Monday, January 21, 2008

Foreclosures, Neighborhoods, and Home Values

Housing Wire has a post today on the foreclosure glut in Milwaukee. When foreclosure reach a high level there is a negative impact on values and neighborhood conditions. Some of these effects are obvious, some less so:

1) The foreclosed house is put on the market. More supply pressures prices down.

2) If the servicer is not the lender there may be a bias to liquidate quickly rather than maximize value. The distress sale at a lower than market price becomes a new comparable establishing a new (lower) value level for similar houses in the neighborhood.

3) During the period starting with the homeowner's financial distress through foreclosure and liquidation the house is probably not being well maintained because the homeowner lacks financial resources and/or motivation and the lender has logistical problems staying on top of maintenance issues. This could be minor (e.g., the grass doesn't get mowed) or major (e.g., the roof leak doesn't get fixed and the ceilings collapse). Either way the house value is negatively impacted, leading to a low value comparable as in 2) above.

4) If the maintenance problem is visible, the entire neighborhood takes a hit. No one likes living in neighborhoods with signs of disorder, and in a market with choices buyers will avoid such neighborhoods. Wesley Skogan describes the impact of disorder on housing markets in more detail in Disorder and Decline.

It's easy to imagine how these effects can lead to even more foreclosures, creating a downward spiral which is very difficult to break. Also, the maintenance issues are not limited just to properties actually in foreclosure. Borrower's who don't have equity have little incentive to maintain their properties. It does not take long for deferred maintenance costs to mount rapidly and take their toll on the property's value. Even if a loan modification addresses an immediate payment problem if the modification doesn't address the borrower's lack of equity the lender could be facing a big maintenance hit down the road.

Wednesday, January 16, 2008

Housing Mess Offers Sunshine for Rents: Not

Criticizing Wall Street Journal stories is turning into this month's theme (see my post yesterday re their failure to put the retail sales data in context and Saturday for ignoring seasonality and year over year change in their coverage of housing inventory). Yesterday the WSJ ran a story headlined, "Home Seller's Pain is Renters' Gain" with the lead, "There's one bright side to the housing crisis: some lower rents." The data buried in the story almost totally contradict these conclusions. Here are the key data points:

  • The data is from the REIS 4th Quarter 2007 report, which tracks 79 markets.
  • In five markets (6% of the covered markets, all in Florida) rents declined since the third quarter. The worst market was Tampa, where effective rents declined 0.6% from the third quarter. The median third quarter rent was $789, the fourth quarter rent was $784, so in the worst rental market in the country median rents declined a whopping $5. There's a renter windfall for you.
  • "In 38 other markets including Chicago, Boston, and St. Louis, rents rose during the fourth quarter, but by less than the national vacancy growth rate of 0.9%." Presumably someone at the Journal knows that rents and vacancy are different things, and they meant "national median rent growth rate" (does anyone edit these stories?). Adding in the 5 declining markets, that means 43 of 79 markets had below average rent growth. Not exactly news if you understand what an average is.
  • "Vacancy rates fell in 47 of the 79 markets tracked by REIS, and average rents saw their largest fourth quarter increase since 2000." So, we had the largest average rent increase for the applicable period in 7 years, and the headline is "Renter's Gain?"

Charitably, this is a really bad case of seeing the story you expect to see in the data. I've looked at a lot of REIS quarterly reports, and there are always a handful of markets which are down. No doubt there is some mild softening in Florida markets (those same markets where rents spiked because rental units were converted to condos), but it just wrong to present this as a meaningful national trend.

Tuesday, January 15, 2008

Noisy Data

Econobrowser has a thoughtful post today illustrating the need to look at more than two periods of data to place that data in context. In this case December retail sales are reported down 0.4%, characterized by Marketwatch as "dismal", the Wall Street Journal as "surprisingly weak", and CNN as "a big drop". The Econobrowser post presents graphs and data demonstrated that this level of fluctuation occurs all the time, and that even looking at two month averages dispels the downtrend. The Capital Spectator puts the data in the proper context by looking at the rolling 12 month trend.

It's no wonder mainstream media numbers are falling when you need to go to the blogs for accurate commentary.

Saturday, January 12, 2008

WSJ Housing Inventory Story turns Up into Down

You may have seen the Wall Street Journal story headlined "Housing Supply Lower, Yet Ample" on January 8, 2008. A lot of people (including me) often just read headlines and would draw the conclusion that the housing market is still soft but might be improving because inventories are down. That conclusion doesn't square with other information I've seen, so I kept reading. The third paragraph contains this tidbit; "The decline is roughly in line with the usual pattern for December, when many potential sellers keep their homes off the market because of the holidays."

To their credit, the Journal did include this information, but it makes you wonder if the person who wrote the headline read that far into the story. Housing inventory is seasonal, and you need to adjust for that. One way to do that is to compare to the previous year's period (e.g., compare December 2006 inventory to December 2007). That information is in the fourth paragraph; "Total listings at the end of December were still up about 23% from a year earlier in the 17 metro areas for which comparable figures from December 2006 were available."

In my book "up about 23%" does not equate to "roughly in line." The headline for this story should be something like, "Housing Inventory Up Substantially Over Prior Year."

Wednesday, January 2, 2008

What Do Rents Have To Do with Home Values?

Several of my favorite blogs (see Calculated Risk today and The Big Picture last month) have reported on efforts which attempt to estimate how far home prices are out of whack by looking at historic ratios between rents and home values. There's no question home values are inflated relative to rent levels, but I'm skeptical that the historical relationship has much to tell us about where home values will be over the next few years for several reasons:

1) Historically rents have been much more volatile than home values at the market level (for example, in San Jose during the implosion effective rents dropped around 25% while home values barely twitched). If rents and home values had much to do with each other it seems like the correlation should be closer.

2) Until the last 5 years or so you could say with a fair amount of confidence the primary drivers of home values were demand (best indicated by employment levels), additions to supply (best measured by new housing starts), and interest rates (lower rates = bigger loans = higher values). Now, we have had demonstrated lax underwriting standards can also lead to leverage-driven value inflation (see my previous post which runs through the numbers on this). None of this has anything to do with rent levels; if anything, rents tend to move in the same direction as home values when the movement is driven by employment and supply changes.

I think the underlying fallacy in associating rents with home values is the belief that people weigh the costs of renting vs. buying and make a rationale choice. No doubt some people do that, but I think most people will buy if it's at all possible and lax underwriting made it possible for more people to buy at higher prices. Even more important, those sales made it possible for everyone who had already bought to leverage up based on the higher values and lax underwriting.

So where will we end up? On the positive side, additions to supply are slowing and interest rates are stable to declining, both positive drivers. On the negative side, if we do slide into a recession the demand vacuum created by employment losses is going to compound the present problem in a really unpleasant way. Rolling 12 month average employment growth is slowing now, and a downturn in that average historically signals a recession with bad real estate consequences (previous post here). The other big unknown and potentially huge negative factor is where mortgage lending underwriting standards stabilize. It was lax underwriting which got us into this mess, and historically underwriting tightens significantly when lenders incur losses. It's entirely conceivable lenders will overtighten and compound the current problem. On the other hand, there will be a lot of pressure, especially on FHA and the GSEs, to keep credit flowing. A recession combined with conservative underwriting will push prices below historical norms. Unfortunately, that seems like the most likely scenario to me.