What a mess. It is difficult to stay focused with so much going on in the world. I have not been writing because macro, geopolitics and mother nature can easily override the best projections for the real estate market. This is just an update of real estate related issues, ignoring external factors.


In no particular order:

 

1.    Paying for Past Sins

Corelogic recently estimated about 11million mortgages are still higher than the value of the underlying real estate collateral. Approximately 7 million borrowers are not paying and are in various stages of foreclosure. As housing value continues to ratchet down, albeit at a slower pace, households with negative equity will increase in number, putting more pressure on prices.

 

2.    Demographics

The most favorable years are behind us. Retirement dreams of cruises, golf and second homes have not materialized for many baby boomers. The aging population should create a drag on demand for housing, prolonging the period needed to absorb the excess inventory. It is unlikely that birthrate and immigration can produce the same demand that we experienced when the baby boomers were buying houses 20 years ago. It is equally unrealistic to expect another era when anyone who can fog a mirror will be given a mortgage in any amount they like.

 

3.    Defunct Secondary Market

The real estate market cannot survive without financing, and financing cannot survive without a vibrant secondary market. It has been over two years since the GSEs(Freddie and Fannie) have been put under conservatorship. Tim Geithner recently submitted a non-plan for GSE reform, confirming that no one is really working on this hot potato. Without a long term strategy for a stable, private and unsubsidized secondary market, real estate financing can disappear with just one false move by the policy makers.

 

4.    The Affordability Fallacy

Affordability is calculated using median income, the prevailing interest rate and home prices. Often overlooked is the 20% down payment used in the index. Prior to the sub-prime bubble, buyers were already trained by Freddie and Fannie that 5% down was adequate. The sub-prime era moved that barrier to nothing down. If affordability is recalculated using a 20% down payment as a barrier, homes may not be as affordable as it seems. The new generation of buyers will have to be retrained to save for a down payment. It will take years.

 

5.    Destroyed Household Balance Sheets 

During the mid 2000ds, households were enjoying the wealth effect created by artificially inflated home prices. Now that home equity has vanished, there is no driver for the 'trade up' market. That sector is now very small but quite active and healthy, reserved only for those who had the foresight to not over leverage and those with plenty of assets. In other words, the prudent and the fat cats.

 

6.    Pent Up Supply

There are pending foreclosures. There are vacant homes sitting on the banks' REO inventory. There are sellers waiting to sell as soon as the market recovers. There are builders ready to replenish the REO inventory at a moment's notice. The pipeline is totally full.

 

7.    No Wage Inflation

If home prices appreciate, the amount needed to finance a purchase increases. In order for the debt to income ratio to remain the  same,  income then has to increase proportionally. Without wage inflation, any increase in home prices would simply remove a number of borrowers from the pool of buyers, driving prices right back down due to less demand.

 

8.    Chaotic Government Regulations

Government intervention has been nothing but mind boggling since the collapse of the sub-prime bubble. The latest antics come from the 50 State Attorney Generals. The counter strategy of the banks is to simply  transform themselves into mortgage brokers instead of lenders. They will originate loans, pocket the fees, then dump the loans on the Feds to be guaranteed by the Treasury. That is why they are screaming bloody murder and lobbying hard against the portion of the Dodd-Frank Bill that requires them to put 5% of their own money at risk.

 

9.    Rising Mortgage Rates

Any price appreciation would remove the reasons for accommodative Fed and Treasury policies, undoubtedly resulting in a rise in mortgage rates. At the time of writing, the trend of mortgage rates is on the upside, even without any signs of a real estate market recovery. That should serve to keep a lid on price appreciation indefinitely.

 

10.  Cost of Housing

Unrelated to home prices or mortgage rates, the basic cost of housing is expected to increase as State and local municipalities struggle to overcome budget deficits. Where possible, local politicians will not only be raising property taxes, but also user fees such as water, sewer, trash or permits and licenses of any type.

 

Addendum [by PT]:

As if on cue, starkly underlining Ramsey's point about mind boggling government intervention, the following news items appeared in recent days:

California politico wants mortgage servicers to pay $20k per foreclosure

 

“A California state representative has filed a bill that would require mortgage servicers to pay $20,000 to local communities for each foreclosure proceeding it files.

California State Assembly member Bob Blumenfield (D-San Fernando Valley) introduced the bill in February.

According to the proposed legislation, the fee will be distributed for public education, local police and fire departments, redevelopment programs, small businesses and programs to mitigate the effects of foreclosure. The bill is scheduled to be heard in committee March 22.

According to the bill's fact sheet, the initiative would generate $10 billion over the next two years. It forbids mortgage servicers from passing the charge on to borrowers.”

 

 

This was closely followed by:

Barney Frank bill charges banks $2.5 billion for housing programs

 

“Rep. Barney Frank (D-Mass.) introduced a bill Thursday that would force the largest banks and hedge funds to pay for two programs that provide mortgage assistance and vacant property cleanup.

According to the bill, these funds would pay for the Department of Housing and Urban Development's Emergency Homeowner Loan Program and the Neighborhood Stabilization Program. The House of Representatives voted to terminate both programs this week, claiming the U.S. government could no longer afford such subsidies.

EHLP was set to take applications this spring. Through it, HUD provides up to $50,000 in interest free loans to assist the unemployed with their mortgage payments for up to 24 months.

HUD has provided roughly $6 billion in NSP grants to nonprofits, local and state governments to buy, rehab and resell previously foreclosed and abandoned property. Republicans voted to cut the remaining $1 billion yet to be spent.

Frank's bill would deliver the tab, roughly $2.5 billion for these two programs to financial institutions with $50 billion or more in assets and hedge funds with at least $10 billion in assets under management.

As Republicans continue to move against such programs with the notion that the government should not pay for it, Democrats are taking up the strategy of charging banks.”

 

 

As Ramsey commented: “Is there no end to this insanity?”

We would point out to the above news items that while it is understandable that populist politicians want the banks to 'pay for their sins' in order to prove their anti-Wall Street credentials to their voters, they may have overlooked that stress tests or no stress tests, the banks are sitting on nearly $3 trillion in mortgage credit, much of which is valued at 'extend and pretend', or as Citigroup calls it 'reasonable stab' valuations, in contravention of all principles of sound business accounting.

Were that not so, i.e., were the banks forced to mark all this toxic debt to market, we suspect that many of the nation's largest banks would have to either declare their insolvency or be bailed out all over again. Meanwhile, the collateral underpinning these loans keeps falling in value, with scant hope of recovery. At present, the average recovery out of RE foreclosures for lenders is in the region of 33%. A back-of-the-envelope calculation arrives at a minimum at 100ds of billions in unrealized losses. That is the reality for the US banking system. As much as politicians would like to punish the banks, if they end up imposing even more costs on them, the chance that a functioning real estate market will reemerge will recede even further.

PT

 


 

 


 

 

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4 Responses to “10 Reasons Why Real Estate May Not Recover For Years”

  • RedQueenRace:

    I know. A bit late, but just catching up. Good stuff.

    “California politico wants mortgage servicers to pay $20k per foreclosure“

    Wow. Just wow. How is it that no one in power can envision what might happen wrt people who are struggling but current in their payments if a disincentive to foreclose is put in place?

  • Good article. I had my early career interrupted by a real estate bust when the S&L’s piled into the DFW market in the early 1980’s. Seems DFW was the last bright spot in the country and those needing places to invest money piled in. Houston went down with the oil bust. The story here was DFW went down as well, but the truth was that oil busted in 1982 and most of the inventory here was piled on afterwards. They all just moved to DFW and Austin and there were S&L’s and pension funds to finance it. The office bust lasted for 10 years in the suburban areas and over 20 in the CBD, despite the population here continuing to grow.

    There was a huge inflation of home prices into the late 1970’s that carried over into the 80’s. But, interest rates finally caught up with the inflation and financing changed to accommodate the higher rates, as the psychology of higher prices remained. The cost of financing was put into the price of the house with buydowns that cost 6 to 10 points up front or deferred interest. Price increases in the economy slowed and wage increases also slowed, but rates didn’t follow the process down for a long time. They poured in and overbuilt DFW and the resale market went to pot. Rates had dropped enough and demand for building sites dropped enough that the new supply kept coming. The REO’s followed and much of the resale market went to foreclosure.

    I debated people at the start of this mess. Calculated Risk had some data that I was able to make sense of and I realized in 2007 that the lower level of new home sales would have still been a record going into this bubble. People were catching falling safes as fast as they still could and the idiots were calling a bottom. I realized then the bottom wouldn’t come until it was near the 1981 record low of 401K annual. We went right through that. I did believe the new home market would rebound and continue to oversupply the market as it had here, but the REO’s hit much harder this time than they did here in the 1980’s and real demand had been exhausted by the massive credit bubble.

    The one thing that hasn’t happened yet is the resale market hasn’t collapsed. The NAR and the CNBS crowd would have us believe it has reached a bottom, but while new home sales are at record lows, namely because builders can’t undersell the market, resales are above pre-bubble record highs. Going into the mid 1990’s, resales hadn’t ever been significantly above the 4 million level. The early 1980’s high interest rate market took resales down to the 2 million level and adjusting for population growth, a real bust should bring a decline to 3 million or less. I have yet to see an annual figure under 4 million.

    We are 4 years into this bust. The most important difference between now and the 1980’s is the demographics. The boomers were still forming households and many had delayed having children, so there was still demand. The DFW market was overbuilt by a boom in 1983 and the real mess didn’t hit until 1987. It was a feeling at that time that the market would pick back up and there would be blips of activity. There were also slightly lower rates. But, the market didn’t recover until 1991, when rates finally began to reflect lower price increases. By that time, other markets had gone bust.

    There was probably a 5 or 6 year surplus of supply built nationwide during this bubble. The stress about this problem is that ever market is separate. That is clearly true, but the boom was nationwide. Some places, the surplus will never be absorbed or it will take decades. Also, gone is the long term decline in mortgage rates, as we are either at a bottom or near one.

    There will be markets recover, but only if the economy itself recovers. But, so much of the economy centers around commercial real estate construction as well and that business has hit the rocks. Here, there is a 5 year or so supply of building sites. There is nothing less desirable than building a home in a delayed development. This probably means there will be more on stream, if building does pick up, further diluting the market.

    The other problem is this phenomenon was worldwide. China also has demographic problems and so does Europe and Japan. Their bubbles have either burst or will burst and the shock waves will hit the material supply business in a big way. Lower construction costs will bring on more supply, undercutting the market just when it might start to recover in some areas. Who will fill those empty Chinese cities or the 300,000 empty homes in Ireland?

  • Bearster:

    Awesome article, thanks Ramsey and Pater!

    Not only do I agree that a recovery in RE is years away, I think there will not be a sharp V shaped bottom, but a multiyear flattening bottoming process. I.e. there is no rush to buy to avoid missing “the” bottom.

    Once the realization sets it in that RE is continuing to fall, I think the rate of decline could accelerate again, especially as the state and local govt’s start laying people off in earnest. What a mess. I reminded of Maria Bartiromo demanding a year or so ago, “what’s wrong with having booms and busts?”

    • Yes, it is very important to keep in mind that real estate cycles are very ‘sticky’. This is due to the fact that houses are very long duration assets, i.e. a newly built home will provide its services for a long, long time. This is what makes the bust following a major malinvestment orgy in the real estate sector different from, say, the technology bust. Aging Cisco routers may require replacement after two or three years. The same is not true of a house. Thus the Fed continues to fail in providing support to the one market sector its interventions were designed to support, i.e. real estate. The desired inflation of collateral values has not happened and won’t happen anytime soon unless the Fed really embarks on a destruction of the currency with some verve.

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