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After more than a year of trumpeting the so-called housing recovery, pundits are beginning to show signs of worry. Existing home sales are weakening, new home sales are dismal, and even the Case-Shiller Index is showing signs that prices are leveling off. The Fed's new Chairperson – Janet Yellen – has expressed her concern more than once.
With all this anxiety, now is a good time to take another look at the true state of housing markets around the country.
The Basic Problem: Death of the Trade-Up Market
The pundits and Wall Street economists have not yet understood that this is the fundamental cause of the housing collapse. Let me summarize the problem for you.
During the roughly 50 years of rising home prices, the first-time buyer was the foundation of the housing market boom. This younger buyer would purchase a home which was smaller and less expensive than most houses. That would enable the seller to "trade up" to a larger, nicer home. These trade-up sellers would then buy and enable another trade-up buyer to do the same.
This trading up was possible because the seller almost always posted a profit on the sale of the house and could plow that into a more expensive home. When the bubble finally burst in late 2006, speculators dumped their properties on the market in metro after metro and prices no longer rose.
Listings soared and sales slowed down even in the hottest markets. Then prices began to decline. That posed a serious problem for the trade-up buyer. Many of them found that they had little or no profit with which to buy another home. A growing number found themselves "underwater." Because they had put little or nothing down, the value of their home was less than the mortgage on the property.
Making matters worse was that after the sub-prime collapse in the spring of 2007, lenders finally tightened up their underwriting standards. They began to demand down payments as in the pre-boom days – 20% or even more. With little or no profit garnered from selling, would-be buyers could not come up with such a steep down payment. Nor could the first time buyer.
And so the trade-up game came to a screeching halt. It has never returned. You need to understand that it will not be coming back. Do I mean never? Not quite. My answer -- not for a long, long time.
Were it not for all-cash buyers propping up the market in a big way over the last few years, prices would have crashed much further. Housing markets are still heavily dependent on the all-cash buyer. Take a good look at this very revealing table from Redfin. It covers 2014 through April.
The Awful State of Housing Markets in Connecticut
I live in Connecticut where we have access to the most detailed and up-to-date housing market statistics in the nation. The firm Raveis & Co. is the largest family-owned brokerage firm in the northeast with offices in six states.
On the Raveis.com website, you can find monthly statistics on every town and city in five New England states and Westchester County in New York. I have posted statistics from the website in several articles. A recent search of the website enabled me to come up with these significant numbers for ten towns and cities in Connecticut. Take a good look.
Let me explain what the numbers tell us. Keep in mind that these are raw, unadjusted numbers – no indices. First, sales are weakening in many Connecticut towns. In doing my search, I found some towns whose April sales were lower than for March. That is terrible.
Second, year-over-year change in average price-per-square-foot (psf) for homes sold is down in a large majority of towns and cities. In Connecticut, we are not seeing a slowing of price increases as the mainstream media and the Case-Shiller Index show. What the raveis.com figures show is actual price declines.
Finally, inventory of homes for sale is rising rapidly. As I have predicted in several articles, homeowners who had waited have decided it is time to put their home on the market. This is also happening in other states covered by raveis.com. If you want to do some research yourself, just go to the raveis.com homepage and link to "Local Housing Data."
Don't think this is limited to the northeast. Take a good look at this Redfin chart for six west coast metros.
Those are huge year-over-year declines in home sales. The growth in homes listed for sale is also very great.
In mid-May, Redfin released housing market figures for April. They show similar weak sales and growing number of listings for metros around the country
These statistics tell the same story as the previous two graphics – weak sales and soaring listings of homes for sale.
In early March, I published an article which discussed why for-sale inventory had plunged for the past two years. I also showed solid evidence from a recent Redfin report that home sellers were going to start listing their homes in a big way. That is exactly what these three graphics show.
What Redfin Can Tell Us
For months now, the online brokerage firm, Redfin.com, has been attempting to explain why the number of active home sellers has declined so drastically in the last two years. I have posted several of their illuminating charts in recent articles.
In a Redfin article posted in late April, they tackled the question of "Why Aren't There More Homes for Sale?" From their research, they came up with this very interesting pie chart showing a breakdown of which homeowners were unlikely to sell their home.
Let me explain this pie chart. As Redfin calculates it, 19% of homeowners have little equity or are underwater with their mortgage. They purchased a house or refinanced between 2004 and 2009. If they were to sell their house, they would not have sufficient cash from the sale to purchase another home.
Another 16% purchased or refinanced between 2011 and 2013 and locked in a low mortgage rate. Were they to sell their home, they would be forced to take out a higher rate mortgage. Redfin argues that they are unlikely to do that.
Finally, 14% purchased or refinanced some time in the last seven years. While they may have enough equity to trade up to a nicer home, they may not be ready to do so.
HELOC Disaster That is Coming
While the Redfin pie chart is revealing, it badly underestimates the extent of the problem. Like all attempts to determine the number of underwater homeowners, Redfin does not include second liens. I have published several articles over the past few years on the home equity lines of credit (HELOC) disaster. The most recent article dealt with what has already begun – the resetting of HELOCs into fully amortizing loans.
Let me briefly explain the HELOC debacle. During the bubble years of 2005 – 2007, HELOCs were doled out to nearly any homeowner who was breathing. In these three years of insanity, roughly 10.8 million HELOCs were originated. Nearly 40% of all these bubble-era HELOCs were taken out in California. Amazingly, more than half of all these HELOCs were actually refinancings of HELOCs taken out only a couple of years earlier.
Although some of these HELOCs have been written off by the banks, the vast majority are still in existence. One of the "too big to fail" banks had $76 billion of these HELOCs still on its balance sheet at the end of the first quarter in 2014. Because these second liens were taken out at the height of the bubble years, it is not an exaggeration to say that perhaps 98% (or more) of homes with these outstanding HELOCs are underwater.
To get a more comprehensive picture of the number of underwater homes, you need to add in the millions of homeowners with HELOCs taken out between 2005 and 2007. These HELOCs will be resetting into fully amortizing loans over the next 3 ½ years. Monthly payments on resetting HELOCs could double or triple. This reset will come as a real shock to these homeowners.
The Refinancing Madness of the Bubble Years
Wall Street has paid almost no attention to the refinancing lunacy that occurred during the key years 2003 - 2006. Yet it is one of the keys in solving the question of why the housing collapse is far from over.
As rampant speculation fueled the housing bubble, homeowners were watching the value of their homes soar. The temptation to pull some of the growing equity out of their house through "cash-out" refinancing was irresistible. Take a look at this chart put out in April 2010 by the President's Financial Crisis Inquiry Commission.
These figures are derived from data which lending institutions are required to report under the Home Mortgage Disclosure Act (HMDA). Notice how refinancing skyrocketed in 2002 - 2003.
More than 24 million mortgages were refinanced just in those two years. Most were homeowners looking to lower the interest rate on their mortgage – a common purpose of traditional refinancing. The Fed had drastically lowered interest rates to minimize the economic fallout from 9/11.
However, a rising percentage were "cash-out refis" where homeowners unlocked the equity in their houses by taking out a mortgage larger than the previous one.
According to HMDA data, more than $2.5 trillion in newly-refinanced loans was originated in 2003. That was more than twice the amount originated just two years earlier.
Nothing so massive had ever been seen before. More shocking was the fact that the median age of the loans that were refinanced in 2003 was less than two years. Owners realized that their home had become a wondrous source of easily obtainable cash.
Freddie Mac calculated that roughly $146 billion was pulled out in "cash-out refis" during 2003. This was a pittance compared to what was coming. In 2004 – 2007 homeowners tapped the equity in their house by pulling out an incredible $962 billion through refinancing. At the peak in 2006 roughly $318 billion was extracted through cash-out refis. These are truly incredible numbers.
Can you see where I am heading with this analysis? To understand the enormity of the underwater problem, you also need to grasp the size of the refinancing frenzy that occurred across the country in 2003 - 2006. Millions of homes that were purchased in 2001 or 2002 were refinanced a few years later with a cash-out first lien. Countless other homeowners tacked on a HELOC and also refinanced that a year or two later.
Millions of homeowners who had purchased prior to 2001 simply refinanced either their first mortgage or second lien and ended up with a much larger total debt on their home.
So if you believe that the mortgages outstanding in the nation today were taken out over quite a few different years, think again. The vast majority of today's mortgages were originated during the insane bubble years of 2004 - 2007. A very high percentage of them are still underwater. It is essential for you and your clients to understand this.
The problem is mind-boggling and will not go away. Wishful thinking will not help at all.
I urge you not to listen to the pundits and Wall Street economists who continue to insist that we are on the path to housing recovery. If you follow them, you and your clients will make major investing mistakes that will cost plenty.
New home sales will not be picking up, so buying home builder stocks should be avoided.
If you are not sure whether your clients should sell their investment homes, my advice is to list them now before markets weaken further.
Finally, as I have made clear in previous writings, this is the time to sell mortgage REITs, not to buy them.
Keith Jurow is a real estate analyst and former author of Minyanville's Housing Market Report. His new subscription real estate report – Capital Preservation Real Estate Report – launched last year.