With flattening house prices how will 300,000 SoCal loanowners get above water?
When lenders began denying short sales, underwater owners were forced to wait for higher prices to sell, and with flattening prices, they are stuck.
Lenders caused the housing market to bottom and to rally in 2012 and 2013 by favoring loan modification over foreclosure and by denying short sales to greatly reduce distressed inventories and overall supply. It worked fabulously for them, and prices rocketed upward for nearly 18 months. The abrupt rise in interest rates in mid-2013 lowered the ceiling of affordability, and the house price rally was stopped dead in its tracks.
When lenders began denying short sales, both they and the borrowers believed they would all be above water in a few years, and the loanowners would sell for enough to pay off the promissory note. This mutually held belief in rapid appreciation leading to an equity sale dissuaded many strategic defaulters and prompted many borrowers to accept loan modifications to play along. But what happens if prices stop going up? Will borrowers still wait patiently — for years — for prices to reach the peak? Will lenders extend loan modification after loan modification to keep borrowers in their homes?
The housing recovery looks to be losing steam. But that may not be a bad thing.
Unless you’re a banker or an underwater borrower who needs to see peak pricing as soon as possible. For those two groups, a stalling recovery is a disaster.
In the latest sign of a market that’s plateauing well below its past highs, home prices in Southern California grew at their slowest pace in two years in June, capping a spring selling season that never quite took off.
The median price of a home sold in the six-county Southland hit $415,000, according to real estate service DataQuick. That number is the biggest in four years, but 18% below the market’s high point in mid-2007.
And the furious gains seen this time last year are a thing of the past. In the last 12 months, home prices climbed 7.8%, barely one-fourth their pace in the prior year.
A plateau suggests there is fundamental support beneath prices. I prefer the ceiling analogy because prices are being limited by the cost of the debt-air beneath prices. If rates go down, the ceiling will go up and so will prices, but if rates go up, the ceiling will go down, and current prices will be under pressure from the weight of inventory above.
But if the market’s highflying days are over, housing in Southern California appears to be entering a healthier phase of growth, real estate agents and economists say.
“I think we’re getting back to a very normal market, finally,” said Syd Leibovitch, president of Rodeo Realty in Beverly Hills.
That depends on how you define normal. The new normal doesn’t look much like the old normal.
Tight credit standards and a still-soft economy are keeping a lid on prices, and Leibovitch said he expects that they will stay flat through the rest of this year.
Indeed, a report last week by real estate website Trulia said asking prices in Orange County — a leading indicator of the sales figures DataQuick measures — grew just four-tenths of a percent in the second quarter. But sellers, at least those with proper expectations, are still drawing multiple offers from buyers who are able to get historically cheap loans.
“This is a balanced market, and that’s a good thing,” said Rich Simonin, chief executive of Westcoe Realty in Riverside. “It is solid for sellers if their price is reasonable. And buyers can still get good interest rates.”
Those buyers have a lot more to choose from. With prices higher than they were a year ago, investors and all-cash buyers have backed away, constituting their smallest share of home sales in four years, according to DataQuick. And banks appear to be loosening the tap on loans just a bit; DataQuick’s tallies of jumbo loans and overall mortgage lending are at their highest level since 2007.
“Many of the market indicators we track continue to ease toward normalcy,” said Andrew LePage, an analyst with the San Diego data firm.
That means more of the market consists of “regular” buyers purchasing houses from “regular” sellers, said Stuart Gabriel, director of UCLA’s Ziman Center for Real Estate. And they’re buying houses that they plan to live in, not investment vehicles that they plan to flip for profit. That will insulate them from ups and downs in the future.
What is he talking about? What is giving him this insight into people’s buying motivation? During the housing bubble, people were foolishly buying houses because they believed they were good investments and that they could flip them for a profit even if that took several years. The profit motive was part of every buying decision, actually living in the property was a secondary consideration.
“That would be a good outcome all around,” he said. “Housing’s not just an investment good. It’s a consumption good. You buy a house you like and enjoy living in, and plan to live in for a while.”
Housing should never be viewed as an investment good as that’s what caused so many problems. People dump bad investments and walk away from them. Do we want to see that again?
The price slowdown, though, could leave one segment of the market stranded: the roughly 300,000 Southland households that still owe more on their homes than they’re worth.
That’s 300,000 potential sellers waiting for higher prices. Those properties are off the market today, but they will reappear as prices go up — if they go up.
Two years of rising prices have pulled many of these so-called underwater borrowers back above the surface. But at the end of the first quarter, 8.1% of home loans in metro Los Angeles remained underwater, according to data firm CoreLogic. In the Inland Empire, that figure is 17.3%.
Few of these borrowers are falling into foreclosure anymore, real estate experts say, but few can afford to sell their homes either. If prices stall, there’s little they can do but wait out the market and keep making their monthly payments, Simonin said.
“They might as well hang on,” he said. “You’ve waited out five years. What’s another?“
For the rest of us, Simonin said, this leveling off is a welcome break. For the first time in 15 years, he said, it doesn’t feel as if the housing market is either soaring or plummeting, and there’s no pressure to buy — or sell — now, lest you miss out on a windfall.
Buyers and sellers can focus on deals that make sense for all involved. In the boom-and-bust Southern California housing market, Simonin said, that’s a nice change of pace.
“This is boring and that’s OK,” he said. “The train will wreck eventually. It always does. But for now, we can enjoy a smooth ride.”
So should these underwater borrowers be looking to sell at their earliest opportunity because a train wreck is imminent?
Bubble reflation will fall short of the peak
Lenders reflated the housing bubble to the degree they can. With restricted inventory, buyers in most markets around the country pushed prices up as high as they can. Since lenders are bound by prudent lending standards, they simply can’t push prices any higher unless mortgage rates go down again or unless buyer’s incomes go up; neither alternative seems likely.
At this point house prices will rise at the rate of wage inflation at best, but if mortgage rates begin to rise, which seems likely, them house prices may not rise at all. This leaves 300,000 underwater borrowers in SoCal and nearly 10 million around the United States trapped in their houses, perhaps for a very long time.
There are only two solutions to the underwater borrower problem: either house prices must go up, or debt levels must go down. As housing markets across the country reach the limit of bubble reflation efforts, the only alternative is for borrowers to pay down their mortgages.
Fortunately, at very low interest rates, more of the payment goes toward principal than at higher rates, and we’ve had near-record low interest rates for several years. Those borrowers are amortizing their loans quickly, and any of them who are underwater will not be underwater for long. This prompts many to erroneously believe amortization on loans will solve the underwater borrower problem in time because whether or not house prices move up, loan balances are going down. Unfortunately, that is not the case.
Many of those most deeply underwater borrowed too much money at the peak either to buy or to refinance. Most couldn’t afford a fully-amortized payment on the loan, so when they borrowed, they either used interest-only or negative amortization loans. Many of those loans blew up and were foreclosed, but many more were modified. Most private-label modified home loans do not amortize, and of the 7 million modified loans, about 5.5 million are private-label. These loans were designed by lenders to benefit lenders, as I documented in Lenders benefit from loan modifications, homeowners not so much.
Loan amortization will not solve the underwater borrower problem because far too many of these loans don’t amortize. The borrower is making no progress on reducing their loan balance. In my opinion, today’s loan modifications are tomorrow’s distressed property sales.
So when will these distressed sales occur? Will all those underwater borrowers wait for the market to come back? Will some strategically default or demand a short-sale approval? Will lenders ultimately be forced to foreclose?
I believe we will see an increase in foreclosures again as first borrowers and then lenders give up on endless can-kicking. Borrowers will again default, and lenders will be forced to foreclose. Without strongly rising prices to give borrowers hope, there is little reason for them to struggle and keep renting from the bank.