The collapse in housing and the 33
percent plunge in house prices since 2006 are favoring renting
over homeownership. This trend will dominate the housing market
for the next four or five years, and put additional pressure on
a weak economy.
Policy makers in Washington continue to have a soft spot
for homeownership. Many recent government actions can be viewed
as attempts to keep people in their homes, even owners who
clearly can’t afford them. In addition to specific plans such as
the Home Affordable Modification Program, or HAMP, and the Home
Affordable Refinance Program, or HARP, the Obama administration
is trying to revive the moribund housing sector by encouraging
mortgage lenders and servicers to refinance loans at lower
rates.
This reduces interest income for banks, which are now
compelled by the Dodd-Frank law to retain 5 percent of the
credit risk on lower-quality residential mortgages that are
securitized and sold to others. Furthermore, banks are reluctant
to refinance loans that Fannie Mae and Freddie Mac (NMCMFUS) then
guarantee and put back to the lenders if they find any defects.
The White House plan is a tough sell.
Refinancing Woes
As banks deleverage and mortgage activities increasingly
involve unwanted loans, the ability to deal with refinancing has
diminished. Four banks now control more than 60 percent of the
mortgage market, and many mortgage servicers have reduced staff
or been slow to gear up to handle delinquent mortgages and
refinancings. Except for those who qualify for HARP, refinancing
is highly unlikely for 8 million owners who are underwater –
owing more than the value of their homes — because new terms
are treated as new loans. Those who have positive home equity
face dramatically tightened lending standards, a clogged
refinancing system and new fees that can wipe out the savings
from refinancing.
Almost 90 percent of mortgages today are only originated
because of guarantees from Freddie Mac, Fannie Mae and the
Federal Housing Authority, and all three have raised their fees
substantially. As a result, many of the 20 million borrowers who
could cut their mortgage rates by more than one percentage point
through refinancing are unable to benefit.
– Second Mortgages: Refinancing underwater borrowers is
tough when they have second mortgages that also have to be
renegotiated, or if mortgage insurers have to agree to the new
loans. Many borrowers can’t qualify for refinancing because of
tightened lending standards. Fannie, Freddie and the FHA have
strengthened their requirements because of pressure from the
administration to avoid more losses on bad mortgages. High
credit scores are needed to refinance outside HARP, along with
two years of tax returns, proof of income and recent evidence of
assets such as retirement and brokerage accounts.
During the housing boom, appraisals for house purchases
were generous. (And why not? Everyone was certain that house
prices would rise indefinitely.) Cooperating appraisers were
often recommended by real-estate brokers and mortgage lenders
who wanted the deals to go through. After the house-price
collapse, however, appraisals became very conservative, as
lenders pressured appraisers to make low estimates.
– Postponed Foreclosures: Foreclosures (HOMFCLOS) have been curtailed
for several years, mainly because the administration essentially
told lenders and servicers to hold off while they attempted
mortgage modifications. Those efforts largely failed. Then the
industry voluntarily imposed a moratorium while it was caught in
the robo-signing flap, in which documents were approved without
proper examination. More recently, lenders and servicers have
been trying to avoid throwing people out of their homes as the
industry worked out the recently announced restitution with the
federal government and state attorneys general for troubled
mortgages. As a result, foreclosures in 2011 fell significantly
from 2010, and in the third quarter were the lowest since 2007.
Sadly, these efforts to keep people in houses they can’t
afford are simply prolonging the process of repairing the
housing mess and getting rid of excess inventories.
These measures are the opposite of the successful program
led by the Resolution Trust Corp. to clean up the savings-and-
loan mess two decades ago, when loans, other assets and whole
financial institutions were sold off quickly to private buyers,
at very low prices. As we discovered then, large inventories of
distressed assets overhang the market and depress prices. To
rejuvenate markets, initial sales at low prices are needed to
attract buyers and lead to higher prices.
– Sagging Homeownership: Despite all the efforts to keep
people in their houses, homeownership is falling. It dropped to
66 percent in the fourth quarter of 2011, compared with a peak
of 69.2 percent in the fourth quarter of 2004. Meanwhile, the
33.5 percent drop in median single-family house prices is the
first nationwide decline since 1930s.
Growing Delinquencies
Foreclosures, high unemployment, tight lending standards
and lack of money for down payments are playing a role. In the
second quarter of 2011, at least 3.6 million mortgages were
delinquent and at risk of foreclosure; that could climb to 5
million with further house-price declines and if the recession I
forecast for this year takes hold.
The FHA reported that 711,082 single-family loans it
insured were seriously delinquent in December 2011, up 3.2
percent from November, and up 18.9 percent compared with
December 2010. That pushed the seriously delinquent rate to 9.59
percent in December from 9.34 percent in November and 8.65
percent in December 2010.
Many people who are technically homeowners are really
renters. They put little if anything down. In many cases, the
equity is negative when, for example, home-improvement loans
piggybacked on first mortgages and brought total indebtedness to
more than 100 percent of the house value. Many also planned to
refinance their mortgages with cash-outs due to appreciation
before their mortgage rates reset upward or, in some cases, even
before they skipped enough monthly payments to be foreclosed.
– Rent-Free Renters: Since 2006, 3.1 million people are
essentially living rent-free by not paying their monthly
mortgage payments. Assuming a monthly mortgage bill equivalent
to the national average of $1,721 per person, these nonpayers
have increased their purchasing power for other items by $65
billion at annual rates, or the equivalent of 5.6 percent of
after-tax income.
That is a big number, but then 12.5 percent of residential
mortgages are past due or in foreclosure. This may be an
important reason that consumer spending has held up as well as
it has in this recovery, despite all the pressure to increase
the saving rate and reduce debt. Nevertheless, as heavy
foreclosures resume and ex-homeowners are forced to pay rent,
this free money will evaporate.
– Ripple Effect: When house prices were rising, Americans
were eager to keep their houses. So the mortgage was the first
bill they paid each month, even if that meant they postponed
payment on credit cards, cars and student loans. Now, with house
prices falling, mortgages are paid last or not at all,
especially by the mortgage-holders who are underwater and may be
strategically defaulting.
If historical trends hold, the total homeownership rate
will return to its earlier base level of 64 percent by the
fourth quarter of 2016. Continuing the average annual growth in
households over the last decade of 891,000 would increase the
total number by 4.5 million by the fourth quarter of 2016. This
is enough to increase the number of new homeowners by 550,000
even with that further drop in the homeownership rate.
But it also means the addition of 3.9 million new renters,
or 780,000 per year. This doesn’t suggest that we are becoming a
nation of renters. Instead, it reflects the elimination of the
widely held belief that house prices always rise and the end of
loose lending practices that drove the homeownership rate to its
2004 peak. In fact, the reversal to falling prices and the
extraordinarily tight lending standards may push the
homeownership rate below that 64 percent norm; it would now be
60.9 percent if all those with mortgages that are delinquent or
in foreclosure become ex-homeowners.
– Affordability (AFFD): There are many, including the always
bullish National Association of Realtors, who believe that
homeownership is bound to rise because houses are now so
affordable. In calculating its housing affordability index, the
association assumes that a family with median income buys a
median-priced single-family house with 20 percent down and
finances at the current 30-year fixed mortgage rate. The
collapse in house prices and decline in mortgage rates in recent
years have more than offset the weakness in median family
income, which, according to the Realtors’ group, dropped from
$63,366 in 2008 to a $60,824 average for the first 11 months of
2011.
Nevertheless, it is impossible to compare the current
attractiveness of buying a home and the conditions in the 1990s
and early 2000s. Unemployment rates were much lower then, and
house prices were rising as they had been since the 1930s.
Financing a mortgage was easy with little or nothing down and
spotty credit. Then, huge house-price declines and widespread
foreclosures were unthinkable.
– Weak Earnings: Furthermore, real weekly earnings are
falling in what is supposed to be an economic recovery, even as
payroll employment growth has been modest. Long-term
unemployment is now becoming common, with 43 percent of the
unemployed out of work 27 weeks or more and the average length
of joblessness at 40 weeks. Job openings have been rising, but
hiring is little changed because many of the long-term
unemployed, and the newcomers to the job market, don’t have the
required skills. Manufacturing output has revived, but it has
been accompanied by the resumption of rapid growth in output per
employee, which means production advances have arrested but not
reversed the long-term downtrend in manufacturing employment.
Realistic housing affordability is also subdued by the 10.7
million underwater homeowners who cannot move to different,
perhaps more expensive houses and thereby free up starter houses
for new homebuyers. A recent study reveals that underwater
borrowers are 30 percent less likely to move than renters or
those with positive home equity.
– Expensive Houses: Despite the collapse in prices,
homeownership is still expensive relative to rentals, even as
apartment rental rates rise and vacancies decline. Moody’s
Analytics Inc. calculates a ratio of home prices to yearly rents
at 11.3, down from the bubble peak of 18.5, but still higher
than the 1989-2003 average of 10. You’d expect house prices to
be lower than average in relation to rents, not higher, now that
prices are falling.
Rents have to be higher for landlords to offset the eroding
value of their properties. The decline in a rental house’s price
is just another cost like taxes and maintenance. In any case,
the house price-to-rent ratio is only relevant to the few who
can qualify to buy.
In past decades, houses have sold for about 15 times rental
income. That was true of the post-World War II years, when
owners of rental properties expected inflation to enhance their
6.7 percent return, not including maintenance costs and property
taxes. If I’m right about the outlook for slow economic growth
and falling house prices, houses and apartments are more likely
to sell below 10 times rental income.
The consumer retrenchment and recession I foresee for this
year will only add to the lack of affordability of owning houses
and to the attractiveness of renting. With it, unemployment will
rise, while incomes will fall further. As employment drops, the
duration of unemployment will rise, labor force participation
will fall and median single-family house prices will decline an
additional 20 percent. That will definitely make ownership less
attractive even if it raises the Realtors’ housing affordability
index.
(A. Gary Shilling is president of A. Gary Shilling Co.
and author of “The Age of Deleveraging: Investment Strategies
for a Decade of Slow Growth and Deflation.” The opinions
expressed are his own. This is the first of a three-part
series.)
Read more opinion online from Bloomberg View.
To contact the writer of this article:
A. Gary Shilling at insight@agaryshilling.com.
To contact the editor responsible for this article:
Max Berley at mberley@bloomberg.net.
Please enable JavaScript to view the comments powered by Disqus.
Article source: http://www.bloomberg.com/news/2012-02-22/why-renters-rule-u-s-housing-market-part-1-a-gary-shilling.html
