Are Home Prices Falling, or Being Pushed Down?
Friday, April 10, 2009 | Ethan Roberts
One of the most frequent questions that I am asked these days is, "Are we close to a bottom in the housing market yet?"
It's a tough question because, just like with stocks, there are multiple forces at work that are all painting a rather confusing picture of the real estate market. And every time I think I just about have it figured out, something else happens that simply leaves me scratching my head in bewilderment.
Dang it, now what?!
Take this past week, for example. The stock market was moving up on word that pending home sales were once again higher. Now, I don't put a lot of stock (no pun intended) into pending home sales, because almost 40% of the current pending contracts are failing to close because the buyers can't get loan approval! Even though the buyers are pre-qualified, usually by automated underwriting systems, when the files go to the underwriters, they are still being rejected.
I'll give you one example. Let's say someone decides they want to move out of their home, rent it out and then move into another home. At one time, this would have been a simple loan to approve, with a contingency of course, that the borrower would have to have a valid lease on their former home in place prior to closing on the new one.
But now, underwriters have become concerned about something known as "Buy and bail." This is the term for a person who moves out of an expensive home that was financed near the market peak with a zero-down mortgage, moves into a similar (but now less-expensive) home, rents out the old home for a while, but then just lets it go into foreclosure.
The owner knows that their credit will take a hit, but they have already bought another home. And especially if they have a well-running car, they may not even care whether their credit is ruined for a few years. They just walk away from the upside-down mortgage, which is usually much more than the rent payments they are receiving. Therefore, the underwriters do not want to approve a new loan for borrowers in this situation, whether they have any intention or not of doing the "buy and bail."
Essentially, all will suffer for the sins of a few.
So the only valid real estate statistic, as I have mentioned before, is the closed sale. That means a done deal, with the escrow closed and the keys handed over to the new buyer. Wall Street gets all excited when the National Association of Realtors puts out statistics about the pending sales, but right now it's really just a public relations shell game.
A young homebuyer gets a lesson in pending home sales
Now, I always have to be careful not to make assumptions about the national real estate market based solely on the statistics of my own region in Northeast Florida. But I can tell you that, for the last year or two, the monthly sales here have been a surprisingly accurate forecast for how the rest of the country will do. In fact, knowing how my area has done before the national real estate news comes out, gives me an advantage in knowing whether to trade stock indexes long or short prior to the announcements.
Interestingly, the recent sales in my area are showing improvement. The March closed sales numbers were higher than the ones in February, and February was also up from January. Folks, this is a very good sign.
Also, the March 2009 year-over-year closed sales were almost identical to the March 2008 number. This is a trend that actual began last September, and has continued each and every month since then, and would suggest a bottoming process.
However, as I also mentioned in last week's article, close to half of all the sales right now are either foreclosures or short sales. While this is reducing the huge total inventory of unsold homes, it is doing very little for the majority of unsold non-distressed homes on the market. In fact, the cheaper prices of the foreclosures are steering people away from the non-distressed homes.
There was a time when a foreclosure or two in a neighborhood would not have much of an effect upon the appraisal on a non-distressed home sale. It was typical for appraisers to use three regular sales within the last six months from the same neighborhood, when determining a home value for a sale or a refinance. When there weren't enough sales in that specific neighborhood, they were permitted to look within a two-mile radius to find comparative sales.
However, things are changing radically. New announcements are mandating that appraisers to use at least two comparable sales from only the last 90 days, and only from within a one-mile radius. Since there have been fewer sales, they have to use foreclosure or short sales more often when doing appraisals, and this is trouncing the value of the subject homes.
One has to wonder if the forces from above (i.e., FHA, Fannie Mae) are now putting pressure on appraisers to push prices down in an effort to force a price bottom and an increase in sales. Question: Is this the capitulation stage of the real estate market, and is it being artificially induced so as to speed up the U.S. recovery?
Or am I just being paranoid?
Ethan, with another paranoia-induced sleepless night ...
Another negative is that we are also seeing an increase in the default rate for FHA loans. The default rate has recently risen from 5% to 7%. Default is defined as either 90 days overdue or already in foreclosure. If this continues, taxpayer dollars may have to be used to subsidize the FHA mortgage insurance program for the very first time. Said HUD Secretary Shaun Donovan, "We should, within a few weeks, be able to present to you our estimates of whether (or not) it will be self-financing."
Donovan also defended the default increase by comparing FHA to the subprime loans and noting that the subprime default rate of 23% was much higher.
What kind of rationale is that? Seven out of every 100 loans are going into default, but that's OK with Mr. Donovan because 23 out of every 100 subprime loans have defaulted?
This is the very same program that President Obama and other government officials boasted would NOT have to be subsidized by Average Joe and Sally because the Mortgage Insurance Premium (MIP) built into in all FHA loans would cover any and all defaults.
Even the normally stoic feline had to laugh at that one ...
What we are left with is an interesting tug-of-war between the government's stimulus and home-ownership programs, versus the ever-tightening of the (government-controlled) Fannie Mae and FHA credit markets. Give the first-time homebuyer an $8,000 tax credit for buying a home, but then pressure the lenders to make it as difficult as possible for that buyer to qualify. Lower the interest rates to historically low levels, then increase the mandatory FICO scores, downpayments and debt-to-income ratio.
It's the government vs the government in an absurd tug-of-war ...
I'm not saying that these increased lender restrictions are bad. Far from it; I do think we need to make the standards tougher than in previous years, to decrease the threat of future defaults. My objection is with a government that pretends to really want to help the little guy while, behind the scenes, it does everything it can do to prevent the little guy from obtaining his dream.
So, that giant screeching noise you may be hearing right now is not the sound of home prices falling, so much as it is the sound of home prices being artificially pushed down as quickly as possible. When the bottom will actually come is still anybody's guess!
Capitulation, anyone?
See you next week!
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Ethan Roberts
Chief Investment Officer
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