The case against another catastrophic housing market crash
In my view, the housing market here in Orange County is entering a three to five year period of spring rallies and fall declines with prices likely to flatten. The low end may appreciate while the high end will likely come down. That makes me somewhat bearish, certainly not bullish, but neither do I believe we will see another 20% to 30% leg down in the market to match the one we already witnessed.
The first drop in the market was necessary to adjust prices back to their historic relationship to rental parity. That decline was destined to be steep because the elimination of Option ARMs and interest-only ARMs caused a sudden and dramatic decline in loan balances. The second stage in the decline will be more gentle. Japan had a similar experience. Hopefully, our decline won’t he as long lasting or as deep as theirs was.
Three factors will weigh on the market going forward. First, the overhang of supply is enormous. Lenders will be disposing of distressed inventory for another decade. Their sales will dominate the market for at least three to five years, and these sales will linger for much longer as this crisis will have a long tail.
Second, demand will be weak for a decade as those who have already gone through foreclosure and those yet to go through foreclosure rebuild their credit. In a normal market, buyers from 2002-2012 would be taking the equity from the sale of their starter homes and moving up to a nicer home. Move-up markets like Irvine or the OC beach communities would be the recipients of this move up equity in the form of large down payments. That demand is gone, at it will take a decade after the market finally bottoms before these move-up communities function as before.
And third, rising interest rates as the economy improves will increase the cost of borrowing and reduce loan balances. Hopefully, borrowers will be making more money to counteract this problem, but with persistently high unemployment dogging the market, wage inflation is years into the future.
Kool aid intoxication and the desire for mortgage equity withdrawal cannot overcome these macro forces. Plus, as prices languish year after year, even the most die-hard HELOC abusers will finally accept the housing bubble was a once-in-a-lifetime happening and not the normal state of the housing market. Kool aid will finally wear off.
NEW YORK (Minyanville) — Three years of wrong predictions notwithstanding, perma-bears are emerging from a winter’s hibernation with tall tales of another impending collapse in home prices. They could not be more wrong.
I’m not sure where he is starting from. The bears who said the 2009 rally would not last were right.
For pundits, academics, bloggers and others who get their market “color” from crunching numbers and poring over 50-page-long analyst reports, the situation is dire: Foreclosure machines are whirring again with the big attorney general settlement behind us, employment conditions remain tepid, and getting a mortgage isn’t getting any easier.
And while we may be years away from renewed, sustainable appreciations, there is little actual evidence to support the thesis that home prices are about to implode again. All the above statements by the likes of Zero Hedge may be true, but they only tell half the story and amount to a thinly veiled attempt at fear-mongering, whose real time for glory was in 2006, not 2012.
I’m not aware of any market pundits still claiming a major market implosion is imminent. Perhaps this is a bit of straw-man hyperbole to make the intro more interesting.
His assessment that the market conditions are not as dire as 2006 are true. Of course, then nobody believe the market would go down at all much less decline by more than 30%.
Here are my top five reasons why the housing market will not crash (again):
1. Foreclosure demand far outweighs supply.
The supply numbers aren’t pretty. Recent reports show that “shadow inventory,” the supply of potential foreclosures in the pipeline at banks like JP Morgan(JPM), Bank of America(BAC), Wells Fargo(WFC) and Citigroup(C), is approaching 10 million homes. And with the settlement between big mortgage servicers and state attorney generals over the robosigning debacle behind us, it is true that lenders are again foreclosing at rapid rate.
But what about demand? Buyers of foreclosed homes are literally lining up at auctions to outbid each other. Talk to anyone who is actually in the business of buying and selling bank-owned properties and they will tell you that, in most markets, demand far outweighs supply. Any property priced even remotely well sells above list with multiple offers.
I am in the business of buying and selling bank-owned properties, and although the demand is somewhat higher than years past, the real reason auctions are becoming more competitive is lack of supply. While lenders have been increasing their filings of notices of default, they have been slowing their filings of notices of sale, and they have been calling fewer auctions. In short, the demand argument is hogwash. A lack of supply is creating competitive market conditions at auction and on the MLS.
The demand pool is deep, and now there is a new buyer in town with very, very deep pockets: Wall Street.
Earlier this year, the Obama Administration announced a pilot program to try and turn the vast inventory of homes owned into rentals. Big investment houses, including Wall Street titans like Fortress, Barclays and UBS, are launching funds to snatch up big pools of homes to rent and hold. Notably, these firms’ longer term outlook and modest cash flow targets enable them to pay 10-15% higher prices than your average house flipper.
These funds are all well capitalized and are being joined by scores of family offices, smaller operators and other investors who, short of any novel investment ideas, are following the “smart money.”
This deep demand pool is more than sufficient to sop up foreclosure supply for the foreseeable future.
Wrong again. Lenders own $30 billion in California single-family homes. That’s just the current inventory in one state. Further, lenders foreclose on about $3 billion each month just in California. The largest private equity fund I know of raised a scant $450 million. Optimistic projects are that the industry will raise $100 billion this year. Even that won’t make a big difference in an $11 trillion real estate market.
Whether this trade will go well, however, is another story for another time. (Spoiler Alert: It won’t.)
I look forward to reading his reasoning on that one.
2. Rents are up, rates are down.
As household formation gains momentum in the wake of the Great Recession and real housing inventory remains tight in most metro areas, rents have been rising steadily for the past two years. Combined with low interest rates, those fortunate few who do qualify for financing are finding that the rent vs. buy calculation is tipping back in the favor of buying. Mix in a strong stock market and rising consumer confidence, and there is real, actual homebuyer demand in certain markets that will help prevent another cascade collapse in prices.
I agree with him on this point. The primary reason prices won’t collapse from here is relative affordability. As long as it’s cheaper to own than to rent, there will be demand for home ownership.
3. Homebuilding remains uneconomic.
Until home prices rise again, building new homes will remain an uneconomic prospect; the likes of Lennar, KB Home and Toll Brothers are breaking ground on precious few single family home projects. And while multifamily housing starts are hitting record levels to try and keep up with breakaway rental demand, without new home inventory coming to market, inventory of existing homes will remain relatively tight in the near term, supporting prices.
New home sales have never been a drag on resale house prices. New homes are built in reaction to a market with excess demand. The lack of a new home market is strong evidence the demand he touts in his first point does not exist. The real reason for a lack of new home sales is competition from REO dominating the housing market.
4. Political will.
There are few things on which politicians these days can actually agree. One of those few is that foreclosures are bad. Or, at the very least, a homeowner who loses his home is less likely to vote for the incumbent than look elsewhere for political leadership. And whether we agree or disagree with the relative merits of housing support schemes, politicians and regulators alike have shown remarkable resolve when it comes to propping up the the housing market. As I wrote in 2009 (see Are Housing Fundamentals Still Deteriorating?) and continue to believe today, “Betting on another all-out collapse in residential housing prices is akin to betting on the bankruptcy of the US government. Could it happen? Sure, but that certainly isn’t the base case.”
People made this same argument in 2006. Since then, the government has pulled out all the stops and resorted to unprecedented interventions in the housing and mortgage markets. Despite their efforts, prices fell more than 30%. The author is correct in pointing out that the government will continue to intervene to prop up house prices. He is not correct in believing this will have any effect.
The housing market is driven, in large part, by Americans’ view of their own economic future. If we tend to believe that we’ll keep our jobs, find spouses, be able to afford kids and will be economically okay, buying a home becomes a more appealing option. And while demographic trends surrounding both the Baby Boomer and Millennial generations don’t paint a rosy picture for home prices in the long run, improving confidence doesn’t support the notion that home prices are about to collapse, either.
Minyanville’s Todd Harrison is apt to say, “[We] must trade the tape we have rather than the tape we want.” Housing bears clinging to either past glory in predicting the market’s demise or hopes of future glory predicting another collapse would be well to remember this quip. It may be true that falling home prices could be a boon for the middle class, as prospective homeowners could get in at lower prices. Indeed, the quicker backlogged inventory clears, the quicker the market can get back to trading truly on fundamentals.
I’m not sure who he is reading that is predicting another huge decline. I predicted the first one, but I am not predicting another. However, if one were to occur, I think it would be a positive for the reasons he gave above. The doom and gloom about what would happen if house prices collapsed didn’t pan out last time, and things wouldn’t be that much worse if prices declined another 30% from where they are now.
For example, in Las Vegas, house prices declined about 65% from the peak. One would think the homebuilding industry would be dead there. It’s not. Homebuilders are active in Las Vegas building new homes at lower price points. All homebuilders need to prosper are stable or rising prices and sufficient consumer demand. How high those prices are is irrelevant.
But we live in an environment where an imminent collapse in home prices is just not likely. In fact, it could now be considered a Black Swan, if it weren’t for the fact that everyone is looking for it, rendering it no longer as such.
Lastly, for those of you who do a quick Google search on me and find my begrudging association with the National Association of Realtors, you will find two things. First, I am not a Realtor shill, and have staked my reputation on that fact. Second, my business would actually benefit from falling housing prices and a cooling of the real estate market in general.
In short, I am calling it like I see it — not talking my book. I challenge housing pundits to do the same.
–Written by Andrew Jeffery of Minyanville.
Personally, I would benefit greatly from a rise in prices. My family now owns a number of investment properties, and it would be easier to raise money to buy more properties if investors believed the housing market had bottomed. Further, my local real estate interests are transaction based. Rising house prices and motivated buyers would certainly make me more money from writing this blog. However, like Mr. Jeffery, I am calling it like I see it. House prices are going to be flat with more downside risk than upside potential. It may not be the tape we want, but it is the tape we have.
I know I disagreed with many of this author’s points, but I believe his overall thesis (I also like his book ripping on realtors). House prices are very unlikely to catastrophically collapse from here. I think it boils down to his reason #2: it’s cheaper to own than to rent, and the federal reserve is likely to make sure it stays that way for the foreseeable future through interest rate subsidies.