In my opinion there are strong indications that the long awaited housing recovery is about to begin in the city that became the poster child for home building excess – Phoenix, Arizona. Things are changing so fast, this new outlook is really only clear to those using the most recent pricing and inventory data from services such as the Cromford Report, which updates information daily, and the latest mortgage statistics from the MBA.
Careful calculations show the once scary "Shadow Inventory" in Phoenix is no longer as large as many thought and what remains can effectively be cleared in about a year. And just as important, short term defaults haven't increased indicating the pipeline of distressed homes isn't refilling at the front end from strategic defaults, which could easily have increased after the large price drop last year.
Phoenix Home Prices Are Stable
While other areas of the country are reporting price weakness this year, Phoenix is different. As the chart from the Cromford Report indicates, after the six month price decline from June to December of last year, the median price for greater Phoenix has been flat for five months. On important reason is the shrinking inventory of homes for sale.
Phoenix's Shrinking Inventory
The Phoenix inventory of homes for sale has contracted 25% over the last five months until only 32,000 homes are now listed. At a monthly sales rate of just under 10,000 homes, "months of sales" last week stood at only 3.5 months - a number considered by most as low enough to indicate "recovery mode." This small and "getting smaller" inventory – composed of 55% distressed homes and 45% normal - should help produce price stability over the next 12 months as the distressed inventory is worked off.
Most people operate on the fixed idea that housing cannot recover until unemployment comes down and more buyers appear. This isn't universally true, however. It is an old observation that after a long price decline in any market (stocks, real estate, bonds), prices often begin to recover, not from an increase in demand but from a dearth of supply. This means that instead of more buyers pushing prices higher, prices are essentially "pulled" higher by an inventory "vacuum" or a lack of homes for sale. Indications are pointing to this happening here.
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Phoenix's Shadow Inventory is Fading in the Sun
How about the great "shadow inventory" looming over Phoenix; that huge, uncounted pipeline of delinquent homes still working toward resolution or foreclosure? Let's define shadow inventory as all homes over 90 days delinquent plus mortgages in foreclosure plus all bank owned REOs not yet listed. As the graph below shows, the first part of that definition – the delinquent loan inventory - is rapidly evaporating in the desert sun. The percent of delinquent loans for the state of Arizona (of which Phoenix accounts for 66%) has declined from 7% to 4% in only fifteen months. At this rate, the straight line rate of decay points to the first component of the shadow inventory being depleted within one year - by June 2012!
This "visual forecast" is confirmed by a more detailed, mathematical calculation as follows:
Approximately 48,000 homes in Arizona are 90-days or more delinquent but not yet in foreclosure. Greater Phoenix represents about 66% of Arizona, so we estimate about 32,000 90+ day delinquent homes in Greater Phoenix. I estimate about 10% of these loans will be modified successfully leaving 28,800 to be resolved by short sale or foreclosure. At the moment, each month in Greater Phoenix there are about 1,700 successful short sales and about 5,200 trustee sales of which about 1,600 are sold to third parties and 3,600 revert to the beneficiaries. So I estimate that the 28,800 loans will become 7,100 short sales, 6,700 trustee sales to third parties and 15,000 REOs. There are currently about 28,000 already in foreclosure, so these will generate another 6,900 short sales, 6,500 trustee sales to third parties and 14,600 REOs.
There are some 10,400 REOs already owned by not yet listed on MLS. So the total number of REOs including those not yet listed, those that will emerge from existing foreclosures and those that will result from delinquencies yet to receive a notice of trust sale is:
REOs not listed 10,400
REOs from pending foreclosures 14,600
REOs from 90+ day delinquencies 15,000
The annual sales rate for REOs through ARMLS is 42,633, so the total of 40,000 represents just over 11 month's supply which again presents us with a target date of June 2012.
Phoenix Home Prices
As the inventory of distressed homes is worked off, at some point there should be a price surge as investors begin to notice what is happening and start competing to scoop up the remaining bargains before higher prices carry the opportunity away. I think this price surge will begin in about six months. After the surge, prices should continue upward in a constant positive trend.
While the foundation for a coming price recovery rests on simply having a very, very low supply of homes for sale, prices will have an additional upward bias for a completely new and refreshing reason.
Everyone knows that the sale of a large number of foreclosed homes hurts the value of all homes in an area. For example, according to the Cromford Report, Phoenix had 9,844 home sales last month. Of these sales, 20% were short sales, 45% were REOs and 35% were normal sales (see chart). While the average size home in these categories was about the same, the average price per square foot wasn't. Normal homes sold for $112 a square foot while short sales averaged $74 a square foot and REO sales were $59 a square foot. From this it's easy to see how distressed sales lower the average price - in this case $83 per square foot - affecting the value of all homes in an area.
Few know, however, that an opposite and positive effect can occur too. As the distressed inventory declines the average or median price rises even if the sales price in all three categories stays the same!! It's the changing mix of REOs, SS and Normal sales that makes this happen. In fact one of the reasons Phoenix's median price has been relatively flat this year is because distressed homes have fallen from 73% to 65% of the total (see chart). Theoretically, if short and REO sales went to zero, the median price could rise from $83/sf to $112/sf - and remember, that's with no change in the selling price of any home.
Don't think this is "sleight of hand" mathematics; the price rise is just as real as the price drop was when distressed homes dominated. Once distressed homes are gone, homes throughout Phoenix should be valued quite a bit higher just from this effect alone. Add in a price surge due to "low supply" and together they're a powerful one -two punch. This will go a long way to help reduce the negative equity problem that exists on paper. It's also good news to homebuilders who will no longer have to compete with all that underpriced product.
New Home Construction
Since what is happening in Phoenix is probably also happening in other states that have trustee foreclosure sales like Arizona - states such as California – this more positive outlook in Phoenix may foreshadow a general turnaround in the broader housing market and home construction. This conclusion seems to be indicated by similar target dates in the delinquency decay patterns of the other five states shown in the third graph.
It is my belief that once the distressed inventory is depleted, the number of willing home sellers at current prices will remain low and stay low even after prices rise for a while. To fill the supply large numbers of new homes will suddenly be needed and we think people (builders) will be surprised at how quickly this will occur. We could easily see a demand nationally for over 750,000 new homes in 2012 and a million plus in 2013. Since there is a considerable lead time in setting up to build homes, I think many homebuilders will be caught flat footed.
Good News for Homebuilder Stocks
I think there is finally a strong fundamental reason why home building stocks [D.R. Horton (DHI), KB Home (KBH), and Toll Brothers (TOL)] and the homebuilding ETF (XHB) have probably made bottom and will not experience another large price dip. I think homebuilders are facing a new dawn and much brighter future.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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