7-23 – The Housing “Supply” I See…a Decade Worth to Work Through

by Mark on July 23, 2012

Folks are overly optimistic on the housing “inventory” issue to the point of being sorely misguided;  confirmation bias is rampant with pundits obsessing on inventory but ignoring everything else.

It’s a classic story of “out of sight, out of mind”.  Each time a housing report is released and inventory prints lower or flat the pom-poms come out.  This reminds me of the “hide the rotten sausage” game the banks were playing in 2007-2009 (still playing today actually) with legacy residential mortgage loans and MBS when mark-to-market accounting was in effect. The banks would continually say they had low or no exposure, analysts and investors would accept this at face value, and each quarter the legacy loan and MBS risk hidden somewhere on balance sheet would weigh on capital.

Each 12 to 18 months when housing (on the bubble or at the margin) responds to some sort of massive stimulus effort consensus quickly jumps behind the macro “recovery” theme and forgets the granular.

To me, the “inventory” that NAR reports is absolutely insufficient for meaningful analysis.  That’s because it’s a “best-case, perfect world” scenario. Take short sales for example.  Few are ever “listed” in a traditional manner. Most are “listed” and go “Pending” in a very short period of time;  many times within a few minutes of each.  There are 600k short sales that occur per year and volume is climbing.  This “inventory” is real and short-sales reduce demand for “listed” inventory.  But you will never capture the 50k short sales per month in NAR’s inventory metric.  This smallest of examples alone means NAR’s “inventory” figure underestimates real and available housing supply by 20%.

The “inventory I see” — that has to be cleared (zombie owners de-levered) before this housing market has a shot at a “durable” recovery — could be as high as 30 MILLION units. Most likely a “bottom” can occur after two-thirds is worked through, or ~20mm units.  But no “escape velocity” can ever occur with over half of all mortgage’d households unable to sell and rebuy or rent — sitting stuck in their houses many with a 1% or 2% interest only teaser rate loan modification (sound familiar) — awaiting default or short sale.

Bottom line:   In order to permanently de-lever this housing market something must be done to address the 20 to 30 million homeowners in a negative or “effective” (lacking the equity to pay a Realtor 6% and put 20% down on a new house) negative equity position; with legacy 2nd liens; and without the credit needed to qualify for a new vintage loan. That’s because repeat buyers are the “durable” demand cohort;  not the volatile and thin first-timer buyer and “investor” cohorts that come and go with the stimulus wind like we saw in the first half of 2010 and will again in the second half of this year.

 

Years of “Supply” to Work Through Before Housing can Stabilize and Eventually Achieve “Escape Velocity” and a “Durable” Recovery

The chart below breaks down demand and supply as I see…as it really occurs in practice.

Based on 4.6 million sales per year — of which roughly 1.25mm per year are REO resales and short sales — then the supply below will take well over a decade to burn through at a 75% rate.  Coincidentally, this turns our housing crisis into a 15 to 20 year events, which is just about the exact amount of time Japan’s housing market took to de-lever.

Note, the three constituents of the “Ghost Supply” cohort are not mutually exclusive of each other meaning a homeowner in an “effective” negative equity position may also have a 2nd lien and impaired credit.

 

Undermining Fed monetary policy leaves the housing market vulnerable to years more pain

It is important to note that “stimulus-induced sales volume spurts” like we saw leading into the homebuyer tax-credit sunset of 2010 and are seeing today with rates down 150bps YoY;  institutional investors coming into the housing rental market in an effort to protect against 1.5% 10-year Treasuries and a genuine lack of top rated investable bonds;  the artificial lack of foreclosures etc is exactly the right medicine to eventually clear this housing market…if one chooses the route of de-levering less painfully over time than all at once.   In this regard the Fed has done a fantastic job “creating demand” in this housing market (the effects of Fed policy are not being analyzed here, simply “did Fed policy create housing demand…yes, it has).

However, the all-out gov’t and bank war against allowing lenders to exercise their “right” to foreclose with new/improved mortgage mod and workout programs coming out every few quarters, which have re-levered 6 to 8 million high-risk borrowers with mods more “exotic” than the loans they defaulted from in the first place, and new laws such as in NV, CA and OR — in NV foreclosure activity is down 80% from Oct of last year — has served to undermine Fed monetary policy as it relates specifically to housing.

Bottom line, the Fed created all the demand this housing market needs in order to — over many years — de-lever it from the bubble years credit excesses. But the gov’t and banks took away all the supply through modification can-kicking and new laws.  The unintended consequences are many.  But most obvious is that this housing depression will stretch out many more years than it would have otherwise and a situation now exists in which Fed monetary policy will start having a diminishing effect on housing demand going forward. This is big trouble.

 

{ 8 comments… read them below or add one }

Jer at Trihouse Consulting July 23, 2012 at 4:08 pm

Mark,

As usual, you are right-on target. Obviously, there may be a few, small, regional specific exceptions but until job creation becomes a reality this “ghost supply” will stifle any market recovery.

Jer

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GG July 23, 2012 at 9:02 pm

I’ve been reading your Mr Mortgage blog and this website ever since the crash…when circumstances forced me and people like me to get a crash-course eduction on the TRUTH…you tell it like it is, the way the shills won’t put it even when we know many of them see the same things you do. I wish your blog was bigger, and that this information was more widely known.

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5755hsa July 24, 2012 at 5:38 am

given your data as presented (this is scary shit), is it possible for this market to start seeing real organic growth in this decade? Bill Gross has said that real estate is the best investment going into the future, but I’m not sure what his timeline is…. So much supply…so few real buyers.

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Bill July 28, 2012 at 7:47 pm

Is there a solution that can expedite this timeline?

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Jeff July 29, 2012 at 1:44 pm

Great analysis! My realtor friends tell me the Banks are still playing games with their mortgage debt holdings choosing when to push foreclosures and when not too.

In Tampa, this has resulted in a shortage of available housing which has temporarily created a mania here to buy and sell homes. Realtors are even begging homeowners to sell their homes. However, as soon as the next wave of foreclosures occur and bank owned houses inventory floods the market and this mini-bubble will be squashed. Those new buyers will be left with instant negative equity. You are right on that this will take years to clean up with normal economic growth (which we believe will be anything but normal going forward).

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QQQBall August 5, 2012 at 8:34 am

Let the market reach price equilibrium. Apt dwellers acted prudently; liars got loans and not there are crocodile tears for the fact that they now realize the could never afford the home they are in. Foreclose and former homemoaners move to apts and the apt dwellers can afford the lower priced homes. Disband FNM and FRE, they were never intended to portfolio mortgage. Lower priced homes are not a bad thing and when people default they move out of the home, they do not die.

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ts August 8, 2012 at 2:25 pm

Great analysis, as always. I’m not sure that the Fed has actually created housing demand as much as pushed it forward with low interest rates. DTI is just as dependent on the borrowing rate as it is on the income, so if and when rates were to rise (even a little, as these would be proportionally larger changes with a rate in the 3-handle range), we’d see a big drop in “affordability” as well as difficulties for a fragile, fee-driven lending sector that is locking itself into 3-handle interest payments for the next 30 years at an alarming rate. The next recession is almost certainly going to be set off by an increase in borrowing costs on the corporate/federal side, and/or a crunch in lending profits setting off another retrenchment by lenders (as in 2008) which the Fed couldn’t just bail out. We’re locked in this muddle through economy for awhile, as the alternatives are all less palatable.

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Blaine Miller August 16, 2012 at 11:29 am

Mark,
I just recently became acquainted with your work and I must say that your analysis is dead on. I am also a housing analyst and have been speaking, blogging, and advising clients from pretty much the same perspective. Today that is challenging as just about everyone in the universe regurgitates the real estate recovery meme with reckless abandon.

I work out of the Phoenix area where earlier this year I noted that our market would experience a mini speculative boom – which happened. I also noted that the boom (and rising prices) would be followed by waning demand as investors and first time buyers get priced out of the market – this is now occurring as demand weakened in July. The next phase will be a return to falling prices which I see happening in 2013, if not sooner.

I agree with you 100%. Everyone seems to get on the recovery band wagon every time the market receives a shot of demand stimulus. Too few analysts are capable of discerning the difference between stimulus induced bounces and a real, organically grown recovery. I agree with you, the latter is a long, long ways down the road. Keep up the good work!

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