform to guidelines that had been agreed on. Some banks have already settled with the U.S. over allegations: most noticeably, Bank of America (NYSE:BAC) did so for $8.5 billion in June, for losses incurred through its purchase of mortgage originator Countrywide Financial in 2008 for $2.5 billion. Losses related to Countrywide are estimated at a whopping total of $30 billion. Bank of America is also being sued by AIG for $10 billion over similar allegations.
This is, however, less than what the U.S. government spent to rescue Fannie Mae and Freddie Mac: $138 billion. Unfortunately for taxpayers, Fannie and Freddie are still posting losses and must currently ask the government for additional bailout capital. That situation has led politicians to brainstorm about a restructuring of these two agencies, and a bill proposing to merge them and make them non-profit entities has been introduced. Another bill proposes to replace Fannie and Freddie by private companies. Meanwhile, the Obama administration is examining ways to rent properties that have been seized by Fannie and Freddie through foreclosures until prices recover, when they would be sold (the two agencies were estimated to own 218,000 properties at the end of March 2011). Besides, officials are brainstorming on incentives for banks to reduce defaulted mortgages balances.
As the 2012 presidential election approaches, pressure on Barack Obama is rising to find solutions to improve the housing market. He recently called the latter the 'most stubborn' problem facing the country. The stakes are especially high since some traditional swing states are at the epicenter of the housing crisis (Florida, Nevada, Ohio).
The U.S. government is currently the largest actor of the housing market. It is behind 9 out of 10 new loans, and guarantees half of the current outstanding mortgages. And the weakness of the housing market keeps the government involved in it in order to avoid any further downslide.
On the other hand, banks are being sued for wrongful foreclosure practices. Lenders have been accused of 'robo-signing' mortgage issuance documents: employees did not review loan applications properly before approving them. Furthermore, some banks have been accused of using foreclosure law firms that were too aligned with them. Some lenders could not demonstrate ownership of the mortgages on the properties they were foreclosing on. Several banks have even been accused of backdating or fabricating documents.
The amount of time needed for foreclosures and repossessions has therefore increased. That has led to a slower clearing of the inventory of bank-owned and distressed properties nationwide. In addition, the scrutiny of the mortgage industry's practices has led lenders to become much more diligent when issuing new loans - once again, tightening lending standards. Most likely, banks will settle with the U.S. government over wrongful foreclosure practices accusations, and have hoarded funds to do so. According to estimates, the settlement could reach $20 to $25 billion. Wells Fargo (NYSE:WFC) and Citi (NYSE:C) are arguing that they should pay less than other lenders because they deem their mortgage origination and foreclosure policies superior to that of other competitors. They have, indeed suffered less from delinquencies and questionable repossession practices - as well as bad publicity - than the likes of J.P. Morgan (NYSE:JPM) and Bank of America.
Securitization - the pooling and subsequent slicing of loans by Wall Street, which reached its pinnacle at the height of the real estate bubble - is timidly coming back. While CMBS issuance is still at a fraction of its 2007 level, the CMBS market started recovering in 2009. It has, nevertheless, sidestepped recently and encountered resistance over the past three months. In an interesting development, Citi and Goldman Sachs (NYSE:GS) had to cancel a $1.5 billion CMBS issuance in order to increase protection to senior investors in the offering. Credit announced that it would shut down its CMBS operation on October 13th.
Nevertheless, there are signs that the real estate market is clearing with time. Hurdles are being overcome. Most of the banking sector's problems are either being solved or have already been solved, and the largest write-downs have occurred. Some economists estimate that the U.S. is over two thirds of the way through its housing crisis. Even if prices are not rising again yet, and might not be for some time, inventories of unsold properties are slowly decreasing. A few economists even estimate that prices could be back at their peak levels by 2015. And some cities have demonstrated resiliency, Washington D.C. being probably the best example.
Homeowners losing their home have led to a sharp increase in demand for rental apartments. That, in turn, has created strength in the apartment buildings market - so all segments of the real estate market are not suffering. This has even created an uptick in the construction of multifamily properties, in spite of very little construction lending.
The elephant in the room is of course the economy. Any decrease in economic activity will most certainly impact housing. Any rise in interest rates will also do so, as will a decrease in consumer confidence. The full impact of the downgrade of the U.S.'s credit rating by Standard & Poor's has yet to be understood, and the government will most likely stay deeply involved in the mortgage market for some time.
While there seem to be somewhat of a consensus that a 5 to 10 years period will be necessary for a full recovery of real estate, the adaptability and reactivity of the nation could foster rapid change. On the other hand, long-term structural economic issues could create a drag, if not dealt with swiftly.