Housing Inventory
The year 2007 changed real estate forever. For the first time in modern history, not only have real estate prices since then declined, but it is a prolonged decline and one of substantial magnitude.
When we buy a car, we are trained to expect that the car will decline in value the second it is driven off the lot. When we buy a house, we are trained to expect that the value of the house will appreciate in the future – it is merely held to be a question of by how much and how soon. The entire real estate market was structured based on this belief, from mortgage financing to household financial planning.
Now that real estate price appreciation is no longer guaranteed, economists and housing analysts who continue to rely on what are probably obsolete indicators may be misled.
At the moment, housing bulls opine that "inventory" is low, which is regarded as a sign of a housing market recovery. Is that a valid opinion? It may not be. Allow me to state my case.
Housing inventory is defined as the total number of existing homes plus the new homes completed minus the homes that have been torn down. It is a rather static number and changes very slowly over time. As an indicator, it has little practical use, it is just a number for economists and housing analysts to use in their reports. In order for "inventory" to be meaningful, it needs to be more specific, such as REO inventory in Stockton California or standing inventory of new homes in Sacramento.
The "inventory" that most housing analysts refer to represents generic homes for sale. It is absolutely true that in many metro areas, the for sale inventory is very low, especially at the entry level. There are a number of reasons for this phenomenon:
CANNOT SELL. Corelogic has been estimating under water mortgages for a few years now. Their latest estimate is roughly 11 million, or about 23% of all mortgages. Zillow recently came up with their own estimate of 15.7 million, or about 31.4% of all mortgages. But these estimates are only for the purpose of calculating gross equity. If a homeowner has to sell, one must deduct about 10% selling cost from the equity and the percentage of under water mortgages goes even higher.
Since under water mortgages are more prevalent in lower priced homes, I would not be surprised if over 50% of all entry level homes are in the "cannot sell" category.
WILL NOT SELL. In theory, all homeowners with about 10% equity can sell their property without having to pay for deficiencies, but why would they? If they sell and net an insufficient amount to buy a replacement, why should they sell?
For those who have adequate equity and qualifications to take advantage of current low mortgage rates, they have usually refinanced already. Some may even have refinanced numerous times as rates have declined continuously during the last few years. Now that they have locked in a low rate, there is little incentive for them to sell, especially if it is for a horizontal trade.
If rates go up from here, this group would have even less incentive to sell.
Then there is the psychological barrier. The vast majority of homes purchased as far back as 2003 is worth less today than the original purchase price. Homeowners do not like to sell for less than what they put in. The easiest decision for homeowners in that predicament is to wait it out, which may be a long time.
REOs. This was a steady source of entry level homes. Numerous lenders are holding back an unknown number of properties, mostly for the purpose of selling them in bulk to investors. The wisdom of taking affordable housing from entry level buyers and giving it to fat cat investors is something that escapes me. Only housing experts like Ben Bernanke understand why that would be good for the real estate market.
FLIPPERS AND INVESTORS. During the past few years, investors have been purchasing a significant portion of starter homes. Lately, the flippers have less opportunities to flip. Long term investors would rather keep the cash flow and are unlikely to be offering their inventory for sale without significant price appreciation.
MORE DELAYS. With the settlement of the robo-signing affair, many lenders are reviewing applications for a new round of modifications, including principal reduction. I have no idea how many properties are held off the market due to this process, nor do I know how many will eventually come back on the market.
The above mentioned phenomena may offer an explanation for why the public builders are enjoying the best spring selling season in many years. The builders are always willing sellers. They are also uniquely positioned to take advantage of the giveaway government financing programs. In short, qualified buyers are a rare breed these days. The builders have a few months to coach the marginally qualified buyers into a loan while the house is being constructed.
With the competition from existing homes curtailed and competition for marginal buyers eliminated, how well are the builders really doing? Here is a chart from my cyber friend Calculated Risk:
New Home Sales and recessions, via Calculated Risk – click chart for better resolution.
Headlines from home builders may suggest a very healthy percentage increase in orders, from the dismal pace of the last couple of years. The reality is that in spite of all the accommodations, there are no buyers. Builders still dream of the golden years when buyers were camping out for days just to have the privilege of overpaying for a tract home. As to the few genuinely strong markets like Phoenix, this may be great for Phoenix, but it not going to make homeowners in Detroit feel any better.
In conclusion, June is going to be a very exciting month. The elections in Greece should affect US Treasuries and subsequently mortgage interest rates. The end of Operation Twist and whatever kind of 'QE3' may be implemented thereafter should also impact mortgage rates. In my opinion, if mortgage rates remain at current levels or even increase, all false hopes of a real estate recovery will vanish.
Source: Acting Man
