The Tycoon Report

Case-Shiller Makes a Strong Case for the Housing Bears

Friday, May 29, 2009 | Ethan Roberts

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This past Tuesday, the latest Case-Shiller index was reported before the stock market opened. Once again, it was not good news.

The report indicated that home prices nationwide fell 19.1% in the first quarter of 2009 from the same period one year ago, and there was a 7.5% decline from the fourth quarter of 2008. Those declines were the largest on record, and for the 12th-consecutive month, all 20 of the largest metro areas that the index tracks were showing declines year-over-year.

The hardest-hit areas within the last year were Phoenix (-36%), Las Vegas (-31%), San Francisco (-30%) and Miami (-28%). The least-scathed were Dallas (-5%), Denver (-5%) and Boston (-8%).

Three cities were able to avoid month-to-month declines. Charlotte and Denver had marginal increases, and prices in Dallas were flat. That's nothing to crow about!

cocka-doodle-er, cocka-doodle-um, aw forget it....

One thing that is becoming apparent is that there is a dichotomy between the volume of home sales being reported versus the actual home values. Confusion reigns!

During most real estate markets, increasing home sales will lead to increasing home values. Sales are beginning to show slight increases, but as I have reported in previous Tycoon Report articles, a very high percentage of those sales are either foreclosures or short sales.

In turn, those foreclosures and short sales are hurting the values of non-distressed sales. Thus, we now have a great Catch-22 at work, in which foreclosures drive down home values, and declining home values lead to more foreclosures.

Different Levels of 'Distress'

There is a huge variance in how steeply values have declined among different areas of the United States. For example, Phoenix is down a whopping 53% from its peak in mid-2006, whereas Dallas is down only 11% since its peak in 2007. The areas hit the hardest are typically the ones in which the most speculation was done, and/or the bulk of the subprime loans were produced during 2003-'07.

For the most part, home values have now returned to 2002 levels. This is a problem, because a very large percentage of the homes owned in many parts of the country were purchased between 2002 and 2007. Very few of those homeowners will have any equity in their homes anymore.

What will they do if they need to sell? Will they just walk away and let their homes fall to foreclosure, try to get the lenders to do a short sale, or will they rent their homes? Any of these alternatives leaves them with no equity to purchase another home.

What amazes me is that the stock market did not tank on this news. In fact, an hour later, the consumer sentiment readings came in higher than expected, and the market simply forgot all about North Korean nuke tests and declining home values.

Is that timing just a coincidence? Hmmmm, I wonder.

Barbara Cohen's recent Tycoon articles about artificial inflation of the stock market has me wondering now whenever something like this occurs. But I best not get too paranoid, or else you folks will be recommending the straitjacket for me!

Ethan senses a vast conspiracy afoot.....

Recently there has been talk of another wave of foreclosures, looming on the horizon. We've already had the subprime-loan meltdown, and the fleeing investors who could not sell the flips bought at the market peak. With rising unemployment, we may be about to see a new wave of conventional-mortgage defaults from people with a history of good credit, but not enough in savings to offset job losses or cutbacks from full time to part time.

First-Time Buyers May Be Renting for a Bit Longer ...

Furthermore, lending standards remain as tight as ever. This past weekend, I showed a foreclosure condo to a young woman, who is a first-time homebuyer. The price was very affordable, the unit was in excellent condition, the location was great for her, and she was eager to make an offer.

However, after a half-hour conversation with her mortgage loan officer, I realized that trying to get loan approval on this condo with her FHA loan would be nearly impossible. The FHA rules on condos make it extremely difficult these days to be approved, but not through any fault of the buyer.

These are just some of the rules found in the FHA Condo Requirement Mortgagee Letter:

1) At least 51% of the units in the condominium must be owner-occupied.

2) No single entity may own more than 10% of the total units.

3) There can be no special assessments pending in the condominium.

4) No legal action is pending against the condominium association, or its officers or directors.

5) At least 90% of the total units in the project have been sold.

And the one I like the best....

6) For projects of over 30 units, no more than 10% of the total units are encumbered by FHA-insured mortgages. For projects of 30 units or less, no more than 20% of the total units can be encumbered by FHA-insured mortgages.

So, what FHA is really saying is, "If we are already in there too much, you can't buy a condo with our loan!"

This reminds me of the infamous Groucho Marx line, "I don't care to belong to a club that accepts people like me as members!"

Groucho ponders how he's going to get his FHA loan approved ...

Now, I understand that there are very good reasons for all of these FHA regulations, and they are based upon risk assessment from years of prior lending statistics. But try telling that to a young woman with her heart set on finally finding the perfect first home for herself!

So, with all of the FHA red tape acting as a barrier to her purchase, and given her good credit scores, I asked the loan officer whether taking out a conventional loan was an option for her.

You know what he said?

"No way!"

The problem is that, despite her good credit, she doesn't have a lot of money saved for a downpayment. Right now on condos, even owner occupants have to put down 20% for a conventional mortgage!

On single-family homes, an owner occupant taking a conventional mortgage only needs 5% with some lenders, 10% with others. But there is no longer personal mortgage insurance (PMI) being written for condo loans, so a larger downpayment is required.

It is not my intent to debate the merits of the current tighter lender standards, but simply to highlight them to show one of the main reasons why this week's Case-Shiller index was so bad. So the bottom line is, tighter loan standards, plus rising unemployment, plus continued fear in the marketplace will keep us from reaching a bottom and a turnaround any time soon.

So, if you are trying to sell a home right now, I wish you luck. Your task is difficult. Make sure you have a good realtor to help you price it correctly (which may be less than what you would like).

If you are trying to buy a home right now, the best guidance I can give you is to buy a foreclosure or other distressed sale with enough current equity in it to protect you from any further declines in your local area.

And maybe you should check out Denver, Dallas or Charlotte. I hear their weather is very nice!