Ten Facts about the Real Estate market you need to know

 

Ten Facts about the Real Estate market you need to know

by Sean O'Toole

Most of what you read in the press about the housing market does not take into account factors that are only evident if you are in the industry. Here is what I'm seeing at foreclosure ground zero in California, the top ten facts you need to know.

1. September foreclosure data are way off. National headlines declared foreclosures were down 8% in September. Problem with that reporting is that there were only 19 business days in September vs. 23 in August. Using daily averages, foreclosure volume was up 5 to 28% depending on the measure you use (Notices of Default +5%, Notices of Trustee Sale +28%, Sales at auction +18% - Stat's from www.ForeclosureRadar.com.
2. Foreclosure data do not take process delays into account. There is a minimum of a 90 day, and typically a 120-150 day, delay between notice of default and the sale of a property at auction. While sales at auction are now at $200 million per day in California, they correlate with notices of default filed four to five months ago. Notices of default have increased 58% from five months ago. Expect a similar increase in auction sales in the next five months--or perhaps worse, as the percentage of defaults that end up at auction has been steadily increasing.
3. ARM resets haven't happened yet. Despite all the talk about the problems with ARM resets over the summer, if you look at the reset charts we really didn't see big increases in resets until this month. Given that CA's foreclosure process is typically a minimum of six months from the first missed payment, don't expect to see the first big wave of foreclosures from ARM resets until March or April of 2008. Note that the next peak in resets is March 2008, and the foreclosures from that won't occur until Q3 or Q4 of 2008.
4. The main stream media talk about the credit crunch in August being an indication that the worst is over. Ridiculous. Again we won't see the impact of that in the foreclosure market until Q1 2008. We are just beginning to see the impact of the credit crunch on the non-foreclosure market. New and resale home sales in CA are down to 24,460 in September, a 26.4% decrease since August, which now represent the lowest transaction volume since DataQuick began tracking it in 1988. Note: the current wave of credit tightening severely limits the ability of those in foreclosure to refinance or sell - virtually insuring a significant increase in foreclosures in four plus months.
5. Much like government employment figures, current housing inventory level data, despite being ridiculously high, are grossly understated. No doubt many people are waiting for the market to improve in the spring before selling, especially in affluent areas. The belief is that this is temporary and conditions will improve after the Fed lowers rates and we get through the winter. I've been hearing this same argument since late 2005. At some point many of the believers will lose their faith, or be put in a position where they have to sell. There is massive, pent up, un-counted supply.
6. Congress will make matters worse. Every effort on Capital Hill, no matter how well intentioned, exacerbates the problem. Tax relief for homeowners in foreclosure eliminates a final barrier for those who have struggled to keep going. Paying for the tax relief by reducing the tax breaks from the two of five year rule on secondary properties will kill demand for second homes, one area that has modestly helped keep sales up. As for government moves to tighten lending standards, that would have helped in the 2002 to 2005 period. The market has already self-corrected considerably and some of the current proposals are draconian and can only send the market crashing faster and harder.
7. Recently announced mortgage relief programs make for great headlines, but don't expect much. There is nothing the Fed can do either. Take mortgage interest rates to 0% and most of these "home owners" still either can't afford the payments or don't want to, now that they know home prices are falling. Also, a high percentage of foreclosures now are on speculative homes; why keep paying payments on a property that isn't cash-flow positive and is underwater. In much of Califorina, even in areas where we have already seen 25-35% price declines, the cost of home ownership is still 50% to 100% more then the cost of renting, even with mortgages at zero percent. What's left, 50+ year amortization schedules? Isn't that how we got here in the first place?
8. Builders continue to build. This is absolutely nuts, but there is a rush on to complete units before things get worse. I understand this from the builders' perspective - they've spent millions on infrastructure and the only way to recoup that cost is to build and sell homes. Much like GM, it is cheaper to sell cars at a loss than close the factory. But add this inventory to the resale inventory and it creates huge oversupply. Worse, builders have been the primary drivers behind declining prices. They are aggressively discounting to the point where the resale market simply can't keep up. This has been true in places like Stockton since late 2005 where discounts of 40% from the peak are not uncommon. I had a two bedroom, 1200 square foot hme in Stockton in early 2005 that I thought I'd be able to sell for $350,000. After some delays I put it in escrow for $320k. A builder put up a sign saying new homes from the high $200,000's. I lost my buyer. Finally got it sold for $280,000. I just visited those new homes. I can get a brand new 1,700 square foot, four bedroom home for $265k, and the model home has $75,000 of furniture and smells like fresh baked cookies. Builder discounts will continue to be the primary driver behind price declines, and price declines will continue to be a primary driver behind foreclosures.
9. Median home price reports in the main stream media make conditions appear much better than they are. While Shiller attempts to look at changes in individual home prices rather than the median, the bottom line is that housing data are atrocious. Note that prices could decline 20% across the board and you could still easily have a 10% increase in the median price data. In fact this is not only possible but likely. All accounts are that the low end has been hit harder than the high end. A simple shift in the mix of what is selling can have a huge impact on median prices. Add to that the fact that until recently loan standard tightening increases in fees and credits were being built into prices at an increasing rate, skewing final prices higher than the actual value of the homes.
10. Given the current trajectory of foreclosures, the current and future negative impacts to demand, pent up and continued builder supply, and the delays in the market's visibility to what is really happening, this market contraction has a long way to go. I predict at least a 50% increase in foreclosures, and likely a doubling in properties sold at auction with a peak no earlier than Q3' 2008.

Any effort to fix this should be focused on supply and demand. It will require bold initiatives. Here are a few I have yet to see suggested. If they seem shocking, please only take it as an indication of the magnitude of the problem I see from my experience in the industry.

1. Decrease supply with a national building moratorium. If necessary, cover the builders' cost to sit on the inventory and in-the-ground improvements. It will be cheaper than other bailouts. One clear downside: this will also have an impact on unemployment as contractors have to find other work.
2. Decrease supply by provide an incentive to not sell your home for two years. Perhaps even a draconian incentive like disallowing the $250,000/500,000 capital gains exemption for two years, with exceptions for hardship.
3. Create demand by offering citizenship to qualified immigrants who purchase a home and are not late on a single payment for five years.
4. Offer tax incentives for lenders and the underlying debt holders to do short-refis where the borrower stays in the house and a portion of the debt is forgiven. Essentially a write down, perhaps to current appraised value. Create incentives for the homeowner as well; if they take the offer, eliminate tax relief on the forgiven debt only if they stay out of foreclosure for two years.

I'm sure smarter minds can come up with better ideas. But Congress's current response of over-regulation, foreclosure incentives (tax relief), and demand killers that kill incentives to buy are the opposite of what is needed.

Sean O'Toole writes for iTulip.com and is the Founder and CEO of ForeclosureRadar.com