Spring brings signs of hope and renewal — except in the housing market
Barry Ritholtz
Washington Post
April 7, 10:02 AM



Ahhh, winter is finally over. Each year about this time, flowers push up through the soil, trees begin to bud — and the stories about a real estate recovery appear.

Am I skeptic? But of course. To understand why, let’s consider a few questions:

What is shadow inventory?

This is important, as lowering the total inventory of houses for sale is how prices stabilize and sales volume moves higher.

Most buyers are familiar with ordinary inventory — houses listed for sale with real estate agents or by owners. Unfortunately, shadow inventory adds to the backlog. It includes bank-owned real estate, distressed houses not yet for sale, short sales and delinquencies that have not yet defaulted. Foreclosure properties are also in the shadow inventory.

These houses will eventually become part of the total supply for sale. Although there is no official count, estimates of potential shadow inventory run as high as 10 million.

That’s not all. There’s also a huge overhang of underwater homeowners — whose houses are worth as much as 25 percent less than what is owed. The owners don’t qualify for a mortgage modification. They may be delinquent but aren’t in default.

Two-thirds of all U.S. houses have mortgages. Of those, an estimated 21 to 29 percent of the mortgages are underwater, or up to 16 million houses. When prices finally do rise, we can expect many of these no-longer-underwater owners to put their houses up for sale. If only one in three do, that is another 5 million homes in inventory.

Are houses affordable?

Here’s where every discussion of affordability seems to start: the National Association of Realtors Home Affordability Index. In my view, it’s worthless.

Why did I come to such a harsh conclusion? The index offers little insight into how affordable housing actually is. In the biggest run up in housing prices in American history, the index never dipped into the level of unaffordable. Imagine that.

As ridiculous as that sounds, it’s even more absurd when we look at the NAR methodology, which ignores factors such as family savings rates, cash assets, consumer credit, indebtedness, credit servicing obligations, inflation and income gains.

The affordability index looks at the wrong things and ignores the important ones. The correct question is not whether the houses are affordable in theory. Rather, it’s whether potential buyers can afford to buy them.

Why does this matter?

In the real world, buyers have to be able to meet two key financial factors: down payments and mortgages.

Today, most families are cash poor and debt rich. They are deleveraging, not building up savings. Most simply do not have the $40,000 to put 20 percent down on a median priced house.

If you happen to have a down payment, there’s another hurdle: Qualifying for a mortgage. You must have a good credit score, not too much debt, a steady income, good employment history, etc.

The simple truth: House prices are down 35 percent from their peaks and mortgage rates are at record lows, but for those lacking the down payment and /or ability to access mortgage credit, houses are only theoretically affordable — but not for them.

Are the prices cheap?

Few had forecast the steep drop in median house prices.

Some regions that were excessively frothy during the boom — California, Las Vegas, South Florida and Arizona — have seen much greater price drops. Other areas had laws (Texas) or financial conventions (New York City) that mandated significant down payments and other prudent requirements and avoided much of the bloodshed.

The conventional wisdom seems to be that prices have stabilized and are overdue to start rising. The data, however, suggest something else. The most recent Standard & Poor’s / Case-Shiller index of national prices (January) shows prices are still falling, about 4 percent year-over-year.

There are some favorable factors:

• Prices are falling more slowly than they had been earlier.

• Nationally, house prices are back to where they were in 2003.

• The median prices of renting vs. buying now favor buying.

It’s not terrific progress, but it’s a marked improvement over three years ago.

What is the psychology of renting?

As the chart shows, costs of owning vs. renting are back to where they were in 1997, 1988 and 1976. The context is obviously different today. However, this is a favorite metric to show that houses are not all that expensive.

While rentals look less appealing as they go up in price, the other side of the equation is simple mean reversion. By most other metrics, house prices have nearly reverted to the mean.

The relationship between median income and median purchase price is yet another crucial factor, as any buyer who has a down payment and qualifies for a mortgage must earn enough to pay the mortgage.

And therein lies the rub: Real incomes have been mostly flat for a decade. Without real income growth, buying power simply remains flat. As you might imagine, that does not help price recovery in residential real estate.

House prices relative to income have come back down nearly to the mean. The uptick in 2009-10 was based on the first-time buyer tax credit. Once that expired, the prices dropped again.

So prices remain slightly elevated relative to where they have been historically. The variable, of course, is mortgage rates. The Fed’s zero interest rate policy is keeping mortgage rates at unprecedented low levels.

How do asset prices behave following a bubble?

Regardless of the asset class — stocks, bonds, commodities, houses, etc. — assets do not merely stabilize. We have never seen a stock market run up into bubble territory and then revert to fair value. Instead, we careen wildly past that level, to deeply undersold and exceedingly cheap.

That is the marvelous mechanism of markets. It is how assets are repriced, distressed holdings liquidated, capital markets stabilized, fools revealed, speculators punished — and money returned to its rightful owner, the prudent investor.

For a lasting recovery, we need to see houses cheap enough that they fall into “good hands” — long-term owners who can afford their mortgage payments.

Until that happens, houses will stumble along the bottom of the price range. The nation could easily see another 10 percent to the downside — assuming nothing else goes wrong.

This would actually be good news. The government interventions (first-time buyer tax credit, mortgage modifications and foreclosure abatements) have prevented prices from finding their own levels. If they did, houses would be much more affordable, and buyers would come out in droves.

That is how a true housing recovery begins.


Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. @Ritholtz

Category: Apprenticed Investor, Credit, Real Estate

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

16 Responses to “Spring brings signs of hope and renewal — except in the housing market”

  1. econ scott says:

    Excellent article – all bubbles do go BELOW trend line so housing prices have a little ways to go-real estate troughs are made of exhaustion – not people lining up three deep to buy with 100% cash.

  2. Bridget says:

    Actually, Texas did not have laws requiring large down payments. In purchasing homes, Texans were as able as the rest of the country to utilize all sorts of low and no down payment financing. However, there were some fairly significant restrictions on their ability to cash in on home equity, being largely limited to home equity loans that did not cause mortgage debt to exceed 80% of the home’s value. (once upon a time home equity loans were far more restricted by the state constitution, but the banks persuaded Texans to amend the constitution some years back).

    Some of those who purchased homes during the boom years utilizing no down payment loans will have found themselves upside down. But housing prices never climbed as far and as fast in Texas, so for the most part they are not as far under water. And, if you’ve got nothing down, and no other assets for the lender to pursue, you’ve not got much to lose, do you?

  3. carleric says:

    My daughter is owner/operator of a small Houston-based real estate brokerage and she is convinced you are right and the NAR simply sucks canal water. We have a long long way t go before the market finally stabilizes.

  4. Squashy1 says:

    Econ Scott: Could you provide an example of a housing price trough made of exhaustion in any US market at any time? I’m wondering about the length of time it took to fall, to revert to the mean and/or recover to higher levels. thx

  5. NeutralObserver says:

    This is a story about shadow inventory. My neighbors in the house behind me are selling their house and my wife and I thought maybe we would buy it as income property. We looked on Zillow and didn’t see too many foreclosures except there is one indicated right on my corner. I drove around the neighborhood looking for houses with signs of foreclosure activity, but I did not see too much. So I asked our delivery person what they observed. Whoa!! I got the report that there were many foreclosures in the area and that as soon as the bank kicks the occupants out, the bank rents it to tenants without ever even considering putting the houses on the market. Further it seems there were a whole new bunch of foreclosures over this past Christmas and they were all rented out by the end of January to tenants (not the original “owners”). I am guessing that the banks are either doing this so that they can sell off these properties in blocks to investors as rental properties, or at least keep the properties on their books at full value. So if you think this housing crisis is over and that prices have bottomed, think again. Ask your pool guy, the gardeners, your mail carrier, the delivery people what they see in your neighborhood. You might be surprised.

  6. Simon says:

    I don’t expect the people who made, at least in part, their reputation predicting a major market event to be the best placed to call its end. To this I would add; not all ends are the same, all actors learn and adapt to the current set of circumstances. Additionally those who enabled the bubble are still in power and to some extent may well rather like to see something along similar lines happen again, perhaps thinking that maybe this time they can control it or at least they may relish another chance to try.

  7. Evan says:

    We have been looking for a new house in the San Fernando Valley of Los Angeles. What we have learned is that there are two housing markets. The first, about 25% of the market, has nicely maintained or remodeled homes in nice neighborhoods. These stay on the market for 2-3 weeks before going into escrow. We lost one house on which we were one of 6 bidders. The winning bid was for more than the asking price and 40% down. The second housing market, about 75% of the market, consists of houses that are poorly maintained short sales or foreclosures, badly executed remodels or remodels that were way over-done for the neighborhood, homes that grandparents lived in for 30 years and still have the original appliances, wallpaper, even carpet. We saw one in which the pea green shag carpet was bleached white along the sliding glass door leading to the backyard. This second market typically shows that the house has been on the market for 5 or 6 months to 2 years. It may be that they are delisted and relisted to hide these numbers. It will take a long time for this market to clear.

  8. Latesummer2009 says:

    We too have a bifurcated maket on The Westside of Los Angeles. The first market is less desirable propertie composed of tired, relisted, expired homes and crumbs being parcelled out by banks as foreclosures, auctions and short sales. The second market are homes that are desirable with owners who can actually sell and are not underwater. With no more “mark to market” and banks making 2.5 – 3.0% on US Treasuries risk free, why would they care about lending money at 4% with all the risk?

    That being said we have started to see some impressive 50%+ discounts on selected Westside properties. Rolling weekly sales are now availabl at the click of a link. Now you can see where these half priced properties are.


  9. Bernie X says:

    It is NOT difficult to qualify for a mortgage right now.

    All you need is 4% down, a 640 score and a minimal amount of collections (some lenders let medical collections slide), and income documentation to qualify for an FHA mortgage.

  10. Jim67545 says:

    This article looks like a repeat so I’ll repeat one of the comments I made before:

    You distinguish between delinquency and default, and so say that a loan may be delinquent but not in default. There is no such thing. ALL loans that are delinquent are also in default. There are numerous “events of default” in the note and mortgage including non-payment, failure to pay taxes or keep the property insured, cause waste (damage to the collateral), failure to buy flood insurance if necessary, etc.

    Within this larger group of “events of default” there is non-payment. If a homeowner makes their payment EVEN ONE DAY LATE, they are BOTH delinquent and in default (violation) of the terms of the loan documents which specify that payment is to be made on a certain day of the month – period, no exceptions, no grace period. Confusion often arises because the note usually also calls for a late charge penalty at 15 days delinquent.

    The distinction you should be making is not between delinquency and default (where there is no distinction) but between delinquency and serious delinquency. That is the distinction that matters since for plain jane delinquency the lender will overlook the matter or just charge a late charge while for serious delinquency (ususally 90+ days past due) the lender becomes motivated to consider foreclosure.


    BR: The way I learned the difference in terms was in legal context — if a homeowner is a week late on a payment, they are delinquent — they have not yet defaulted on their mortgage.

  11. theexpertisin says:

    BR, this is perhaps the most cogent analysis of the housing situation

  12. theexpertisin says:

    BR, a superb piece.

    You have nailed each aspect of the housing situation spot on. It is 100% accurate from my vantage point as a practitioner.

  13. limulus polyphemus says:

    It’s clear to me that BOA does not want to clear the deadwood. My personal example:

    Owners of a home in Cape Cod enter bankruptcy in 2009. From 2009 throu 2011 the home is on the market while the asking price steadily drops from 900k to 670k. No sale – priced 35% above market. In September of 2011 I offer cash for the home at the market. The owners accept, but there is still no action from the bank. So BOA has had 2 years with no payments while it denies the reality of the market, and 7 more months of no payments while a market offer sits on the table. It’s clear to me that the bank feels no pressure to foreclose or sell underwater homes. Extend and pretend is clearly the order of the day.

  14. louis says:

    Don’t forget all that will be moving into their rental properties during the next 5 years. Hopefully they can sell the primary residence for the outstanding loan amount. They will be able to sell those, won’t they?

  15. rubicon_runner says:

    limulus polyphemus

    You have made a great point about this real estate market; the banks have zero motivation to clear the books.
    They can sit and wait it out; they are the new patient investors.
    Scary….they have become the stong hands.

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