For four years, I have stood alone in offering compelling evidence that the housing crash is far from over and that the so-called recovery is nothing more than an illusion.
Recently, concerns began to be uttered in the mainstream media that the recovery was showing signs of faltering. After all, new home sales were weak and the Case-Shiller index was showing slower price gains.
Did this mean that Wall Street economists finally thought there was something to be worried about? Not at all. Sales of million-dollar homes were stronger than ever. Wall Street is still convinced that a return of the housing collapse is totally out of the question.
With mounting signs that the housing recovery is faltering, let’s take an in-depth look at whether the recovery has any basis in reality.
Soaring Inventory of Homes for Sale
In an article published in early June, I offered evidence that the number of homes for sale has soared in major metros around the country. As I predicted, owners who had held their houses off the market expecting to get a higher price have been pouring onto the market in droves.
In Connecticut where I live, listings have been climbing rapidly for months. Take a look at this table of ten towns/cities where listings have risen substantially.
A year ago, listings in town after town were substantially lower than the previous year. This turnaround in the number of homes for sale has been dramatic and is getting worse.
It would be a mistake for you to think that this is happening only in Connecticut. The following table shows the soaring number of listings in ten major metros around the country.
If sales volume was stronger, this huge increase in home listings would not be very troublesome. However, Redfin.com’s latest report for June showed that sales volume was down year-over-year in 21 out of 29 major metros which they track. You don’t need to be a genius to understand what the soaring number of listings combined with weak sales means for home prices.
The Delinquency Problem Just Will Not Go Away
I have also been writing about the serious delinquency problem for four years. Wall Street continues to disregard the issue.
There are two key points which are absolutely crucial for you to understand.
First, the delinquency figures put out by the Mortgage Bankers Association and others are misleading and quite useless. Why? More than 22 million homeowners have had their mortgages modified since 2008. Most of them had been delinquent in their payments. Once the modifications become permanent, the loan is considered current and no longer delinquent. So of course, this pushes the delinquency rate way down. What do you think the delinquency rate would have been without these modifications?
As I have emphasized in article after article, between 40% and 80% of homeowners with modified mortgages have re-defaulted. Take a look at the latest re-default figures through July 2014 from TCW for mortgages held in private, non-guaranteed mortgage-backed securities (RMBS).
For the first time, TCW now includes the re-default rate for the 2012 and 2013 modifications. Notice how the re-default rate for the 2012 modifications has already surpassed 30% and is clearly heading higher.
Second, the servicing banks continue to avoid foreclosing on these seriously delinquent properties. This has nothing to do with court delays in those states which require judicial foreclosures. Take a good look at this map showing the average length of time that defaulted properties have been delinquent in different states as of June 2014.
Source: Black Knight Financial Services
You can see that the average length of delinquency for states which do not mandate a judicial foreclosure has now grown to more than two years. In those states which require court approval of foreclosures, the average delinquency period is almost three years.
For the worst culprit -- New York State – the average time in delinquency now approaches four years. I have written about the delinquency problem in this state since 2011. Delinquent borrowers there laugh while they remain in their home for years without either paying a nickel or being forced out through foreclosure. Before you condemn these squatters, ask yourself whether you would be able to resist such a tempting deal. By way of contrast, delinquent renters are normally evicted within six months.
I am now convinced that the servicing banks are simply not interested in pursuing foreclosure. I suspect that most of the lenders are unwilling to take the hit on their earnings that foreclosing would compel them to do.
The “too-big-to-fail” banks – which all have large servicing divisions -- have no incentive to pursue foreclosure because they own second liens on millions of properties whose first lien they service. There is a clear conflict of interest because foreclosing on the first lien would render their second lien on these underwater properties essentially worthless.
Do the lenders really think that this delaying strategy can solve the problem of seriously delinquent homeowners? My answer: I doubt that they really care about long-term solutions. Their focus is strictly on short-term earnings-per-share. They are inclined to let someone else worry about long-term solutions.
Underwater Homeowners Are Becoming Landlords with Two Properties
Several recent articles have made it increasingly clear that a growing number of homeowners have decided to rent out their home instead of selling it. Then they buy a second property. For example, an article posted this past January by CNBC’s Diana Olick pointed out that underwater owners who cannot or will not sell their property for a loss before moving have chosen to rent it out instead. She called them “accidental landlords.”
In Olick’s view, the unwillingness of so many owners to list their underwater property before buying another one was a key reason why home listings had declined so substantially in the last three years. She cited the example of one woman who told her, “When I get enough equity, I will definitely sell.” That statement articulates the problem precisely.
Another article published on CNNMoney in June emphasized that underwater homeowners were also enticed by the very low mortgage interest rate on their home and the rising rent the house could bring to forego selling their home and rent it out instead. Apparently, the burdens of becoming an accidental landlord did not deter them from becoming the owner of two properties.
An earlier article published in October 2013 by USA Today presented solid evidence that this decision by underwater owners to rent out their property was having a huge impact. The article offered very important data from the U.S. Census Bureau which showed the enormous growth in the number of houses for rent in major housing markets around the country. Take a good look at this table culled from the Census Bureau statistics.
You can see that the percentage of single-family houses which were rented has risen substantially in every one of these markets. The article pointed out that in 32 of the largest metros, at least one-fifth of occupied homes were rented out.
You need to understand that the decision by underwater homeowners to rent out their house instead of selling it is an act of desperation. During the heyday of the trade-up housing market, these owners would never have done this. They did not need to. With steadily rising home prices, they had the equity to sell their home and then put the profit into another house. Not any more.
As I have argued repeatedly for several years, this trade-up market is dead. You must get used to that idea. Until you accept this as fact, it will be very hard for you to comprehend what is occurring in major metro housing markets and what awaits us down the road.
This enormous increase in the number of single-family homes for rent is something that was overlooked by those real estate investment firms which thought they could profit handsomely from the buy-to-rent craze that swept the nation in the past few years. Unfortunately, they are competing with millions of underwater homeowners who have decided to rent out the property.
For example, Colony American Homes owned 16,500 homes as of early May according to an August article in National Mortgage News. This online mortgage news service reported that Colony’s occupancy rate for these properties was only 73%. That is terrible.
Is The Soaring Number of Homes for Rent Just Temporary?
Can anything on the horizon turn this trend around? What might cause underwater homeowners to decide to list their home for sale rather than renting it out?
Put yourself in the shoes of an underwater homeowner. Perhaps you have decided to take a job out of your area or move to where the opportunities are better. Or how about this one? You have outgrown the home you bought eight years ago and would like to buy a larger house. Unfortunately, you purchased your house at the height of the bubble and it is still underwater. You are very reluctant to either take a loss with a short sale or bring cash to the closing if you decide to sell.
What options do these homeowners have? If there is equity in their home, they can put it on the market without being troubled by these concerns. As I have shown, homeowners with equity are doing just that in increasing numbers.
Here is the problem which no one else seems to report. There are far fewer homeowners with positive equity than the media portrays. I have discussed this for several years. Let me briefly summarize why this is so.
During the bubble years of 2004 – 2007, an incredible number of first mortgages were originated either for a home purchase or a refinance. Take a good look at this chart using HMDA data from the 2010 Financial Crisis Inquiry Commission.
You can see that until 2003, origination of first mortgages for home purchase never went much above four million. Then home buying skyrocketed in the bubble years of 2003 – 2006 as speculators poured into major metros.
Even more important was the unbelievable surge in refinancing. As I discussed in a recent article on bubble-era jumbo mortgages, cash-out refinancing soared in 2004 and then reached incredible levels in 2005 – 2007. If you add in the roughly 10 million home equity lines of credit (HELOC) originated in these three years, you can begin to get a sense of the unbelievable number of homes that are underwater today.
There are now roughly 50 million first mortgages outstanding in the United States. You must understand that the vast majority of those properties with first liens originated during the bubble years of 2004 – 2007 are still underwater.
Why? According to Redfin.com, the average down payment for less expensive homes throughout the bubble years was a mere 4.2%. It was only 8.2% for mid-range houses. Hence it is safe to say that a majority of bubble-era borrowers with only a first lien are underwater.
However, the problem of underwater properties is much greater than that. Roughly 40% of these bubble-era borrowers also have a second lien. The overwhelming majority of those with both a first and second mortgage are badly underwater.
Now you may ask: What about the millions of homeowners who refinanced since 2010? Are they also underwater?
Keep in mind that the average age of mortgages refinanced in 2013 was roughly seven years. So what? Just do the arithmetic. Clearly, the overwhelming majority of these refinanced mortgages had been taken out during the bubble years. Although a high percentage of the owners who refinanced last year opted for a 15-year mortgage, it was not done to reduce the outstanding principal balance.
Since 2008, the great majority of refinancings were done by Fannie Mae and Freddie Mac – 19.4 million through May 2014 according to the Federal Housing Finance Administration (FHFA). Since August 2013 after interest rates began to rise, refinance volume has utterly collapsed. Is it because of this rate rise? Perhaps in small part. But refinancing volume actually peaked in the first quarter of last year before the rise in rates.
As I see it, the main cause of this plunge in refinancing is that we are running out of homeowners who still have equity in their house and have not yet refinanced. That leaves millions of underwater homeowners who either cannot or don’t want to refinance. Unable to sell at a profit, they have decided to rent out their house and hope for a further price rise to make them whole.
Those desperate homeowners opting to rent out their house rather than selling at a loss have no idea what headwinds await them. You do.
With listings soaring and prices now weakening around the country, the number of underwater homeowners will be increasing rather than falling. Here is my advice to you and to your clients in this situation:
- Disregard the optimistic pundits and do not assume that your underwater house will regain its equity in the foreseeable future.
- If you are thinking of moving, put your house on the market now at a realistic price and take your lumps before the market deteriorates further.
If you have clients with underwater investment properties, my analysis also applies to them. They should seriously consider liquidating their investment real estate holdings while markets are still liquid.
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.