Real Estate 2010: A Sobering Analysis
by: Pater Tenebrarum December 16, 2010
Pater Tenebrarum picture Pater Tenebrarum
We are happy to once again present an article by our friend and real estate specialist Ramsey Su. These are his observations on the state of the US real estate market as at end 2010 they make for interesting, but as you might expect, also sobering reading. We can only concur with Ramsey that the policy of "kicking the can down the road" is not going to produce genuine recovery. It is time to face up to reality.
2010 Year End Real Estate Observations
As the year draws to an end, it is time to revisit some of housing issues and examine what progress has been made.
The best quote of 2010:
"The real estate market is like a steamroller moving at 1 mph. You are standing in cement 100 yards away."
The Hidden Housing Subsidy
For the segment of the population that decided to, either voluntarily or involuntarily, stop making mortgage payments, 2010 was a great year. The Home Affordable Modification Program (HAMP) and the robo-signing scandal probably gave the average household a few extra months of free housing, on top of the free housing period that a normal foreclosure process provides.
This housing subsidy is expanding to include tenants. Lenders must serve 90 days notices to tenants of foreclosed properties. The tenant can still challenge the eviction in court, buying even more time. I see no reason why every foreclosure is not going to be occupied by a "tenant" in the future. In the mean time, lenders are offering very generous cash-for-keys programs.
I have not read any reports that quantify this subsidy. My estimate, via the proprietary cocktail napkin formula, is about $100 billion for 2010.
This subsidy is inversely correlated to foreclosures and subsequent evictions. The big servicers are ramping up foreclosures again after fixing the robo- signing problems. As the number of completed foreclosures increases, the housing subsidy is automatically removed. I believe this subsidy provided significant support to the struggling economy in 2010. Withdrawing this support is going to be detrimental to society.
So far, displaced occupants seem to able to find alternative housing. No-one knows what percentage moved in with relatives, doubled up with friends, stay at homeless shelters or simply became permanent renters. Enough time has elapsed since the real estate bubble popped. Compounded by long-term unemployment, I believe there is a significant number of households that have exhausted all savings and alternatives. This may be one of the most challenging issues of 2011.
The Mortgage Subsidy
Rates are still low but the stimulating effect is over. The market has adjusted and buyers are accustomed to these rates. More stimulus would require a lowering of the rate, probably down to the low 3% range to have any effect. Any rate reversal such as that we are now experiencing would put an end to the market.
Bernanke spent almost $2 trillion initially to drive long rates down.
The $600 billion QE2 has no effect to date and there are only a few months left. I am sure Bernanke will use the "it would have been much worse" argument and declare success. The reality is that there will be no QE3, not with Ron Paul now as the watchdog of the Fed. Besides, Bernanke's credibility is as negative as the equity of a house in Las Vegas.
Systemic Failure of the Secondary Market
Another year has gone by with absolutely no progress in FRE/FNM/FHA (Freddie Mac, Fannie Mae and the Federal Housing Administration) reform. It seems like no one wants to touch this hot potato. In order to keep the secondary market alive the Treasury has to keep funding the losses and the Fed has no choice but to keep buying the junk. I believe neither the Democrats nor the Republicans appreciate the dire condition of the secondary market. I have not seen one single proposal that can stabilize FRE and FNM. The country, and the world, have no stomach for any more bailouts. I believe a collapse is imminent. It may happen the next time FRE and FNM ask for a handout and reveal the cost of the robo-signing episode.
Where is That Pent Up Demand?
Nationwide the average cost of a home is comfortably below $200,000. Using a FHA loan, $10,000 (in down payment) can easily move a renter into a home and have money left over for some freshening up. The monthly mortgage payment is just over $1,000 lower than rent in many areas. This is the opportunity of a lifetime. Everyone who can buy is buying or has already bought. The problem is that there are not many in a position to buy, not enough to offset the excess inventory.
It is not a fluke that existing home sales are 25% below last year and prices are not going up.
What is the true demand? There is no shortage of experts who would tell you that if you average this over that, spread it over X years, we can conclude we have a housing shortage. Just use common sense. How many units do we need in 2011, 2012, 2013? Bob Toll and Ara Hovnanian are two CEOs that regularly used the word demographics as the very definition for growing housing demand. They claimed baby boomers are going to retire and buy second homes, maybe even third homes. Population will keep growing and so will the demand for housing. Now that the boomers are at retirement age, the reality is that they do not even have money to retire, not to mention that winter home in Florida, which is currently dirt cheap.
The country is going through structural changes in population growth and employment. The changing demographics actually reduce the demand for housing. Sooner or later we must face the fact that the US economy does not need its current labor force. Furthermore, our labor force is not competitive against the rest of the world in terms of skills and cost. The nation has to decide whether to provide aid indefinitely or to pull the rug out from the unemployed. Regardless, the excess labor force is not going to represent home buyers.
If we do not build a single house for the next three years, there will still be plenty of shelter for everyone. Every house constructed is just one added to the excess inventory, further delaying recovery.
Unintended Consequences of Low Mortgage Rates
Bernanke on "60 Minutes" recently openly admitted that he did not see the sub-prime crisis coming. If he cannot see the obvious, there is no chance that he would understand some of the consequences of his actions. During the mid 2000's, almost the entire mortgage universe had been refinanced. This included many baby boomers who were at the last half of the 30-year mortgage they took out when they purchased their home. The refinancing bubble that resulted from the irresponsible actions of Greenspan reset the 30-year mortgage clock. All borrowers looked at was how the refinance lowered their house payment by $X per month, without giving a second thought to the fact that they have also extended the term to a new 30-year loan.
Another round of refinancing occurred when Bernanke pushed rates down to the 4% range. The only borrowers left who have not refinanced are those with no equity and/or are facing foreclosure.
Boomers who are reaching the traditional retirement age find themselves strapped with 25+ years left on their mortgage. Instead of preparing for the mortgage burning party that their parents had when that generation retired, they are wondering how they can make house payments on a lower income upon retirement.
Since this is just the first year of the boomers reaching 65, this is going to be a negative drag on housing for years to come.
Conclusion
2010 was the year of the World Cup of Can Kicking. Greece, Ireland, the UK, the ECB and of course the US all kicked the can down the road. Unfortunately, the can is heavy and the kickers are exhausted. Some type of catastrophic collapse is imminent. These are not predictions, these are facts. We know foreclosures are coming. We know rates have stopped going down. We know the Fed has not announced plans to support or drive mortgage rates down. Unknown is how extreme the bailouts may become.
That said, I actually believe it would be positive if there were a few major mishaps. If Greece or Ireland default on their bonds, it will free them of the ball and chain that hinders recovery. If the US real estate market collapses, maybe there will be true FRE/FNM reform, maybe the builders would be forced to stop building and maybe we can be on our way to a true sustainable recovery under the new normal, and maybe, just maybe, Bernanke will resign
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