Friday, October 29, 2010

The Complete Housing Analysis

Every month I provide an update on housing data as it is released to the marketplace.  What I would like to do here is provide a comprehensive outlook for where we are today looking at the total housing picture.  This will provide a benchmark we can build on as data is released in the future.

The following discussion will be broken down as follows:

1.  Basic Supply/Demand Economics
2.  The Current Housing Inventory
3.  The Shadow Housing Inventory
4.  The Total Housing Inventory
5.  Fraudclosure/MERS

The first lesson that we learn in economics is supply vs. demand vs. price.  I was never a fan of the sliding charts that they presented in economics classes (nor was I a fan of just about anything presented in traditional education).  I did better on exams just using common sense, such as:

If you increase the supply of something (the number of homes on your street for sale increases from 3 to 9) and  demand stays the same (the number of qualified buyers in the market looking to purchase a home) then prices will fall.  Simple right?

If the supply stays the same (the number of homes on your street for sale stays at 3) and demand falls (the number of qualified buyers in the market looking for a home decreases) then prices will fall.  Easy.

Alright, now let's look at it how economists and financial analysts do and add in their vocabulary.

The most recent housing sales data (for the month of September which was released on Oct 25th) showed that:

There were 4,040,000 existing homes for sale in September. (Supply)

Total home sales are currently at 377,500 per month. (Demand)

This means there are 10.7 months of inventory on the market.  This is how long it would take for all homes to sell if no additional homes were put on the market.

4,040,000 / 377,500 = 10.7 months

This number is an estimate to show the health of the market.  A strong market has 3 - 6 months of inventory.  A very weak market has above 8 months.

Our discussion so far has left out an important part of the total housing picture.  That is the shadow inventory, which you have probably heard much about on the news.  In order to determine the total months of inventory we need to add the shadow portion.  We will do that now, but before we get there, let's discuss the actual foreclosure process and how homes are labeled at each step along the way.

When a homeowner misses a mortgage payment the home becomes delinquent.  After a certain period of time the home will go into default.  Two things can happen here.  The bank can attempt to sell the home in a short sale meaning they will accept an offer from a buyer for less than the mortgage is worth, allowing them to not have to deal with formal foreclosure proceedings. 

The second option would be to formally foreclose on the property.  The bank will then attempt to sell the house at an auction, and if they do not receive the desired bid the property will become Real Estate Owned. (REO)  That means it sits on the bank's balance sheet as their property.  They will then put the home on the market with a realtor and it will look like any other home on your street for sale.

So we must analyze each portion of this process to determine total shadow inventory:

The easiest number to determine are homes in default, which according to Lender Processing Services, stood at 2,020,000 as of July. (Certainly higher now, but the numbers are released on delay)

Next up are the delinquent homeowners, which is more difficult to determine, but a very important piece of the total puzzle.  When looking at delinquent homeowners you need to estimate how many homeowners that enter delinquency that will end up in foreclosure.  (They will not bring their payments current)

In order to do this we look at the historical cure rate (homeowners paying to become current).  The following graph shows the percentage of homeowners who cure their mortgages when they are 30 days, 60 days, and 90 days late.  The numbers are incredible:

Loans 90 days late are almost certain to enter foreclosure.  This number is at 2,470,000 million.

Loans 60 days late are 95% certain to enter foreclosure.  This number is at 761,000, so 95% of that total would be 723,000.

Loans 30 days late are 70% certain to enter foreclosure.  This number is at 1,800,000, so 70% of that total would be 1.25 million.

(Data based on July number, certainly worse today)

The third category is the final stage of the foreclosure process; the REO's or bank owned properties.  This is most difficult of the three to determine.  These are the true "shadow" homes because they are currently on the bank's books but they are holding them off the market in attempt to stay solvent.  They are praying the housing market comes back.

Estimates from multiple sources that try to track this number range from 500,000 to 2,000,000.  I will take the absolute bottom at 500,000.

This now gives us total shadow inventory:

Deliquent (30, 60, 90 days): 4,443,000
Default: 2,470,000
REO (Held Off Market): 500,000

Total Shadow Inventory: 7,413,000

Total Current Inventory: 4,040,000

Total Inventory: 11,453,000

Current Sales Rate: 377,500 per month

Total Months Of Supply: 30.3 months

This number combines data from September (total current inventory) with data from July (total shadow inventory) so one would would rationally assume that a portion of July shadow has become part of the September current.  This is a correct assumption.

However, understand that the housing market, based on an endless amount of new data, has begun to turn downward since July and the size of the shadow market has most likely grown significantly since the July period.  This would offset the imbalance and perhaps means the situation is worse than what is presented above.

Finally, how does the recent fraudclosure disaster factor into this situation?

More of the homeowners that are diligently paying on their homes that are underwater are going to hear about people that went to the banks and demanded to see the title.  Many of these people will do the same, and many of them will then stop paying their mortgages.  This will add to the shadow inventory above.

The housing market cannot bottom until the inventory is allowed to clear through the market.  Supply must meet demand at free market prices.  The average rate a bank allows a homeowner to live payment free (in delinquency) to formal foreclosure is currently 469 days.  For Bank of America, our country's largest mortgage servicer, this number is over 700 days.

Summary:  The housing market based on fundamental supply and demand projects a picture of pricing collapse, not recovery.  This analysis has only factored in the supply side of the picture.  When looking at demand (unemployment, savings, wages, credit availability) the picture becomes far darker.

h/t Calculated Risk, Keith Jurow

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