Pinpointing an end to the distressed real estate market

REThink Real Estate

By Inman News Feed
Add Comment Add Comment | Comments: 0 | Posted Jun. 23, 2011

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REThink Real Estate

Tara-Nicholle Nelson
Inman News™

Q: When do you estimate the return of the fully "standard sale" market?

A: My friend, I went out of the business of gazing into my real estate crystal ball a long, long time ago. Once was, every year I was asked to predict precisely when in the next year the market would recover.

Nowadays, the most I'll do is call out several markets a year that I think are showing signs that they'll do better than average -- things like net population growth, net job growth, low unemployment rates and high affordability all generally point to a city that will fare better than others.

As well, there are a few markets in which demand is so restricted by tight land-use guidelines and the very minimal availability of land that they tend to fare relatively well throughout a recession, like my own San Francisco Bay Area stomping grounds. Relatively.

These days, I won't even have a discussion about when the real estate market will recover without having a long talk about what recovery actually means! Used to be, people wanted to know when home values would return to their peak. After a four-year-long reality check that peak pricing was based on some fundamental market dysfunctions, though, now those asking about recovery often simply crave to know when the hemorrhage will end (i.e., when the foreclosure rate will slow down or when home values will stop declining).

So, your question is smartly framed: When will the market once again return to a state in which the vast majority of sales are "standard" sales (by which I presume that you mean not short sales and not foreclosures)?

Given that somewhere between 30 and 40 percent of the sales currently on the market are distressed transactions involving homes on which the sellers owe more than the home's fair market value or bank-owned properties, a return to a market climate of mostly "standard" sales will reflect a massive change in the market, in the direction that virtually everyone would call recovery.

I can't give you a date and time at which you can click on the latest report and should expect to see zero foreclosures; actually, even in the most thriving markets there are a couple of foreclosures here and there. However there are a number of indicators we can look to to give us a general sense for the soonest we can expect distressed properties will become a much smaller share of the market than they are now.

So, far, 2011 is on track to have a record-high rate of foreclosures -- even compared to the last few years. In part, this is due to the long-overdue foreclosures that backed up when the robo-signing scandal caused widespread foreclosure freezes last fall.

Those freezes have largely been lifted, and where they haven't, they will soon be, as the banks are now approaching a settlement with the attorneys general who called them on the carpet for widespread failure to read documents and failure to verify facts before they foreclosed on borrowers' homes. These thaws have and will continue to spike the already record pace of foreclosures throughout this year.

Additionally, 2011 and 2012 will be peak years for the resetting of adjustable-rate mortgages that were originated at the peak of the market, around 2006-07.

As those mortgages continue to reset in large numbers, and their owners find themselves unwilling to continue paying on homes that are worth so little, or unable to refinance their mortgages because their homes' values have declined so vastly, we'll likely see these resets continue to contribute to the foreclosure rate.

It could easily be late 2012 or early 2013 before we see the foreclosure rate come down dramatically -- maybe later, and as many as 24-48 months thereafter before we would see the market realistically absorb most of these foreclosures.

And this just takes foreclosures into account! Because so many Americans are so deeply upside down, we could see an elevated rate of short sales for years and years to come.

What could brighten up this fairly grim outlook? Anything the banks or the attorneys general do to coerce the banks to start writing down principal on home loans would help -- whether you think it's fair or not, the data shows that negative equity is a very weighty contributing factor to foreclosures, strategic and otherwise.

And negative equity is certainly the cause of every short sale. Also, a significant uptick in serious loan modifications that would ease upside-down homeowners' payment burden might also get us back to a "standard sale" market in a shorter period of time.

However, what we know is likely to happen is that the loan market will continue to tighten up, making it harder for even willing and creditworthy buyers to buy, as Fannie Mae and Freddie Mac are phased out.

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