It May Take Years for Housing to Bottom

By
Real Estate Agent with Realty Direct

It May Take Years for Housing to Bottom
John Lounsbury


How far are we from a bottom in U.S. home prices? There are many estimates that there could be another 10% or more for the national average and median prices to decline. This author estimated that 2010 had a most probable decline around 11% from December 2009, with further declines possible in 2011. Little decline has actually been seen as prices are quite near where they were nine months ago. However, in the past couple of months predictions of further price declines have increased. Two weeks ago I pointed out that the outlook for home prices may be degrading.

20% Price Decline to the Bottom?

Barry Ritholtz provides the following chart, originally from the New York Times, but updated for The Big Picture by Steve Barry.

This decline is certainly within the possible limits I have discussed earlier in the year (see here and here) but the projection curve drawn by Steve Barry shows a much more gradual drop to the bottom than I have envisioned. I estimate that he is showing another 3.5 to 4 years to get 90% of the way there and 5-6 years to fully bottom out. My thinking has been that the drop to the final bottom will be much quicker, driven by the weight of foreclosures over the next one to two years. However, current market conditions are causing me to reconsider.

Could Housing Go Below "Normal"?

What has not been considered by either Barry or me is the recurrence of another depression for housing, such as occurred from WW I to WW II. What sort of economic disaster would cause home prices to decline 55% to 60% from here? That is what would happen if the decline reproduced the 1920 bottom.

Or, asking a different question: What sort of economic disaster would result if home prices declined 55% to 60% from here? In such severe deflation, most mortgagors would default and every mortgage lender would be insolvent. There would be no future TARP or other shenanigan that could accommodate that eventuality. This will be discussed further later in the article.

Under Water Mortgages

Calculated Risk has an excellent post about underwater mortgages. CR states that 4.1 million homeowners owe 50% or more than their house is actually worth. The accompanying graph shows some of the numbers 



Although the graph shows the peak in 50%+ underwater properties occurred a year ago, the decline from the peaks is so small that it cannot be said there has been significant improvement. If there are further drops in home values across some parts of the country, these curves could easily rise again even though continuing foreclosures are removing underwater homes from the data.

Just how bad is a 50% underwater mortgage situation? It means that a house worth $100K has a mortgage balance of $150K; and a house worth $200K has a mortgage balance of $300K. Just think of the poor soul who bought an overpriced McMansion for $960K with 20% down. That would be a $768K mortgage. If the McMansion might now bring $500K, this person has lost his $196K savings plus would have to fork over more than $250K in cash to sell his house in a traditional sale. If he uses a standardrealty contract, he would have to come up with an additional $30K for the realtor commissions.

Most people faced with these numbers will either walk away or arrange for a short sale. Either way the sale is distressed and depresses the market.

Up to 7 Million More Foreclosures

As mentioned previously, there are 4.1 million mortgagors 50% or more underwater. In addition to these folks, CR estimates that there are an additional 5 million people between 20% and 50% underwater and over 14 million underwater all together. Estimates that I have seen that there may be another 3 million foreclosures to come are probably way too low.

Michael David White has extensive residential real estate data and graphics at his website, Housing Story.net. There he reported (June 20) that less than 30% of mortgages 30 days delinquent are now being cured and that 14% of all mortgages are 30 days delinquent. There are approximately 55 million mortgages in the US and approximately 7.7 million are 30 days delinquent. At the current cure rate, about 5.5 million defaults are expected. Of course, if there are additional delinquencies arising in the coming months that number could rise. Keith Jurow has an excellent analysis that projects there will be a total of approximately 7 million additional foreclosures.

Some of the delinquencies may be sold through short sales and not actually end up counted as foreclosures. This is not a significant point, however, for two reasons. First, and most importantly, short sales and sales after foreclosure are all counted as distressed transactions and both have depressing effects on sale prices. Secondly, short sales have been a small portion of distressed sales and would have a minor statistical effect anyway, although short sales have started to increase in number this year.

Four Years or More to the Bottom?

Without an improvement in the delinquency and cure rates, it seems that a reasonable estimate of 5.5 - 7 million or more future foreclosures is appropriate. If there is a further drop in home prices and very slow improvement in employment numbers, the delinquency rate could increase further. In such a case 6-7 million foreclosures could be a low estimate.

The estimates in the preceding paragraph are close to double what I estimated at the beginning of the year, but are similar to estimates made by others at that time. See here.

The banks may continue to go slowly on completing foreclosure proceedings in some markets because of insufficient resale demand and a reluctance to recognize write downs on these assets. Thus, the rate of foreclosure proceedings execution may remain slower than historically experienced and the total number, be it 5 million, 6 million, 7 million or some higher number, may be spread over several years.

Combined sales for existing homes and new homes are currently 4.4 million a year. The peak for percentage of homes sold being distressed was 40% earlier this year and is currently 30%. If the 40% ratio could be regained and maintained, at current sales rates 1.8 million distressed sales would be completed a year. If 7 million foreclosures are yet to come, it would take almost four years to clear the distressed property backlog at current depressed sales rates. And that does not include the distressed sale properties currently on the market or REO (real estate owned - by lenders) properties currently withheld from the market, perhaps another million (+/-). The Barry projection of 4-6 years to reach the bottom may not be out of line.

Could We Repeat the Great Depression in Housing?

If we were ever to experience the improbable drop to Great Depression levels of home prices, it seems certain that at least 9 million (rather than 7 million) additional foreclosures would occur. And 10-14 million would be likely. These estimates are based on the Calculated Risk numbers cited previously. Something like the 20 year long depression in home prices, similar to the 1920-40 era, could be repeated.

Economic conditions are different today than in the 1920s and 1930s. Government is more proactive in reflationary efforts. Thus, a proximate repeat of the previous housing depression is not likely. However, a "shadow" image could occur and the bottom for prices and the length of the housing recession could be worse than we are now estimating.

As Michael David White points out in the following attention getting graph, an undershoot to match the bubble overshoot would take house prices to zero.




White is not seriously suggesting this could happen. But he certainly emphasizes the thought that return to "normal" may not be as far as prices could correct.

Avoiding a Debacle

Some may say we have already had a debacle. Certainly 45 million living below the poverty level would think so. And 30 million (+/-), that are unemployed, under employed or simply too discouraged to even look for work and be counted, would think so. But if the conditions occurred that drove another 10 million or more foreclosures and saw home prices drop to Great Depression levels, the current conditions might be remembered as the good old days.

There is simply only one condition that will avoid a worsening of then current projections, and that is improved employment. The current employment growth rate under 1 million per year doesn't even keep up with population growth. To restore employment to levels seen before the Great Recession would take 10 years of employment growth averaging 3 million per year. Such an occurrence would definitely create a growth in demand for housing and avoid a long drawn out bottom as occurred 1920-40.

But to avoid the debacle of decline well below the historical "norm", employment growth below 3 million per year could turn the trick. If employment growth were to average 2 million per year, well above the 1.2 million needed to compensate for population growth, home prices would probably stabilize near the level depicted by Steve Barry. And if the 2 million per year growth in employment started now and was maintained through 2012, the 4-6 years to get to bottom inferred by the Barry graph could be shortened.

Of course, the quality of the jobs will be important. Just as we could not become wealthy maxing out credit cards and selling houses to each other, we cannot buy many houses flipping hamburgers and selling them to each other.

Further Reading

The Calculated Risk article has several addition graphs and related discussion that are worth reading and Housing Story.net has a wealth of useful residential real estate information, data and graphics. Keith Jurow has a good article about an "avalanche" of foreclosures. Charles Hugh Smith posted an article after this was finished that forecasts a housing bottom in 2014.

Disclosure: No positions.

Source: Seeking Alpha



For more questions regarding buying or selling a home in Maryland, DC, or Virginia, you can reach us at the following:

BBT Team
Keller Williams Preferred Properties
9701 Apollo Drive, Suite 102
Largo, MD 20774
Main: 240737-5000
Phone: 240-737-5024
EFax: 240-296-5024
Email: info@bbtrealestategroup.com

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Rainmaker
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Dan Edward Phillips
Dan Edward Phillips - Eureka, CA
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Good Morning Brian, great post. Thanks for sharing the information, it is appericated.

Sep 28, 2010 08:45 AM #1
Rainer
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Aklile Mariam
Long and Foster Real Estate - CAPITOL HILL - Washington, DC
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Thank you for sharing Brian. I know, I am posting four months late but I would like to give you credit for posting this detailed informative Article supported with the Visualization.

Feb 06, 2011 08:14 PM #2
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Janice Roosevelt
Rory Burkhart Team, Keller Williams - West Chester, PA
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Very thoughtful, with points well supported. Thanks Brian.

Mar 08, 2011 07:23 AM #3
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