Shadow Inventory Signaled Three Years of Falling Prices in 2010
Is the US housing market going down in flames again. A precipitous drop in 2008 was temporarily halted by a massive government effort, but with the market props removed, it looks like house prices are going to resume their decline.
By John Gittelsohn and Kathleen M. Howley
(c) 2010 Bloomberg News
Wednesday, September 15, 2010; 12:24 AM
Shadow inventory — the supply of homes in default or foreclosure that may be offered for sale — is preventing prices from bottoming after a 28 percent plunge from 2006, according to analysts from Moody’s Analytics Inc., Fannie Mae, Morgan Stanley and Barclays Plc. Those properties are in addition to houses that are vacant or that may soon be put on the market by owners.
“Whether it’s the sidelined, shadow or current inventory, the issue is there’s more supply than demand,” said Oliver Chang, a U.S. housing strategist with Morgan Stanley in San Francisco. “Once you reach a bottom, it will take three or four years for prices to begin to rise 1 or 2 percent a year.”
When many people read predictions like that, they dismiss it as just another opinion. There is a reason analysts believe this. Why do markets work that way? Why will it take three or four years to bottom and why will appreciation be so slow thereafter?
A good example to look at is the farmland price bubble of the 1970s — a bubble that took 20 years to reach its peak in nominal dollars. When a bubble bursts, sellers accumulate as everyone tries to bail out before prices fall further. The inevitable foreclosures plus those who purchased at higher price points form an overhead supply that must be liquidated before prices can go back up. The weight of this inventory if left unchecked will push prices well below the previous equilibrium as is now happening in Las Vegas. Over time this inventory is sold, and the weight of this inventory lessens, and prices can slowly begin to rise. It is only after all this inventory is purged can prices resume a level of appreciation equal to wage incomes.
Rising supply threatens to undermine government efforts to boost the housing market as homebuyers wait for better deals. Further price declines are necessary for a sustainable rebound as a stimulus-driven recovery falters, said Joshua Shapiro, chief U.S. economist of Maria Fiorini Ramirez Inc., a New York economic forecasting firm.
Sales of new and existing homes fell to the lowest levels on record in July as a federal tax credit for buyers expired and U.S. unemployment remained near a 26-year high. The median price of a previously owned home in the month was $182,600, about the level it was in 2003, the National Association of Realtors said.
There were 4 million homes listed with brokers for sale as of July. It would take a record 12.5 months for those properties to be sold at that month’s sales pace, according to the Chicago- based Realtors group.
“The best thing that could happen is for prices to get to a level that clears the market,” said Shapiro, who predicts prices may fall another 10 percent to 15 percent. “Right now, buyers know it hasn’t hit bottom, so they’re sitting on the sidelines.”
Inflated prices make for unmotivated buyers. Wise buyers know that prices are not going up (fools still get duped by realtors), so a deflationary psychology takes over. Buyers should wait because they will get a better deal if they do. Further, if buyers act in unison, the deflation becomes self generated. It isn’t until prices fall to the point where renting carries a heavy premium that buyers are pushed off the sidelines.
About 2 million houses will be seized by lenders by the end of next year, according to Mark Zandi, chief economist of Moody’s Analytics in West Chester, Pennsylvania. He estimates prices will drop 5 percent by 2013.
After reaching bottom, prices will gain at the historic annual pace of 3 percent, requiring more than 10 years to return to their peak, he said.
“A long if not lost decade,” Zandi said.
The national declines likely will be weighed down by more troubled markets. Working through the inventory depends on variables such as local employment and the amount of homeowner debt, said Sam Khater, chief economist for CoreLogic Inc., a Santa Ana, California-based real estate and financial information company. Nevada has the highest percentage of homes with mortgages more than the properties are worth, while New York state has the lowest, according to CoreLogic.
Douglas Duncan, chief economist for Washington-based Fannie Mae, the largest U.S. mortgage finance company, said in a Bloomberg Radio interview last week that 7 million U.S. homes are vacant or in the foreclosure process. Morgan Stanley’s Chang said the number of bank-owned and foreclosure-bound homes that have yet to hit the market is closer to 8 million.
Sandipan Deb, a residential credit strategist for Barclays in New York, said prices will drop another 8 percent — to 2002 levels — before beginning a recovery in 2014.
That is a reasonable prediction. The weight of this inventory is too much, and the banks are going to liquidate this inventory eventually, or they will own a great many houses for a very long time.
“On a national level, you have never seen a decline of this sort,” Deb said in a telephone interview. “I would caveat that by saying you also have not seen an increase on a national level like we saw from 2002 or 2003 to 2006.”
In addition to the as many as 8 million properties vacant or in foreclosure, owners of another 3.8 million homes — 5 percent of U.S. households — said they are “very likely” to put their properties on the market within six months if there is improvement, according to a July survey by Seattle-based Zillow.
“This has the potential to create a sawtooth pattern along the bottom,” Stan Humphries, Zillow’s chief economist, said in a telephone interview. “Homes begin to sell and a few sidelined sellers rush into the marketplace and flood the marketplace.”
The impact of overhead supply is as described above: sellers waiting for price improvement suddenly appear on the MLS when they get a whiff of their wishing price, and as the decline grinds on, sellers have a tendency to become more motivated and lower their wishing prices until they finally capitulate and sell the property for whatever they can get. That is the interaction between the psychology of the individual sellers and the broader market.
If the market doesn’t fall to its natural bottom, price gains in the next five to 10 years won’t keep pace with inflation as the difference is made up “on the backend,” said Barry Ritholtz, chief executive officer of FusionIQ, a New York research company. Price increases that fail to at least match inflation are the same as reductions in value, Ritholtz said.
The Obama administration’s effort to help mortgage holders, the Home Affordable Modification Program, or HAMP, is another source of future inventory as owners with new loan terms re- default, Ritholtz said. About half of the modifications done in 2009 were behind in payments by the first quarter of 2010, according to the Treasury Department.
“The belief has been: if we stimulate sales with a tax credit and delay foreclosures with modifications, the market would stabilize,” said Ritholtz, author of “Bailout Nation.” “We’re just putting off the day of reckoning and drawing out the pain by not letting the housing market hit its bottom.”
I have the utmost respect for Barry Ritholtz. His analysis is always right on.
Government policy contributed to a recent stabilization in prices that may have been an “illusion,” said Zach Pandl, an economist at Nomura Securities International Inc. The S&P/Case- Shiller index of home prices in 20 U.S. cities rose 4.2 percent in June from a year earlier. The measure is a three-month moving average, which means data in the month were still influenced by transactions that may have benefited from the tax incentive.
Even if modifications fail, keeping foreclosures off the market is worth the risk of a delayed recovery, Pandl said.
“It’s too painful and too damaging to let it happen all at once,” Pandl said from New York.
I still think that contention is nonsense. Everyone who was involved with peddling these stupid market props will look for justification of their failure after the fact. The government props were wasted money and resources. There is no silver lining in that dark cloud.
Owners of about 11 million homes, or 23 percent of households with a mortgage, owed more than their property was worth as of June 30, according to CoreLogic. Another 2.4 million borrowers had less than 5 percent equity in their houses and probably would lose money on a sale after paying broker fees and closing costs, CoreLogic said Aug 25.
In Nevada, 68 percent of homes were underwater in July, with mortgage loans statewide totaling 120 percent of home values, according to CoreLogic. Only 7.1 percent of properties in New York state were underwater, with the total loan-to-value equivalent of 50 percent, the company said.
Brandi Miner, director of marketing for the Georgia Association of Realtors, is holding back on selling her one- bedroom condominium in Atlanta’s Buckhead district because she has an underwater mortgage. She paid $155,000 for the property in 2005.
“I’m stuck,” Miner said. “I thought it was a stepping stone to a house.”
I never quite understood this “stepping stone” idea. If you buy a house because houses are going up in price, both the house you are in and the house you want are going up together. How does buying the stepping-stone house get you any closer? Or is it good enough to stay within reach?
Miner pays about $1,100 a month for her mortgage plus $225 in condo dues, a higher price than she would spend for a three-bedroom house in a good Atlanta-area neighborhood at today’s prices, she said. Selling now would cost her $10,000 to $15,000, Miner estimated.
“I’m not $200,000 in the hole, thank God,” she said. “But the quarter of the country that’s underwater — that’s me.”
That must make those California borrowers who are $200,000 in the hole realize what fools they were.
Detroit, Las Vegas and Fort Myers, Florida, will take until at least 2020 to return homeowners to positive equity, CoreLogic said in a March report that compared prices in 10 metro areas. Atlanta, Dallas and California’s Riverside and San Bernardino counties will need until 2016. The Washington, D.C., area will take the least amount of time, with negative equity disappearing around 2015, CoreLogic said.
CoreLogic is wrong. They assume all markets will bottom at equal times and at prices relative to where they are today. Since many markets never deflated, these must still decline in price before they hit bottom. The low end is close to the bottom, but the mid to high end is not. Further, Riverside County is close to the bottom, and Orange County is not.
The slide in values and record-low interest rates may offer some bargains for property hunters. Prices have returned to historically affordable levels, said Karl Case, professor emeritus of economics at Wellesley College in Wellesley, Massachusetts, and co-creator of the S&P/Case-Shiller index. He estimates a bottom for prices in six months.
“It doesn’t take a tremendous number of people to turn the housing market, because only about 5 percent of the stock trades in a given year,” Case said in a telephone interview. “There’s still a lot of people who are employed, many of whom have been looking for the opportunity to buy.”
Case is an example of a homeowner waiting to sell because of low demand. He’s seeking to sell the A-frame on 15 acres near Cooperstown, New York, that he bought for $190,000 in 2005.
“I want to keep it if I can’t get what I want,” he said. “It’s a terrific little getaway and I’m not going to give it away.”
OMG! That is so embarrassing. Karl Case is a loan owner in denial! Over the last year or so, Karl Case has been inexplicably bullish. Now I understand: he suffers from position bias. He is being influenced by his personal position in the market which he needs to move in his favor. He is not objectively looking at the data and making a sound analysis. He is instead interpreting what he sees based on what he wants to see, and in the process, he is ruining his credibility.
Some indicators show the real estate market has begun to turn a corner. Pending sales of existing houses increased 5.2 percent from June to July, the National Association of Realtors reported Sept. 2. Economists had estimated a 1 percent decline, according to the median of 37 forecasts in a Bloomberg survey.
“The market is starting to show some signs of stabilization,” Nicolas Retsinas, director emeritus of Harvard University’s Joint Center for Housing Studies, said during an Aug. 31 interview on Bloomberg Television’s “InsideTrack.” “But a robust recovery is a long time away.”
The number of U.S. homes in default or foreclosure fell to 7.04 million as of July 31 from a high of 8.12 million in January, Lender Processing Services Inc., a Jacksonville, Florida-based mortgage servicing company, reported Sept. 2.
Defaulted mortgages as of July took an average 469 days to reach foreclosure, up from 319 days in January 2009. That’s an indication lenders — with the help of the government loan modification programs — are delaying resolutions and preventing the market from flooding with distressed properties, said Herb Blecher, senior vice president for analytics at LPS.
“The efforts to date have been worthwhile,” Blecher said in a telephone interview from Denver. “They both helped borrowers stay in their homes and kept that supply of distressed properties on the market somewhat limited.”
Bullshit. The foolish series of mistakes made by people in our government and their lending overlords has squandered our resources and accomplished nothing — expect perhaps to shift these losses to US taxpayers. The market will not recover faster, nor will it regain good sales volumes until prices are lowered to levels where the inventory can be cleared.