this report was first published as part of the Mortgage Pages research series on 9/3/09

A reporter from the Journal called me yesterday with a single housing data point about the July Existing Home Sales report that puts the mid-to-high end market into absolute perspective.

Let me frame this…in the bubble years existing sales $500k and over were common. In CA alone, from early 2005 to late 2007, the average house price was over $450k. Total sales were huge then too…over 700k nationally in many summer months.

In July 2009 there were only 460k single family (ex-condo) sales – by the way that was down from June’s 465k, but that got lost in the housing bottom headlines. Of the 460k houses sold, only 12k or roughly 2.5% had a purchase price over $500k. I don’t have inventory numbers on houses for sale over $500k but even at 5% of the total inventory that is 1.75 years of supply. Oh, and by the way in CA alone last month there was close to 12k NODs on props over $500k.

This 2.5% sales rate goes to underscore how insignificant (and ruined in many cases) the organic move-up/across buyer has become due to epidemic negative equity and absolute lack of affordability through exotic finance. Unless he can sell and re-buy he will remain gone.

But what really is negative equity? Unlike the bubble years when zero down or a 100% HELOC after the purchase in order to replenish savings was the norm, today’s buyer has to sell for enough to cover the Realtor cost and the 20% down needed to buy most mid-to-high end houses using new vintage loans. Most analysts look at the reported negative-equity figures as the tipping point — it’s not.

If homeowners can’t sell for enough to pay a Realtor 6%, extract the down on the new property, and pay for moving costs they are effectively in a negative equity position. Homeowners know this — a homeowner that has only 15% equity knows they are trapped in their house. We are still learning what this realization does to spending habits, as the focus for many becomes ‘how do I earn or save my way out of this’.

When looking at neg-equity if you move the bar down to 90%, 80%, or even 74% (6% Realtor fee + 20% down) then it changes everything. The vast majority of homeowners in the nation become stuck (see chart below). Without these existing homeowners active in the real estate market, we will never find a true bottom.

The 2.5% sales number also highlights how devastating the Jumbo Prime, Pay Option and Alt-A implosions and subsequent foreclosure waves will be on the market even if it is kicked down the road through mortgage mod initiatives. Where are the buyers going to come from? Supply is already out of control in the mid-to-upper price bands. Unlike the low end of the market that is so hot today, investors won’t be in there buying a $600k house because they know the buyers are far and few in between. In addition, with mid-to-high end rents tumbling the cap rates make it prohibitive. You can also scratch off the list most first-time buyers.

That leaves a few different directions the mid-to-high end can go...which one sounds the most logical to you? 1) even more exotic purchase loans than we saw during the bubble — that allow over 100% LTVs and do not verify income — are created that essentially allow for easy house swapping 2) banks just never foreclose and kick the can down the road until the majority of homeowners earn their way out of their neg-equity hole 3) millions of foreigners are given immediate citizenship for a resi real estate investment over $500k 4) principal balances are forgiven allowing people without damaged credit and too much other debt to sell and rebuy 5) everyone gets a 100% raise 6) massive inflation takes the values of real property back through the roof allowing those without damaged credit and too much other debt to sell and rebuy 7) prices fall in line with the most readily available financing ($417k and below) and to levels at which the majority can afford (and at which they are buying right now).

I am sure there are others or a combination of many that could have been on the list but the most obvious is #7 — that is exactly what we have seen since 2007. This is why at the end of the day — when gov’t is gone and the ‘new normal’ can be found — a $1 million house will be the home of a millionaire — someone that can afford the $270k cash down and that has the $200k fully documented annual income needed to qualify. Most other houses will fall in the middle somewhere.

The chart below is from First American’s recent Negative Equity report. The states with stars next to them have an average LTV that is higher than the point needed to pay a Realtor and put 20% on a new house. The states with boxes to the right — the most heavily populated — are at the next level of pain. Nevada needs bulldozers, gasoline and torches.

Best,

Mark Hanson

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Filed on: September, 17 2009 by Mark

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