No Recovery Without Real Estate Recovering

There can be no economic recovery until the National Housing Clearance event has ended. Distressed housing not only depresses prices, causing a contraction of the wealth effect, but also continues to destroy capital as lenders realize enormous loan losses. Capital formation which becomes the basis for expansion is retarded as capital is diverted to loan reserves rather than loan origination. It has been four long years through which the “shadow inventory” in the foreclosure and the short sale pipeline has been steadily reduced, while previous home buyers have been removed from the market and downgraded to tenant status. That’s good for landlords and good for the credit worthy buyers and investors able to purchase, but terrible for the general economy.

No Recovery Without Real Estate Recovering

The real estate market needs another good year. Prices in the foreclosure riddled and underwater MSA’s of Southern California, Nevada, South Florida, and Arizona, the so called “Sand States” are finally stabilizing. In Phoenix, many of the entry level sub-segments have actually appreciated in the past 4 months as inventory is absorbed to the point that supply is now tight. As predicted by many, a housing shortage is possible due to the lag time required from start up to finish of the average rental community or, believe it or not, new construction. The lack of jobs and the general fear of more economic contraction has caused pent-up demand, as graduates unable to find work return home, laid-off workers combine households to survive, and crowded households delay move up purchases.

Another year of economic activity that avoids a recession would clear much of the remaining distressed properties and open a path for full recovery in the ensuing years, as more and more “penalized” buyers become eligible to purchase and the normal annual growth demand eventually stimulates new construction. A new recession would delay the recovery and exacerbate the mortgage process as more and more lenders become risk averse; and it would place more downward pressure on higher end home prices. Potential buyers would remain tenants much longer.

It is so simple to me. With less than 8% of the population employed in manufacturing, the lack of housing construction seriously impacts jobs. The housing crisis has traumatized the participants who have become deeply afraid of making another bad loan which may be construed as an illegal loan or a loan that costs them their precious job. In a time period when virtually nothing is made in the United States, we still produce our own homes and every home that is built produces dozens of construction jobs plus dozens of clerical, title, sales, financing, and real estate jobs, which in turn support dozens and dozens of butcher, baker, and candlestick maker jobs. The velocity of money would finally start, which helps virtually all segments of the economy. Job creation and the healing of the economy would begin when housing starts to recover in earnest with construction of new homes. If the incumbents want to be re-elected in the fall of 2012, then address housing, and jobs, jobs, and more jobs will be created. In my opinion, employment can start tomorrow if just a few common sense policies were instituted.

In 2003, the underwriting standards were so loose that anyone could obtain a loan; underwriting standards were beyond ridiculous. The lenders accepted too much risk and we all are paying for it now. My tenants, barely capable of scraping together the security deposit required to rent our properties, became home owners. Speculators polluted the market; liar loans and NINJA (no income, no job) loans were endorsed, allowing for abuses beyond comprehension that today lenders are still clearing. Enormously un-qualified buyers were allowed to close loans that were doomed to failure. There is no call for a return to the days of stupidity, just an expansion of business. If you are in the bicycle business, make bicycles; if you are in the lending business, make loans.

Real estate prices have been devastated; first by over supply of inventory, now by lack of demand on the buyers’ side. Today’s historically low rates make economic sense because the difference in the monthly payment of owning a home is far cheaper than the monthly rental payment of an equivalent home. Low rates have stimulated some owner occupant demand and helped greatly stimulate investor demand due to the high cash flow component; however, lending is still restrictive. As of October 1, 2011, the FHA loan limits in many sections of the US will be dramatically reduced at a time when demand needs to be stimulated, not retarded.

Here in Maricopa County, home of the Phoenix MSA, the loan limits for FHA has been $346,250, but as of October 1, 2011 the limits were reduced to $271,050. Many potential sales will be lost; prices will be further compressed to reflect reduced financing capability, and the lenders involved in clearing the inventory of distressed properties will take further losses. Historically low rates alone cannot stimulate demand. Loan affordability is tremendous; loan availability is fair with much room for improvement. Raise the limits, do not LOWER the limits. Former home owners that have either sold their home through the short sale process or had the misfortune to have allowed a foreclosure are prohibited from obtaining another loan for a minimum of 2 years to 7 years. This is great for investors guaranteeing a consistent supply of long term tenants, but continues to impact the demand side, continuing to weaken housing further.

With weaker demand, homes with prices above the limits of government insured financing will experience a softening of prices. Softening of prices will reflect greater losses for lenders involved in clearing distressed properties, further weakening the ability of lenders to create a capital pool, as earning are still diverted to address loan losses particularly in the Sand States of California, Arizona, Nevada, and Florida. The "penalty period" should be REDUCED to allow more buyers to enter the market. More buyers and higher limits will allow for prices to rise.

Should lending limits and underwriting be expanded just a little, millions of buyers could possibly be affected. Prices would start to rise and the pent up demand could quickly absorb the remaining inventory of distressed properties. A rising price environment would vastly lower lender losses, which will allow for capital formation, leading to greater lending flexibility, re-establishing the “wealth effect” as properties begin to appreciate and recover, and it would stimulate new construction. Jobs WILL be created, millions of jobs.

Should the penalty period for obtaining a new loan be reduced or eliminated, millions of buyers could enter the market and tremendously increase the demand side of the equation. Should Fannie Mae (OTC: FNMA.OB) and Freddie Mac (OTC: FMCC.OB) consider a re-financing program modeled after the FHA Streamline Re-Finance, whereby an existing borrower with the previous 12 months of on-time payments may lower the rate and re-finance their existing loan with very little paperwork and NO appraisal, the default rate would be lowered for the lender and there would be much more discretionary income to spend in the economy from the borrower. Millions of loans could be saved and hundreds of millions of dollars would become available to be deployed throughout the business world. The real estate market is trying to stabilize. There has been little or no new construction for the last 4 years and absorption of existing inventory is taking place. The “shadow inventory” of distressed properties still in the pipeline is decreasing.

Once the poster child for success, Metro Phoenix rose to dazzling heights and then crashed and burned. Empires built over many years crumbled while workers tied to construction left in a mass exodus creating vacancy factors for landlords. Shops and businesses felt the impact of the virtual halt in new construction. Estimates of upwards of 300,000 people left Maricopa County. Huge numbers of undocumented workers without construction jobs left; some went back home, others drifted across the US to find work elsewhere. The freeways flowed easy due to the reduced use; schools lost federal revenue as enrollment declined. The real estate market was devastated. Now, Metro Phoenix has become the #1 market in the US for Fannie Mae; Fannie Mae properties are selling for 107% of appraised value in 6 days. Phoenix is the number 6 market in the US for job creation, and inward migration has started as people liquidate homes elsewhere. The demographic shift from the cold North to the sunny South appears to be re-activating. Prices are starting to rise in the entry level homes and the financing favorable price ranges under $300,000. The market NEEDS another year! Financing NEEDS to be more accommodative! Solve the housing crisis and create a MILLIONS OF JOBS!

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