I am sharing a couple of links to an interview I did yesterday on National Public Radio with Alex Cohen, host of “All Things Considered.” The topic of discussion was the proposed foreclosure registry in San Diego, aimed at reducing blight across bank-owned single family homes. This is a general article about the proposal, and this is the actual podcast. My radio interview starts at 1:07:20 on the MP3 file.
Minutes recently released from the 2006 meetings of Federal Open Market Committee (FOMC) offer some disturbing insights into the failure of Fed officials to understand how deeply intertwined the housing sector and financial markets are. This New York Times piece goes into much detail regarding this and other less-than-flattering aspects of these meetings. While residential investment represents a tiny four percent (4%) of Gross Domestic Product (GDP), it has far reaching backward- and forward-linkages into many other components of GDP, such as construction, construction materials, durable goods, home furnishings, brokerage and financial services. For this reason, it is often said that when it comes to the strong effect residential investment has on the economy, that housing is the “tail that wags the dog.”
When evaluating where we are in the housing cycle, it is often useful to evaluate fundamental valuation metrics and compare current trends versus historical averages. Below is a graph (click to enlarge) depicting the national price-to-rent ratio, which depicts how homes are trading relative to their rental values. This metric is similar to the P/E (price/earnings) ratio typically used in analyzing the stock market.
This graph uses the Case-Shiller Composite 20 and CoreLogic House Price Index, and sets the baseline period at January 1998, which is assigned a value of 1.0. The current ratio (as of October 2011) on both indices is at 2000 levels, indicating that we are very close to long-run historic average metrics. While foreclosures/short sales (lagging economic indicators) still account for a significant share of existing home sales, the good news is that delinquency rates (leading economic indicators) are gradually diminishing. As such, we can expect home prices to bounce around gently for several months, then gradually start to recover based on improving fundamentals.
In response to the National Association of Realtors (NAR) August existing home sales data, released here today showing that sales compared to the previous year are up and inventories are down, I issued the following statement:
“Although the year-over-year sales numbers look very positive, the reality is that last year’s August sales numbers were unusually low due to the post-Homebuyer Tax Credit hangover effect, so this year looks higher mainly by comparison only. We’re still below healthy levels.
We are seeing the foreclosure pipeline starting to open up again, which is good news. This will help achieve price discovery and equilibrium, which has been a huge problem over the past couple of years. In fact, the average home sold in a foreclosure proceeding has been delinquent for nearly 600 days, up from 478 days the year prior. In August, we started to see banks unload foreclosures and arrange short sales at a higher pace. Homes at risk of foreclosure accounted for 31% of sales in August, up from 29% in July. And because distressed sales occur at substantial discounts, this explains the median price decrease for August.
Overall, I believe these numbers continue to show that the housing market is now basically at the bottom, and although the August numbers appear positive, I don’t believe they foretell ongoing positive movement in the short- or medium-term.”
In response to the National Association of Realtors (NAR) data, released August 18th, showing that existing home sales slipped nationally and regionally in July, I issued the following statement:
“The research released by the National Association of Realtors showing a decrease in existing home sales reflects a continuing fall in the housing market, which is now basically at the bottom, with little or no movement expected in the short- to medium-term. The reason for the continuing decline in July can be attributed to negative jobs data throughout the month of July, as well as a crisis of confidence related to the debt ceiling impasse. In addition, when purchasing a home, buyers often look to capturing the “sweet spot” between low pricing and low interest rates. The Fed’s announcement last week to keep the short-term rate at near-zero for another two years removed any urgency for buyers who now have the convenience of waiting out the market to see if prices will in fact get a bit lower before pulling the trigger. Although July 2011 sales compared to July 2010 are up, this increase is misleading, as last July was the first month of sales data after expiration of the homebuyer tax credit, meaning sales were pushed forward into the months leading up to July 2010, causing that month’s sales to be unusually low. As such, a significant increase was expected.”
Here is the link to the official release: NAR Official Release
This New York Times piece, written by Andrew Martin and David Streitfeld, highlights the latest “foreclosure-gate” debacle — that is, the shoddy preparation of mortgage documents which has stalled foreclosures in 23 judicial foreclosure states — and the effect it has on home sales. While the article focuses on sales declines, it altogether ignores the issue of price stability. With fewer homes released into the market, supply is constrained, creating a bit of temporary price stability that otherwise may not have existed. Either way, like most efforts under the current administration, this series of events will simply slow the decline to where the housing market will end up anyway. Here’s a link to the article:
M.P. McQueen’s recent piece in The Wall Street Journal highlights a concept that I routinely teach in my “Real Estate Finance and Investments” course at UCLA: the incremental cost of borrowing. This concept basically conveys the importance of knowing the cost (or interest rate) on each additional dollar of financing.
In class, the example I typically use is to compare an $80,000 loan at 12% interest with a $90,000 loan at 13% (both loans are 25-year fully amortizing, with monthly compounding). While the difference may not be immediately intuitive, the additional $10,000 under the larger loan carries with it an interest rate of over 20%! In other words, you can conceptualize the $90,000 loan as being comprised of an $80,000 loan at 12%, together with a $10,000 loan at just over 20%, to equal a $90,000 loan at 13%. Feel free to contact me should you wish to see a more detailed explanation of how to calculate the incremental cost of financing, but in the meantime, check out the article below, where I discuss a case study that applies this concept to “cash-in” refinancings. This is a critical issue given today’s market dynamics:
My colleague Eric Sussman and I wrote a piece that appears in the Opinion section of today’s Los Angeles Times, related to the City of LA’s Rent Stabilization Ordinance. Below is the article as well as a web link:
L.A. should abandon rent control
Politicians should work with the private sector to encourage affordable housing and rent stability through productive incentives.
Paul Habibi and Eric Sussman
May 21, 2010
On Friday, the Los Angeles City Council is likely to pass an ordinance preventing many landlords from raising rents for four months. This is a step in the wrong direction. Instead, the council should revoke the city’s Rent Stabilization Ordinance entirely.
Rent control policies have laudable goals, especially in populous and undersupplied housing markets like Los Angeles’. However, the city’s law, like all rent control, has failed to accomplish its objectives in the more than 30 years since it was passed. Rent control is widely accepted by many economists to have had an adverse effect on both the quantity and quality of housing.
L.A.’s rent stabilization law has many flaws. First, it applies only to projects of a certain size and age. All residents within such projects are protected, regardless of income or net worth. Thus, an eight-unit building built in 1977 is subject to rent control, while a 10-unit building built in 1979 is exempt. It also wasn’t designed to protect those who most need it. A lawyer earning $200,000 a year renting in a pre-1978 building would be afforded the benefits of rent control, whereas a struggling retiree living off Social Security, but renting in a post-1978 building, would not be. This, of course, makes little sense. Moreover, the outcomes of rent control are entirely predictable, based on simple economic principles. The negative effects include:
A shortage of apartments and artificial inflation of rents, because the limited stock of unregulated units must absorb the excess demand for rent-controlled units.
A reluctance on the part of owners to build new apartments out of fear that rent control laws will be extended.
A tendency of owners to defer repairs and renovations because of the limited prospects for return on their investments. This has a job-killing effect too, because landlords aren’t hiring as many carpenters, painters, electricians, plumbers, roofers and landscapers.
Lowered property tax revenue, because landlords covered by the rent stabilization ordinance can demonstrate that their buildings are less valuable.
An incentive for landlords to remove units from the rental market to achieve higher returns through other means, such as condo conversions.
An increase in animosity between landlords and tenants, with landlords being motivated to seek creative or illegal means to evict tenants, and tenants being motivated to seek equally creative ways (through such unauthorized things as subleasing or bringing in additional occupants) to hold onto rent-controlled units.
The fact is that most tenants in rent-controlled units are already paying below-market rents. Some 40% of renters pay less than 30% of their income for rent and can afford modest rent increases. For a tenant paying $500 a month, the current 3% allowable annual increase under L.A.’s ordinance amounts to a modest $15 per month. Moreover, while the council seems intent on denying landlords even that 3% raise, it just approved a 4.8% increase in electricity rates, which landlords will have to absorb.
Abandoning rent control would not mean abandoning the worthy goals of affordable housing and rent stability. But it would put the burden on the public sector, where it belongs. It is not equitable or desirable to have one narrow and arbitrary segment of the private sector burdened with this responsibility.
Politicians at all levels need to work with the private sector to promote the development of affordable housing. Certain economic “carrots” (as opposed to the rent control “stick”), such as property tax reductions, accelerated depreciation deductions and the ability to exclude for tax purposes a portion of rents received from low-income tenants, would promote the development of affordable housing. The costs of these “carrots” would be borne by all. Need-based programs to subsidize rent for those who require such assistance can and should be expanded. HUD’s Section 8 program is one such example. While it too may have its issues — and it does — it is at least needs-based and allows landlords to achieve something far closer to market rents for their rental units.
With its flawed rent control law, Los Angeles has opted to take a simplistic approach to a complex problem. Whatever the City Council does or doesn’t do in Friday’s vote, it will have done nothing to address the underlying needs of either landlords or tenants.
Paul Habibi and Eric Sussman are lecturers in real estate at the UCLA Anderson Graduate School of Management and owners of rent-controlled property in Los Angeles.
I am quoted in today’s Los Angeles Times, on a piece by E. Scott Reckard related to a slight decrease in California homeowner delinquencies. In a separate report, the Mortgage Bankers Association announced in its Q1 report that delinquencies nationwide were slightly lower while foreclosures were slightly higher, indicating that we are gradually working through the logjam of excess shadown housing inventory. All good news. Link below:
If you only read one article out of each day’s Wall Street Journal, select something from Review & Outlook at the back of Section A. I particularly enjoyed yesterday’s editorial on the need for reform of the GSEs, addressing a recent proposal by GOP Senators McCain, Shelby and Gregg. The essence of the argument is that no financial reform is adequate so long as it exempts Fannie Mae and Freddie Mac, two of the biggest culprits in the housing meltdown. In an attempt to wind down government support for these entities, the McCain proposal seeks to shrink the size of their portfolios, increase capital requirements, and repeal the infamous affordable housing mandates which dramatically increased subprime exposure.
The GSEs have had a host of problems, the most significant issue of which is the asymmetric privatization of gains and socialization of losses – that is, “crony capitalism.” Further, losses to these GSEs are effectively off-balance-sheet, and thus their expected $380 billion budgetary impact is hidden from the government’s books. If we are to see meaningful financial reform, we must address the GSEs role in the housing bubble and create a structure where these entities are left to stand on their own two feet. Link below: