For a while in 2010, some economists thought that real estate prices had reached a bottom and would soon begin their ascent back to the bubble year’s prices. Soon, they all found out that prices were being artificially inflated by the first time homebuyers’ tax credit. Now the question is, when are prices going to stop falling and reach a bottom?
There is a unique phenomenon taking place in some REO saturated areas that appears to be making prices spin out of control in a seemingly never-ending tailspin into the abyss.
First let’s take a look at the amount of equity people have in their home that have mortgages.
What is important about this chart is that the further underwater someone is, the less likely they are to continue to make mortgage payments. There is a mental threshold near the -20% to -25% equity range as people really start considering non-payment.
Which brings us to the next part of the puzzle: delinquencies. As you can see, these numbers are not historically normal as delinquencies usually hover in the 5-6% area. Having a delinquency rate close to 13% is indicative of an out of whack economy. More importantly, it is clear that people are strategically defaulting.
Notice the large volume of loans in “90 days late” category in the chart above. Fewer than 1% of loans that are 90 days delinquent are made current before foreclosure, so you can go ahead and kiss these suckers goodbye.
And then we have the big boy: SUPPLY. Because of the number of delinquencies, there seems to be a never-ending supply slugging through the inventory pipeline. With close to 7 million loans in some stage of delinquency, there is literally no telling when the trend in the graph below is going to change.
A total of more than 2 million houses are in some stage of the foreclosure process. We also know that, in some cases, people are living in their homes without paying a mortgage for two years before a notice of default is even filed. This chart does not account for situations like that.
Here is where it gets really tricky… The more foreclosures in a certain area, the steeper the discount is when they are resold. For example, in California, where more than 44% of all sales are foreclosures, the average foreclosed home is sold at a 34% discount.
So when this volume of discounted houses hits the market, what happens?
People’s houses go further underwater, making them more likely to default, which adds to the supply, which are sold at a discount, which means people’s houses go further underwater….
And where does this cycle end? That’s a good question that few analysts are actually discussing. The answer is simple, income. The problem is that income levels have remained stagnant for the last decade while national real estate prices shot through the moon. Until income levels begin to rise, real estate prices will fall until historical ratios are reached.
- Hunter Thompson
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Hunter, great post. And I completely agree – now that we’re back to traditional lending standards, it’s very, very simple equation. Either incomes have to rise or prices have to fall so that we hit our traditional ratios that equate with bank lending standards and requirements. Unfortunately it appears as though we are heading into a multi year deflationary period for housing, unless incomes suddenly increase, which I don’t think anyone is expecting. Thanks again for the great post, Jeremy
Posted by Investor J | June 17, 2011, 8:09 pm