Pent up housing supply far larger than latent demand

Ordinarily, housing market pricing gets pushed up to the limit of affordability. Chronic shortages of housing keep prices high, and homebuilders respond by providing new homes to meet the demand. In short, demand nearly always outpaced supply. In the aftermath of the housing bubble, that is no longer the case.

Many of the houses built during the rally of the housing bubble were a response to artificial demand caused by unstable loans being given to people who didn’t have the capacity to repay the debt. As a result, homebuilders produced many homes that were not necessary, and to make matters worse, the people to whom these houses were sold now have bad credit, so demand is curtailed until their credit is restored. Further, the collapse in pricing has reduced the store of equity many owners used to have. Thus, the move-up market has been nearly eliminated.

So now we have an excess of supply caused by the recycling of foreclosure and the disposal of excess construction at a time when demand is unusually low due to the credit problems created by the housing bubble. Contrary to popular belief, Desire is not demand. People may want houses, but only those able to deploy real money toward buying a house count toward demand.

Housing’s Huge Supply and Demand Imbalance

Published: Tuesday, 3 Jan 2012 | 12:45 PM ET

By: Diana Olick
CNBC Real Estate Reporter

“Pent-up demand.” That is the rallying cry of the housing bulls, as they forecast the great recovery of 2012. So many potential buyers are doubled up with family, stuck in undesirable rentals or just plain afraid to put their current home on the market, but that’s about to change, say these optimistic prognosticators.

realtors will blather on about pent-up demand when they have nothing else. It’s nonsense, but it sounds reasonable to those who don’t understand the difference between desire and demand.

… “There are relatively few borrowers that can qualify for a mortgage given today’s tight lending standards,” says Laurie Goodman, Senior Managing Director at Amherst Securities. “Aside from FHA and VA mortgage, you need 20 percent down, and that’s very, very difficult for most borrowers.”

One hundred percent financing was seen as a boon to housing because it eliminated the onerous requirement for down payments. The folly of this idea became obvious when many of the people who used this financing lost their houses.

When 100% financing came on the scene, many assumed that “innovation” would eliminate the need to save money, so many people stopped saving. Prior to 2006, the only savings for a house came from appreciation equity. Since the collapse of the housing bubble, savings rates have increased, but not enough to give people 20% down payments on houses with still-inflated prices.

Demand — the ability of potential buyers to come up with a loan and a down payment — is greatly reduced.

Goodman, one of the best number crunchers I’ve come across in this field, claims there is far more distress in the housing market than some of the leading mortgage data providers portray. She counts eight to ten million more foreclosures over the next six years, because she adds borrowers currently in mortgage modifications.

“That includes borrowers who have never missed a payment before, but are deeply underwater and are apt to default because borrowers just like them are defaulting on a regular basis,” Goodman contends.

She is exactly right. The loan modifications will nearly all fail, and many underwater borrowers will strategically default in the next few years. Measures of shadow inventory are not counting these people, but reality is they will become foreclosure statistics.

She notes that household formation has been running very low of late, just 5-800,000 a year. A normal level is 1.1 to 1.2 million units a year.

“Even if we go back to 1.2 million units a year, and even if 50 percent of those are home buyers, which I think is a very, very high number [the rest being renters], that won’t be sufficient to clean up the huge overhang of supply we’re going to have over the next four to six years,” she calculates.

I totally agree. The imbalance of supply and demand is too great. Lenders have been doing everything possible to keep supply limited to match the weak demand, but they are merely accumulating REOs and shadow inventory.

Why is 50 percent high? She calculates on:

“The homeownership rate for the U.S. as a whole is 66 percent. If you take out the borrowers who haven’t made a mortgage payment in a year it is 62 percent. The Center for Joint Studies at Harvard estimates that out of the 1.2 million units per annum household formation over the next decade, 70 percent will be minorities, who have lower home ownership rates. In this context, 50 percent seems generous.”

Her conclusion, and the one I’ve been promoting for over a year now, is that the only way to re-balance supply and demand is to get investors into the market in force to buy up these properties and meet the huge rental the demand that will continue for several years.

I’m doing my part…

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As we reported last week, hedge funds are busy working on deals, but government needs to help. Fannie Mae and Freddie Mac are currently sitting on a huge supply of foreclosed properties and facing even more down the pike.The Federal Housing Finance Agency (Fannie and Freddie’s conservator), along with the U.S. Treasury Department, need to get moving on their so-far inchoate plan to sell these REOs in bulk to investors, and in doing so, make sure said investors are provided with financial incentives to make it worth their while. As Goodman notes, these investors will be buying single family homes, not multi-family apartment buildings (which have identical units), so they need to build out property management organizations to handle repairs, manage tenants and keep the properties rented.

“I fully expect that they will end up implementing something at some point this year,” adds Goodman, “because there is simply no choice.”

Yesterday I noted the REO inventory at the GSEs and FHA is growing out of control. Part of that discussion was a reference to the plan to sell bulk REO to investors. I wouldn’t say they don’t have a choice because they can sell these to small investors. If they made investment loans easier to get, they could sell a great many of these to individuals. It’s the 1% looking for a special deal from the government who will likely end up with many of them.