A recap of recent events and how these issues impact the housing market.

Irvine Home Address … 5 PERIWINKLE Irvine, CA 92618

Resale Home Price …… $500,000

Freedom–calls my name

Serenity–keeps me sane

Happineses–it dulls the pain

Honest–to see my place

Open–to other ways

Willingness–to understand

Justice–but do not judge

Courtesy–for others' flaws

Kindness–it's not that hard

Self-restraint–of toungue and pen

Inventory–my daily friend

Analysis–let down your guard

Look in the mirror

What do you see?

The shattered fortress

That once bound me

Dream Theater — Shattered Fortress

The Walls Keep Tumbling Down: Foreclosure Flap and Other Housing Industry Woes

Published: October 13, 2010

After suspending foreclosures in order to review cases that may be flawed by procedural errors or fraud, major mortgage companies have injected new uncertainty into the already weak housing market. While few of the homeowners under scrutiny are likely to avoid foreclosure, the freeze adds additional confusion and delays recovery of the troubled housing sector, according to Wharton faculty and real estate analysts.

The foreclosure flap is the most recent of many setbacks for the troubled industry, even as a new generation of potential buyers is rethinking the traditional dream of homeownership. "Buying a home doesn't make sense for a large proportion of the population," says Wharton real estate professor Fernando Ferreira, noting that ownership reduces the flexibility to pursue work in other regions and ties up cash in a down payment that might be used for better investments. "We forgot these lessons in the housing boom. But I think the new generation is learning them — at least for the next five to 10 years."

Our government's obsession with home ownership has blinded lawmakers and bureaucrats to the advantages of renting. Real estate is not going to produce high returns over the next decade as we work off the excesses of the housing bubble, and everyone who has bought property because they think they will make a fortune on appreciation is going to be very disappointed.

After discovering that employees violated procedures while attempting to process a crush of foreclosure cases, three of the nation's leading mortgage servicers — J.P.Morgan Chase, GMAC and Bank of America — are holding off on further action in 23 states that require foreclosures to undergo judicial review. One GMAC "robo-signer" acknowledged signing off on as many as 10,000 cases a month, even though the law requires the signer to review all documents personally. Bank of America later extended its halt to foreclosures in all 50 states.

Wharton real estate professor Susan Wachter says the foreclosure freeze might temporarily buoy prices by keeping foreclosed properties off the market and could give some families another chance to come up with enough money to save their home. However, she expects that most of the now-stalled foreclosures will eventually move forward. "This will only delay the market clearing process."

The banks can't afford the write-downs associated with the market clearing process, so they actively encourage and participate in delaying foreclosures.

According to Wharton real estate professor Georgette Chapman Phillips, lenders may be guilty of shoddy paperwork, although she stops short of calling it fraud. Lengthy delays or overturning foreclosures based on improper documentation, she adds, would create new levels of moral hazard that might lead even more homeowners to stop paying their mortgages. "This is a horrible mess created by the banks and the secondary market. It's sloppiness, but the borrowers are not asserting fraud in the lending of money. We can't ignore that, at the bottom of all this, the people who were foreclosed upon didn't pay their mortgages."

All the nonsense about improper foreclosures seems to miss one basic point: the people being foreclosed on are not paying their mortgage. Banks are worried that walking away will be socially acceptable. Well, it has. People who are not paying their mortgages have now achieved victim status which will almost certainly make their ranks grow larger. The housing entitlement in this country has gotten so bad that people no longer believe they have to pay for their housing. Whatever they can move into they can keep.

The Key Driver: Jobs

The questionable cases are part of a backlog of more than 1.2 million loans that are in the process of foreclosure in the United States, according to RealtyTrac, a housing data firm based in Irvine, Calif. In addition, another 900,000 properties taken back by banks remain on lenders' books, while five million more loans are seriously delinquent. The National Association of Realtors reports that distress sales, including foreclosures, made up 34% of all existing home sales in August.

For every property in visible bank inventory, there are four that are in shadow inventory waiting for the banks to initiate foreclosure proceedings.

"The only way to clear prices is by getting rid of the foreclosure backlog, but that will take a long time to work out. It's still a multi-year process," says Wharton real estate professor Joseph Gyourko, adding that 20% to 25% of all U.S. homes are worth less than what their owners owe lenders. "Every one of them is a candidate for default and foreclosure. It will just take a while to work through."

It looks like flipping houses in Las Vegas will be a viable business plan for a while….

While housing is always highly cyclical, Gyourko says the current prospects for recovery are hampered by extremely low levels of activity throughout the market, including new housing starts and sales volume. And the current slump is different from others because it is driven not only by imbalances in the sector, but also by larger economic problems. "This recovery is different. It's slower than normal…. You won't get much pickup in housing market activity — buying and selling — until you get job growth." Wachter agrees: "The key driver in housing is still jobs."

It is ultimately about jobs, but we have a chicken and egg problem with housing. One reason growth in residential investment corresponds to the bottom of recessions is because once job growth creates housing demand, that puts people back to work in homebuilding which creates even more job growth and more housing demand. Since our current problems are centered in housing, any recovery will not get the same housing demand and homebuilding job growth that helps the recovery gain strength.

Rick Sharga, senior vice president at RealtyTrac, says the latest foreclosure problems represent a "breach of trust" but will have little effect on the final resolution of cases. "It really is more of a temporary delaying issue." The foreclosure reviews will probably add 60 to 90 days to the process, Sharga predicts. This could cause foreclosures to be delayed an additional 6 to 18 months and string out the adjustment in home prices by that amount of time, according to residential mortgage tracker Access Mortgage Research & Consulting. While Chase has disclosed that 56,000 cases are under review, the other companies have not said how many foreclosures will be delayed. Some of the states with the largest numbers of foreclosures — including California, Nevada, Arizona and Michigan — are not ones that require formal judicial review for a lender to take back possession of a property.

According to RealtyTrac, foreclosure filings — including default notices, scheduled auctions and bank repossessions — were reported on 338,836 properties in the U.S. in August, up 4% from July, but down 5% from August 2009. One in every 381 U.S. housing units received some form of a foreclosure filing during the month. Sharga suggests that 2011 will be the peak year in bank repossessions, and that "2012 will be a little better….In 2013, we could see foreclosure activity drop significantly [as] we deal with getting through the overhang of foreclosed properties."

I think he is dreaming to think foreclosure activity will see any significant decline in activity even when the economy picks up. People couldn't afford their houses in good times, so when the economy picks up, loan owners are still facing the fact that they can't afford their homes. Foreclosure activity will likely peak in 2012, but there will be a long tail as this drags on for many years.

Of the 900,000 foreclosed homes now owned by banks, only a third are on the market, he notes. Banks are carrying homes on their books because of delays in processing the volume of paperwork and also because of state laws that put a six-month hold on sales as a way of giving owners a last chance to pay back their loans. Another factor, Sharga says, is banks' unwillingness to take title to foreclosed properties because new accounting rules would require the homes to be valued at their current market price. In many cases, the amount would be less than the outstanding loan, diminishing the bank's financial statements.

While some forecasters have suggested there are as many as eight million homes in the so-called "shadow inventory" of properties waiting to come on the market, RealtyTrac estimates that the total number of distressed properties that will change hands as a result of the financial crisis will top out at 3 million to 3.5 million. According to Wachter, when homes are sold in foreclosure, they go for 40% to 50% less than in a standard transaction between homeowners.

I don't know why he thinks so many will ultimately keep their homes. I wager the number will be closer to eight million homes than three million homes.

… According to Wachter, a look at the city-by-city Case-Shiller data shows that homes in some markets are improving strongly while others are continuing to lose value. For example, the most recent data shows home prices are up in San Francisco (11.2%), San Diego (9.3%) and Los Angeles (7.5%) compared to the same month last year. At the same time, prices for the period are down in Las Vegas (4.9%), Charlotte (3.5%) and Tampa (3.2%). "Different markets are responding in different ways," Wachter notes. "The story now is that markets are bifurcating between the ones that are coming back and the markets that are very slow to recover."

The differences in the performance of various markets has largely been dictated by how much squatting the banks are allowing. In the markets doing the best, loan owners are not being foreclosed on. in the markets doing the worst, loan owners are being booted out.

Homeowners who are disappointed with their decision to buy a home are only discovering what housing economists have always known — a home should not be considered an investment, Gyourko states. Paying a mortgage can be a good way to save because it requires the discipline to make regular payments. But, he notes, a rise in the price of a home is less valuable than a rise in price for other investments, such as stocks or bonds. If a homeowner pays $100,000 for a house that appreciates in value to $200,000, the gain is not really $100,000; the homeowner would not realize the gain because he or she would still need to find a new place to live. A comparable home would also have appreciated as much, eating into the homeowner's gain. A stock that rose in value by the same amount would yield the full $100,000 gain upon sale, less taxes.

Did you catch that? Home price appreciation is not the great deal everyone thinks it is. You still have to live somewhere, and if you spend the house — like everyone else did — then you still need to replace it with a house that has also gone up dramatically in price. People who buy for appreciation do not get the same advantages as a competing investment. Of course, everyone ignores those issues when prices are rallying and lenders are giving out HELOCs like crack to an addict.

In the years leading into the crisis, Gyourko says, homeowners "fooled" themselves into thinking their homes were investment vehicles, and they leveraged the value of their homes to borrow new money for vacations, cars or college educations. "But that's risky. When prices dropped, these homeowners were underwater." The only time home price appreciation counts as savings is when the homeowner trades down in the quality of their housing, or dies and no longer needs a new place to live.

Homeownership also prevents workers from relocating to get a better job if they are locked into a home that cannot easily be sold. In a paper written with Ferriera, Gyourko found that between 1985 and 2007, people with negative equity in their homes were one-third less likely to move. "A lot of people are stuck," he says.

Loan owners don't move. If there is a better job in another town, forget it.

According to Ferreira, the market is close to being stabilized, but could continue to decline over the next two years; he does not expect a pick up in prices for five or possibly even 10 years. In addition, it is difficult to even forecast prices because so few transactions are occurring. Between 1980 and 1986, he says, the U.S. housing market recorded 600,000 to 800,000 home sales per year. That figure jumped to 1.4 million in 2005-2006. Now the market is down to 350,000-400,000 home sales per year, even though the nation's population has grown more than 30% since 1980.

Yet another problem that will weigh on the market in the future are those homes owned by people who are able to make their mortgage payments, or have paid off their loans, but would still like to move to a bigger or a smaller home, to a new neighborhood or to another state. These people, Ferreira says, have been holding off on listing their homes because the market is so weak. Eventually, he adds, they will grow tired of waiting and will put their homes up for sale, adding even more supply to the market and further depressing prices. "They can stick with the investment for now, but the reality is that eventually — and that can be one, two or three years from now — a lot of people will be tired of investing in housing and will sell for any price."

He is describing market capitulation. Until everyone abandons hope and sells, the overhang of supply will keep prices from rising.

Over the long run, Ferreira predicts that housing will return no more than 3% a year, barely keeping pace with inflation. Going forward, he says, homes should be considered a place to live, not an investment. "I strongly recommend not using housing as a potential investment. Leave that for the speculators. If you buy a house, you should buy it for your own consumption. That's all you should care about."

Owner occupants should never consider home price appreciation in their purchase decision. For one, most people dramatically overestimate how much house prices will go up. When people start factoring in appreciation, they are usually just playing games with numbers to find some rationalization for an emotional decision they already made.

This neighborhood is crumbling

I have written many times about how the banks have withheld supply to artificially support prices. The neighborhood where today's featured property is located is a perfect example of what happens when the inventory gets too abundant for the available sellers to mop up.

This particular neighborhood within Oak Creek is north of Alton and adjacent to the shopping center. There are numerous three-story units and a mix of other product types. The prices for these units has been holding steady at $610,000 to $650,000 for the last 18 months. Since the expiration of the tax credits, very little has sold, and a few of the properties not mired in short-sale debt have been competing for the few remaining buyers.

The bank bought this property at auction in February, and they put in on the MLS in June. The have been steadily lowering their price, and they are still unable to find a buyer:

Date	Event		Price
Sep 29, 2010	Price Changed		$500,000
Sep 02, 2010	Price Changed		$555,000
Jul 29, 2010	Price Changed		$595,000
Jun 22, 2010	Listed		$625,000
Feb 16, 2010	Sold (Public Records) This home was foreclosedForeclosure is a process that transfers the right of home ownership from the homeowner to the bank or lender. A home goes into foreclosure when the owner stops paying his mortgage loan payments. and bank-ownedShort for "real estate owned," REOs are foreclosed homes owned by banks and lenders..		$617,971

Their first list price was reasonable for comps at the time. When they lowered the price below $600K, I imagine they where quite surprised the offers didn't come flooding in. Now they stand at $500,000. Where are the multiple offers over the ask? Why have they had to lower the prices 20% and they still haven't found a buyer?

The answer is simple: the tax credit pulled all the demand forward, and there are no buyers ready, willing, and able to pay the previous price equilibrium. I must admit, I am surprised by how far the banks and the flippers have had to lower prices to get out of these properties. When some of these properties close, the comps are going to be crushed, and a big drop will become reality.

Hat tip to Shevy for pointing out this neighborhood's activity.

A refi they will regret

The previous owner of today's featured property paid $695,000 on 6/28/2004. They used a $556,000 first mortgage and a $139,000 down payment. The wend into default in mid 2009, and the bank bought it at foreclosure for $617,971 which is the total of the note, missed payments, various fees, and so on — BTW, that means many of the bank losses I show are actually much larger.

The owners refinanced their first mortgage for $562,500 on 6/15/2007. They only took out $6,500 which probably covered their origination fees plus gave them a few dollars. The refinance cost them their non-recourse protections. When the bank finally disposes of the REO, they may go after this couple for the shortfall. The previous owners already lost $139,000 and their good credit, and later the bank may come back for another pound of flesh.

Irvine Home Address … 5 PERIWINKLE Irvine, CA 92618

Resale Home Price … $500,000

Home Purchase Price … $617,971

Home Purchase Date …. 2/16/10

Net Gain (Loss) ………. $(147,971)

Percent Change ………. -23.9%

Annual Appreciation … -31.4%

Cost of Ownership

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$500,000 ………. Asking Price

$17,500 ………. 3.5% Down FHA Financing

4.25% …………… Mortgage Interest Rate

$482,500 ………. 30-Year Mortgage

$94,874 ………. Income Requirement

$2,374 ………. Monthly Mortgage Payment

$433 ………. Property Tax

$160 ………. Special Taxes and Levies (Mello Roos)

$42 ………. Homeowners Insurance

$43 ………. Homeowners Association Fees

============================================

$3,052 ………. Monthly Cash Outlays

-$375 ………. Tax Savings (% of Interest and Property Tax)

-$665 ………. Equity Hidden in Payment

$27 ………. Lost Income to Down Payment (net of taxes)

$63 ………. Maintenance and Replacement Reserves

============================================

$2,101 ………. Monthly Cost of Ownership

Cash Acquisition Demands

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$5,000 ………. Furnishing and Move In @1%

$5,000 ………. Closing Costs @1%

$4,825 ………… Interest Points @1% of Loan

$17,500 ………. Down Payment

============================================

$32,325 ………. Total Cash Costs

$32,200 ………… Emergency Cash Reserves

============================================

$64,525 ………. Total Savings Needed

Property Details for 5 PERIWINKLE Irvine, CA 92618

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Beds: 2

Baths: 3 baths

Home size: 1,750 sq ft

($286 / sq ft)

Lot Size: 2,000 sq ft

Year Built: 2001

Days on Market: 117

Listing Updated: 40457

MLS Number: U10002802

Property Type: Condominium, Residential

Community: Oak Creek

Tract: Othr

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According to the listing agent, this listing is a bank owned (foreclosed) property.

PRICE REDUCED! WELCOME HOME TO THE CITY OF IRVINE AND WHAT MAY WELL BE THE VERY BEST CITY IN ORANGE COUNTY.THIS IS A SINGLE FAMILY DETACHED CONDOMINIUM LOCATED IN THE SOUGHT AFTER OAK CREEK COMMUNITY. THE PROPERTY FEATURES TWO BEDROOMS PLUS A DEN, AND 3 BATHROOMS. YOU ARE PART OF A GATED ASSOCIATION THAT CREATES THE FEELING OF BEING ON PERMANENT VACATION IN AN EXCLUSIVE RESORT. YOU WILL ENJOY THE ASSOCIATION POOL AND SPA, AND MANICURED GREENBELTS. THE LOCATION IS FANTASTIC YOU ARE CLOSE TO ALL THE GREAT THINGS IN IRVINE; PARKS, SCHOOLS, GOLF,THE NATURE CONSERVANCY, RECREATION, THE SPECTRUM, AND SO MUCH MORE. SO COME HOME TO IRVINE, AND START TO LIVE THE ORANGE COUNTY LIFESTYLE TODAY. THE BUYER SHOULD INVESTIGATE THE PROPERTY WITH PROFESSIONAL INSPECTORS.