Tuesday, July 10, 2012

Foreclosure Supply and the Housing Market

by Bill McBride on 7/10/2012 05:01:00 PM

First a few excerpts from this article by Diana Olick at CNBC: When Foreclosure Supplies Fall, the Bottom Falls Out of Housing

While foreclosures brought home prices down initially, they are now driving them up because there is so much demand from investors and first time buyers, looking for bargains. Supplies of these cheap homes are also dwindling, because banks are still working to modify many troubled loans, and states that require a judge in the foreclosure process are still facing a huge backlog.
This new lack of distressed supply may lead to what housing analyst Mark Hanson calls, “an investor gut check.” He sees early results that sales volume in many of the markets that were deemed to be “recovering” are actually falling.

“First is the artificial lack of distressed supply, which is the market in all of the miracle 'recovery' regions. As I have pounded the table over for years ... 'investors and first timers are thin and volatile cohorts that have been known to up and leave markets in a matter of a month or two leading to a demand collapse'. But equally responsible are Zombie Homeowners; those without enough equity to pay a Realtor 6 percent and put 20 percent down on a new house and/or good enough credit or strong enough income to secure a new mortgage loan,” writes Hanson.

Hanson calls the lack of distressed supply “artificial” because he believes banks are holding back some distressed inventory and/or that many of the loan modifications being worked out will inevitably fail. He points out that distressed supply is vital to a market like Phoenix, because 66 percent of its current borrowers owe more on their mortgages than their homes are currently worth, and are therefore stuck in place, unable to buy or sell.

“Without repeat buyers in the market leaving a unit of supply when they move up, laterally or down (in the case of empty nesters), supply is simply removed from the market and not replaced,” notes Hanson.
Look at the headline "When Foreclosure Supplies Fall, the Bottom Falls Out of Housing". Really? I think we need to define "housing" and what a "housing recovery" looks like.

When I think of "housing", I think of 1) residential investment, especially housing starts and new home sales, and 2) house prices for existing homes. When the supply falls - especially foreclosure supply - I'd expect there to be less downward pressure on house prices, and also more opportunity for new home sales. That is what we are seeing.

So what does the headline mean? A decline in existing home sales? Yes, sales have declined year-over-year in some distressed markets (like Phoenix and Las Vegas), but that is not bad news. As I've pointed out before, those looking at the number of existing home sales to judge a "housing recovery" are looking in the wrong place.

Mark Hanson makes some interesting points, and this raises the question again of why supply has fallen so sharply. There are probably several reasons for the decline in supply: 1) negative equity keeps people from selling (and buying as Hanson notes), 2) banks aren't foreclosing quickly and are focusing more on modifications and short sales, 3) cash-flow investors have purchased a substantial number of houses, especially at the low end, and they will not be sellers for some time, and 4) seller price expectations (when sellers expect prices to stabilize, they no longer rush to sell).

For these reasons (and probably others), there is less supply. And this in turn might lead to fewer sales since investors and first time buyers are focused on the low end of the market (I also expect sales to decline from record levels in areas like Las Vegas). But lower existing home sales doesn't mean the "bottom falls out of housing". Actually it could mean the housing market is improving!

To look for a "housing recovery", we need to focus on residential investment (new home sales and housing starts) and existing home prices. Lower supply is a positive for both.