It’s human nature to dream about the future. What’s going to happen next year? We all have dreams and aspirations, and the beginning of the year is usually a time of hope and optimism about the future. For those of us interested in real estate markets, it’s time to take a look at the big issues that will impact the direction of pricing, sales and affordability over the coming 12 months. With so much market manipulation, the future prices of homes largely depends on what policies come of of Washington and the boardrooms of the major banks. The old days of a free market where prices are determined by market forces are gone for the foreseeable future. Prediction the future depends on predicting policy changes, which is much harder to do.
Over the weekend, Mike posted a great recap on the main — and oft ignored — issues that will impact housing in 2013. The rest of this week, I will focus on the other issues raised by the mainstream media and provide you will a more balanced view of what the future holds.
The main issues Mike raised are as follows:
- Mortgage Forgiveness Debt Relief Act expires on December 31, 2012 for principal residences.
- Home Mortgage Interest Deduction may be capped along with all other deductions.
- Due to an impending bailout, FHA retooling of it’s fees and it’s credit guidelines.
- The Law of Diminishing Returns sets in on low mortgage rates.
These issues are being largely ignored by the mainstream media, likely because they have bearish implications, and the mainstream media has fully embraced its optimism bias toward the so-called housing recovery. Below are the big issues facing the housing market according to the Wall Street Journal.
Home prices finally hit a bottom in 2012. So will 2013 be the year of recovery or relapse? Each day this week, we offered an area of focus for 2013. Here’s a recap of our earlier predictions, and the final installment:
1. The shadow inventory is shrinking. Banks could begin to increase the pace of foreclosed-property sales in markets with large backlogs, but they’re unlikely to deluge the market.
The shadow inventory has not pummeled the housing market because lenders have become more adept at processing them. Banks went “all in” betting on success of loan modifications in 2012 and dramatically slowed their foreclosure processing. If loan modification programs are successful this time — they have proven a dismal failure over the last six years — then they may succeed in keeping these properties out of the foreclosure pipeline. In my opinion, based on previous performance of loan modification programs, the banks will fail, and foreclosure processing will pick up in 2013 and remain elevated for another two or three years while the squatters are purged from the system.
2. Rising prices could boost demand. Buyers now have something they haven’t had in the past few years—urgency. Rent and price gains are beginning to change consumer attitudes about home purchases.
Buy now or be priced out forever, right? Higher prices and rising interest rates will slow housing market appreciation and will likely reduce demand.
3. Housing inventory should hit a bottom. Builders are ramping up new construction, and price gains could lead more would-be sellers to test the market.
I hope this prediction is correct. Since inventory levels are at record lows relative to the size of the housing market, it’s likely inventory will pick up in 2013. If it doesn’t, sales volumes will plummet and the recovery will be called into question.
4. Credit standards should stay tight. While rising prices could serve as a tailwind, new regulations may lock in some of the defensive underwriting posture while impeding capital rules may lead banks to pare their lending footprint.
With the FHA facing a bailout, and with delinquency rates still very high relative to historic norms, it’s unlikely lending standards will loosen up in 2013.
5. Home prices should stay in positive territory next year, but everything ultimately depends on what happens in the economy.
An improving economy is the only thing that will increase demand among owner occupants. Until that happens, the recovery is smoke and mirrors, an illusion created by restricted supply. I think it likely that we will see owner-occupant demand break out of it’s three-year holding pattern at 1990s levels.
Job growth hasn’t been great, yet it has been strong enough to nudge the housing market forward. If it continues, the experience of the past year shows that the sector’s many challenges—tight credit, high levels of underwater borrowers, and elevated foreclosures—can be overcome.
To be sure, annual price gains of some phenomenal magnitude (see Phoenix, where prices are up 17%) aren’t sustainable unless incomes pick up. Instead, prices that have been rising in these hard-hit cities are more likely rebounding from extremely low levels—the result of housing having fallen far below its replacement costs—and recent gains should eventually level off at a more measured pace.
That is also true. I pointed out many times that prices are well below levels of historic affordability in Las Vegas and other beaten-down markets. One of the reasons I like the Las Vegas market is due to the potential for rebound appreciation. We’ve already seen it in Phoenix, and even Las Vegas was up about 10% last year.
Any renewed weakness in job growth could put housing back into the stall that it found itself in between 2010 and 2011. The housing market is still fragile. Millions of homeowners owe more than their homes are worth, and millions more don’t have enough equity to make a down payment on another home.
The lack of move-up equity is going to dog the housing market for another decade. If the crash had been allowed to proceed without government meddling, the excess debt would have been wiped out, and the resulting rally would have given everyone equity which in turn would have ignited sales in the move-up market. As it stands, any price increases end up restoring collateral value to the banks and do nothing to give loanowners equity to buy a move-up property.
If lawmakers can’t agree on a series of spending cuts and tax hikes to avert the “fiscal cliff,” that could crimp demand or damage confidence. There’s also still the potential for a renewed recession from the euro-zone crisis, or the prospect that short sales slide because Congress doesn’t extend a tax provision that allows borrowers to avoid paying taxes on forgiven mortgage debt.
The fiscal cliff talks will bring renewed scrutiny to the mortgage-interest deduction. Few expect a wholesale repeal of the deduction. More likely are compromises that cap overall deductions, that reduce the deduction for top earners, or that limit the deduction to interest on $500,000 in debt.
Those issues are a big deal. They are footnotes in this article, but if short sales get taxed on the losses, inventory will evaporate as loanowners decide to squat and take their chances with debt forgiveness after a foreclosure.
But absent a renewed recession or other unforeseen shocks, housing in 2013 looks poised to consolidate the gains of 2012.
That is optimism bias. Any of a number of easily foreseen shocks could cause housing markets to roll over in 2013.
- Interest rates could go up.
- Bank foreclosure processing could increase.
- The economy could slip into recession.
- Policy changes at the FHA or the GSEs could further restrict credit.
- Tax policy could limit the desirability of debt.
The Federal Reserve has made clear it will do what it can to be rates low. Homes are still at their most affordable levels in at least 15 years, based on traditional price-to-income and price-to-rent measures. And housing is expected to begin contributing more meaningfully to the economy.
I do believe house prices will go up in 2013, perhaps a lot if interest rates keep falling and inventory remains constricted. The market manipulations are working, and if they continue to work, house prices will go up, banks will recover more on their bad loans, loanowners and homeowners alike will rejoice, and future buyers will get hurt by higher prices and less affordability.
A crushing fall from entitlement
The former owner of today’s featured property came to rely on either free money or free housing in the 13 years she owned this property. Now that she lost her cash cow, what will she do? The adjustment from the house paying her to her paying for a rental will be rough. I can’t say I feel particularly sorry for her.
- This property was purchased for $635,000 on 2/25/1999. The owner used a $476,250 first mortgage, a $95,250 second mortgage, and a $63,500 down payment.
- On 10/14/1999 she refinanced with a $499,500 first mortgage and a $100,000 stand-alone second.
- On 1/14/2002 she refinanced with a $592,000 first mortgage.
- On 2/13/2002 she opened a $100,000 HELOC.
- On 11/26/2003 she refinanced with a $650,000 first mortgage and obtained a $47,500 stand-alone second.
- On 6/9/2005 she refinanced with a $918,000 first mortgage.
- On 7/26/2005 she obtained a $200,000 HELOC.
- On 7/30/2007, just before the credit crunch, she obtained a $500,000 HELOC.
- Total property debt was $1,418,000 assuming she maxed out the final HELOC.
- Total mortgage equity withdrawal was $846,500.
Since there was no market for properties in this price range over the last four years, the lender chose to let her squat instead. The first NOD was issued on 4/1/2009, so she didn’t make any payments since late 2008. She wasn’t booted out until 10/19/2012, a full four years later.
This former owner obtained $846,500 in free money and four years of free housing.
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Proprietary OC Housing News home purchase analysis
$819,900 …….. Asking Price
$635,000 ………. Purchase Price
2/25/1999 ………. Purchase Date
$184,900 ………. Gross Gain (Loss)
($65,592) ………… Commissions and Costs at 8%
$119,308 ………. Net Gain (Loss)
29.1% ………. Gross Percent Change
18.8% ………. Net Percent Change
1.8% ………… Annual Appreciation
Cost of Home Ownership
$819,900 …….. Asking Price
$163,980 ………… 20% Down Conventional
3.41% …………. Mortgage Interest Rate
30 ……………… Number of Years
$655,920 …….. Mortgage
$156,700 ………. Income Requirement
$2,913 ………… Monthly Mortgage Payment
$711 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$205 ………… Homeowners Insurance at 0.3%
$0 ………… Private Mortgage Insurance
$220 ………… Homeowners Association Fees
$4,048 ………. Monthly Cash Outlays
($644) ………. Tax Savings
($1,049) ………. Equity Hidden in Payment
$174 ………….. Lost Income to Down Payment
$122 ………….. Maintenance and Replacement Reserves
$2,652 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$9,699 ………… Furnishing and Move In at 1% + $1,500
$9,699 ………… Closing Costs at 1% + $1,500
$6,559 ………… Interest Points
$163,980 ………… Down Payment
$189,937 ………. Total Cash Costs
$40,600 ………. Emergency Cash Reserves
$230,537 ………. Total Savings Needed