Las Vegas: a case study in successful housing market manipulation

When housing bears made their case back at the peak of the housing bubble, they made assumptions about the application of the rules — rules that were subsequently changed. By the old rules, which served us for hundreds of years, when borrowers defaulted on their loans, banks were supposed to mark the value of the loans on their books to fair market value and record any losses. Under the old regime, banks would have recognized loan losses, foreclosed on the homes, and subsequently sold the properties to recover their capital and put that capital back to work. When the government suspended mark-to-market accounting in April of 2009, the mechanism that would have put millions of REOs on the market was effectively circumvented.

With the pressure removed from lenders to foreclose, it was time to try everything possible to make prices bottom and go back up. Despite changing the accounting rules, lowering interest rates from 6.5% to 4.5%, and providing huge tax incentives, the government and the federal reserve were unable to create market momentum and put in a durable bottom. Prices did go up for a while, but they later (and quite predictably) reversed course and declined for 18 consecutive months from August of 2010 to February of 2012. The first attempt at manipulating the housing market failed. Unfortunately for lenders, failure is not an option. Banks are still exposed to $1 trillion in unsecured mortgage debt. They must make market prices go up because declining prices increases their loss exposure and puts them at risk of insolvency or bankruptcy.

So undaunted by previous failures, lenders and the government set out to engineer another bottom in the housing market and force prices to move up as quickly as possible. They corrected two of the problems they had from the previous failed market manipulation. First, they lowered interest rates even more which pushed the cost of ownership to historically low levels relative to rent. And by making the stimulus interest-rate based, they wouldn’t face the certain end date of the tax credit stimulus. Second, the banks realized it was better to keep loanowners in the house as money-renters using loan modifications even if the borrowers weren’t making full payments because loan modifications kept supply off the MLS. Further, the loan modifications made politicians happy because they were helping loanowners stay in their homes. It doesn’t seem to bother loanowners that they are paying on a larger balance because the lender tacked on missed payments, fees, lost interest and other charges. As long as they have hope of equity again someday, they will ride the market up and give most of it to the bank. With a new greater stimulus in place and effective control of the supply, the stage was finally set for a second engineered bottom. This time, they have been successful so far, and it appears they’ve created a set of circumstances that will reflate the bubble.

One of the hardest hit markets during the housing bubble was Las Vegas, Nevada. relative to historic valuations based on rent the crash there has been epic. As has been the case with other markets, the worse the mortgage distress the more supply has been withheld from the market (see: Low housing inventory is an indicator of residual mortgage distress). Bubble reflation is strongest where supply restrictions are the most extreme.

What’s Fueling the Housing Boom in Vegas?

Published: Tuesday, 5 Mar 2013 | 9:28 AM ET

By: Diana Olick — CNBC Real Estate Reporter

Chris and Candace Rodgers wanted to move to a bigger house in a better neighborhood. With the Las Vegas housing market recovering—prices still down over 50 percent from the recent peak—they figured it was the perfect time. Unfortunately, there was nothing to buy.

Demand is up somewhat off the lows of the recession, but it’s nowhere close to what it was in the early 00s even prior to the housing bubble mania. Prices are going up because there is no supply on the market.

“We looked at a lot of the existing homes, and some of them were bank owned and were in pretty bad shape,” said Chris. “By the time you replaced old stuff, put in new carpet and paint, you’re up to this price, so they might have been bargains for the base price but not after.”

Instead, the Rodgers turned to new construction. They bought exactly what they wanted from Pardee Homes, a Los Angeles-based builder with a large footprint in Las Vegas. …

The builders are doing well because they are the only stable source of supply, particularly for buyers using low-down payment loans who can’t compete with stronger offers from buyers with large down payments who waive their appraisal contingencies.

“Certainly it’s a strong comeback from where we were a year ago,” explained Klif Andrews, Nevada president of Pardee Homes. “The overall economy has gotten better, the buyers understand now that these low interest rates are a real dramatic opportunity for them, and most of all the resale inventory has dried up.

“At minimum there are at least ten thousand individual primary homeowners that are put on the sidelines because the hedge funds are coming in and absorbing the assets,” said Noah Herrera, vice president of the Greater Las Vegas Association of Realtors.

In all of the most beaten down markets, the major hedge funds are active acquiring properties. They are not active in the coastal California housing markets because our prices don’t make sense from a cashflow basis. These funds are making it even more difficult for first-time homebuyers to get properties. Many are turning to builders to meet their needs.

Investors swarmed into the Las Vegas market, much like they did in Phoenix, AZ, using all-cash private equity funds to buy distressed properties in bulk. As competition grew and supplies shrunk, prices took off. While still well below the peak, the median home price is up 24 percent in Las Vegas from a year ago, according to Applied Analysis. Part of that is a shift in the mix of homes selling, as fewer distressed homes come to market. The new dynamic has kept regular move-up buyers on the sidelines and new listings historically low.

The prices of individual homes is not up 24% in Las Vegas, but there has been significant price appreciation there.

(Read More: Home Buyers Are Back, but Where Are the Houses?)

“What’s holding people back from buying a property is a fear of selling their property and not being able to find one. That’s what the problem is,” noted Herrera.

That’s not what the problem is. It may be keeping a few sellers off the market, but the real problem is the huge percentage of underwater homes who don’t want to list and take the consequences of a short sale. Why should they? If they wait long enough, rising prices will bail them out.

The Las Vegas market is being fueled by investors, but even the investors can’t find the great bargains anymore. While the economy has improved some, the drop in foreclosures is really due to a new law that went into effect in Nevada last year; it criminalizes faulty foreclosures.

In Nevada, changes to the foreclosure laws dried up the supply. In the rest of the country, the bank settlement agreement prompted the banks to stop foreclosure. The result is the same; no foreclosures means no REO inventory to sell.

Last week I spoke at length with a real estate attorney in Las Vegas. He said one of the unintended consequences of the Nevada foreclosure law has been the suspension of nearly all private lending. If it’s not insured by the GSEs or the FHA, lenders simply won’t make the loan. Considering they probably can’t foreclose on the property, they would be foolish to do so. Their money would be entirely at risk.

Banks have therefore tried to do more short sales and loan modifications. Foreclosures in Nevada dropped 36 percent in 2012 from the previous year, according to RealtyTrac, but the distress is still there.

People in Las Vegas talk about shadow inventory to the point where nobody really wants to talk about it anymore, said Mike Brunson, a local appraiser. “People will argue and say it isn’t, but I can name a dozen people off the top of my head who have been in their houses for over three years without a payment.

Doesn’t that sound like the arguments in the comments here and on Patrick’s site? No matter how much people are exposed to the delinquency numbers, they refuse to believe there are distressed properties lingering in the market. It’s worse in Las Vegas than in many other markets because prices dropped so much that nearly everyone strategically defaulted, but the problem is everywhere.

Brunson called Las Vegas the Titanic of the real estate market. It was once thought unsinkable, and even now that the worst is over, he still thinks the market is on a well-provisioned life raft, not on solid ground.

He recognizes the market recovery is being engineered.

“The only thing that concerns me is that we have been here before and the market itself is not what is driving the price increases. It’s not that we have new employers coming in and creating tens of thousands of new jobs that are leading to people buying new houses.

This is the same argument I have been making over and over again. The demand is not coming from owner-occupants. A healthy price rally is fueled by job growth and an influx of owner-occupants adding to demand.

It’s not that there’s anything wrong with investor demand. Investor demand is usually necessary to put in a durable bottom, but investors generally don’t bid prices up in wild speculation over long periods.

It’s ‘Las Vegas is on sale,’ and investors are buying up everything they can in the used market.

Whatever the cause, the result is new construction and new life breathed into the nation’s home builders.

“There’s been a lot of talk about shadow inventory. It’s gone on for years, and the reality is there’s not enough inventory out there to meet demand today. Demand has increased, certainly our buyers see that, and we’re getting a lot of buyers because of that,” argued Andrews, whose company is, he said, building 150 percent more homes than a year ago.

He is right. The shadow inventory is not impacting the market because the houses are safely tucked away in shadow inventory. The nature of shadow inventory has changed. Rather than being must-sell inventory waiting in the shadows, now it’s can’t sell inventory suspended in the clouds. I will have a post exploring this in more detail this week.

Brunson acknowledged there is no question the demand is real. The sales are real. But he still worries about the fundamentals, such as the slow economic growth and the fact that so much of the funding for new home sales is coming from low down payment, government-backed mortgages.

“We have been here before,” said Brunson.

What remains to be seen is if history will repeat itself or if this recovery is as unique as the collapse that preceded it.

I like Mr. Brunson. His cautious skepticism mirrors my own. Since lenders are not being forced to sell property, and likely won’t be in the future, the probability of a market crash is very low. Although I don’t think a crash is likely, this engineered recovery will not be a smooth process of quickly rising prices leading to another HELOC abuse house party like 2004. Prices may fall again or flatten out for a very long time. The future is made more uncertain by the shaky foundation of market manipulation engineered by the banks. However, so far, their plan is working, and prices are rising rapidly.