Debunking the Housing Recovery Story (Part 1 of 5)

Ahhh, Spring is here. Each year around this time, the flowers push up through the soil, the trees begin to bud — and the Real Estate recovery stories start to appear.

It is a perennial rite of Spring, not remotely slowed down by such niggling factors as consistently being wrong year after year, unsupported by data, and ignoring key factors that strongly suggest “Not this year.”

All this week, we are going to review the many factors that are overhanging residential housing. Each of the following 5 factors will be discussed. By the time Friday rolls around, I expect you will be looking at those calling for a Housing recovery a bit more skeptically.

The factors we will be discussing include:

-Shadow Inventory (REO + Investors)
-Pricing Mean Reversion/Foreclosure Overhang
-Home Affordability/Employment & Wages
-Psychology of Renting
-Mortgage Rates

This morning, let’s discuss Shadow Inventory. This is important, as we have heard from Housing Bulls as part of their recovery thesis that the decrease in inventory of homes for sale is a net positive.

I would argue that the massive supply of homes in the Shadow Inventory make this judgment premature. There are numerous definitions floating around, but I prefer to start with the following: Ordinary Inventory are homes that are listed for sale with either MLS or privately (FSBO) or are in some public way known to potential buyers as for sale. These are what are counted in the official inventory.

Shadow Inventory includes: Bank owned Real Estate (REOs), distressed homes not yet for sale, including short sales and delinquencies not yet defaulted. Various properties in different stages of Foreclosure are also in the shadow inventory.

This definition still yields a broad range of potential shadow homes that will eventually become part of the total supply. Michael Olenick (at naked capitalism) puts the range of potential shadow inventory from 1.6 million homes(CoreLogic) 8.2-10.3 million (Laurie Goodman, Amherst Securities).

But even those numbers do not represent the complete picture. I include in my definition of shadow inventory the enormous overhang of underwater homes — these are the houses that don’t qualify for a mortgage mod, but whose owners are still making most of their payments. They have minor delinquencies, but are not in default. The owners are frozen — economically immobile — since they cannot move to a different area to take a job.

The problem is the homes are worth anywhere from 5-25% less than their mortgage. A sale will not be possible without lender permission or a large check to make up the shortfall.

About a third of homes (30-40%) in the US have no mortgage — cash purchases or paid off mortgages mean they are owned outright. Of the remaining homes, estimates range from 21% to 29% are worth less than their mortgages. That’s between 12 – 18 million houses as potential supply at higher prices.

The key question for the Housing Recovery case: What happens if and when prices begin to rise? Do these underwater owners relax, feeling better about their positions? Or, do they finally hot the nid when the opportunity presents itself?

The truth is that we simply do not know. But is is reasonable to assume that many of these homes would be put up for sale and become inventory. If only a third do, that is another 4 million homes for sale.


Tomorrow: Pricing Mean Reversion/Foreclosure Overhang

This post originally appeared at The Big Picture and is posted with permission.

2 Responses to "Debunking the Housing Recovery Story (Part 1 of 5)"

  1. scott goff   April 2, 2012 at 11:00 pm

    Housing prices will not rise. As inflation begins interest rates will rise keeping housing prices
    depressed while other prices rise. The housing market is so able to be manipulated by the government they will not be able to resist trying to use it to "monitor" the inflation they are engendering to relieve debt burdens. Right now they are trying to restructure as much debt as they can with low interest rates but this cannot last as the distortions arising out this manipulation are causing stresses of their own. Unless, of course, the eurocrisis brings everything down- then all bets are off. As every comedian knows, it's all in the timing.

  2. joseph glynn   April 4, 2012 at 7:34 pm

    Excellent. I am looking forward to future installments. Honesty is the best policy and I really wish the mainstream media would stop treating people like gullible idiots, which is what people become when confused, bombarded constantly with hype, promises, spin and sophistry. There is a job to be done and it begins with an honest appraisal of our true circumstances, openness, transparency,.. then an informed consensus can be reached. Thats a vital step to debating and reaching agreement on appropriate policy prescriptions with broad buy-in and acceptability and which might actually move the economy forward in the right direction. Best regards.