Oct072014

How restricted for-sale housing inventory saps demand

Lenders restricted MLS inventory to drive up house prices, which also drives up rent; higher rent makes it more difficult to save for a down payment.

loan-modificationI recently asked, Do loan modifications cause rents to rise too?

We know providing loan modification subsidies serves to increase home prices because it keeps these homes off the MLS and forces buyers to pay more for those properties not burdened by a loanowner surviving on a loan modification. That mechanism is well understood. What’s less obvious is the impact this has on rent as well.

If the loanowner were not granted a loan modification, the resulting foreclosure would recycle the property and put it in the hands of an owner who would extract the full financial value. If the property is picked up by an owner-occupant, they pay a monthly mortgage payment approximating rent, thus providing a return to the investor who provided the mortgage. If the property is picked up by an investor, they charge a tenant a monthly market rent which also extracts the maximum market value.

The loanowner living in a property they can’t afford with a loan modification subsidy is preventing either owner-occupants or investors from maximizing the economic value of the property, impacting both resale prices and rental rates.

There is no question loan modifications impact resale value of homes and inflate market prices. In my opinion, the same forces impact market rent, and it explains some of why rents went up and remain high even when incomes are stagnant.

The problem with higher rents and stagnant wages means that renters pay a greater portion of their income towards housing, but it’s not only renters who pay more; homeowners do too.

How Americans Spend: 1993 vs. 2013

By Rani Molla, Sep 18, 2014

Labor Department data released last week paints a full picture of how much Americans earned and what they spent their money on in 2013. Compared to the year before, Americans earned and spent less in general, but spent more on health care and housing. What about 20 years ago?

In 1993 on average Americans spent a greater share of our total expenditures on food, entertainment and reading than we did in 2013. We spent less of our total expenditures on health care, housing and property taxes than we do now.

The charts below show how expenditures like reading and housing changed as a percentage of our total spending broken down by age group. You can see that every age group spends a smaller share of their expenditures on reading than their counterparts did 20 years ago, while every group spends more on housing.

housing expenditure

The increase housing costs has many different reasons. First, during the housing bubble, people took on excessive debts using toxic mortgage terms that caused their house payments to rise. These rising payments caused a lot of foreclosures, but for those who stayed in their houses, they’ve endured much higher mortgage payments, even with loan modifications.

Also, as rising mortgage payments caused a large number of foreclosures, those former owners entered the renter pool. These new renters flooded the market with demand, and there was a significant lag before the supply of rentals matched the demand. For example, the day after foreclosure, the family must have a rental, but the house they moved out of may be in limbo for several months as investors fixed them up for habitation or several years as lenders sat on shadow inventory. This lag caused a sudden spike in rental rates that later leveled off, but never really came down.

OCHN_Riverside_Housing_Market_Report_2014-6

These two disruptions to the housing market caused both renters and homeowners to pay higher housing costs even as house prices crashed. Further, since the bottom didn’t last very long, very few new homeowners got in while prices and the corresponding cost of ownership was low; many of these good deals were absorbed by investors. The net result is a large increase in aggregate housing costs.

The market needs down payment money

What lenders want more than anything is to replace their bad bubble-era loans with new stable loans with borrowers who can afford the payments on stable terms. They’ve already lowered mortgage rates to record lows to help this process along, but they are running into major problems with transaction volume and demand, and one of the major limiting factors is the lack of down payment money among potential homebuyers.

During the housing bubble, people had access to 100% financing, so few were saving for a down payment. After the housing bubble, the Great Recession caused many people to dip into savings just to make ends meet. jesus_Bernanke_savesFurther, since the federal reserve lowered interest rates to zero, beyond the emotional need for reserves for stress reduction, people had little or no incentive to save.

The end result of these circumstances is that very few potential homebuyers have the necessary down payment, even the paltry 3.5% required by the FHA. And since renters are putting such a larger percentage of their income toward rent, even if they wanted to endure 0.2% savings interest rates, they don’t have the disposable income necessary to save for a down payment. No down payment, no sale.

Restricting MLS inventory may help lenders in the short term, but the rising prices and rising rents in excess of wage growth is hurting demand in the long term.

delinquency_downpayment

Saving for a down payment

I prepared the Renter’s guide to preparing for home ownership) to address the down payment problem. I’ve incorporated that work into the OC Housing News Guide to Rent Versus Own Decision. Check it out.

[listing mls=”PW14107947″]