IT’S ALL ABOUT HOUSING
July 2005 marked the beginning of a negative housing cycle that many regions of the country remain in today. Few forecast-ed the steep nature of decline nor it’s duration. A similar trend in financial markets further complicated housing’s impact on balance sheets, leaving households, businesses, and institutions at risk. Equity markets have recovered reasonably from their lows. While showing signs of improvement, home values still remain well below their 2008 levels. Whether the asset is a mutual fund within your retirement account, or your principal residence, any gain or loss does not occur until that asset is sold. Some had the resources to wait out the storm; others did not.Federal intervention provided liquidity to over-leveraged institutions in sufficient amounts to avoid systemic chaos in the financial sector. Accounting rules were relaxed to postpone recognition of a decline in collateral values. Policy actions averted any potential “run” on our banking system while providing select institutions the cash they needed to survive. These actions did nothing to deal with the fundamental economic problem. The underlying collateral, which remains in distress today, is residential real estate.
On a national basis, home values remain down by over thirty percent from their peak in June of 2006. Put simply, that means that on average, ninety million homes lost about fifty thousand dollars each in value during the past five years. The math is simple; collectively, about 4.5 trillion dollars in home equity evaporated. Frankly, no one, not even the federal government, can absorb that level of loss. The only logical public policy alternative is to support and restore the housing sector. The appreciation of home values offers the most realistic potential for recovering some or all of the 4.5 trillion dollars.
THE NEW ROLE OF GOVERNMENT IN HOUSING
Public Policy played a considerable role in creating the housing bubble and ultimately will be central to recovery in this sector. To date, government actions in response to this crisis have been mainly focused on averting institutional failures while never really addressing the core problem of declining real estate asset values. The time is quickly approaching when the disposition of “troubled assets” will have to be accounted for on someone’s balance sheet.
The complexity surrounding the securitization of troubled assets is just one of the challenges we face. The potential loss is beyond any institution’s ability to survive. Frankly, the problem cannot be solved through traditional methods of foreclosure and resale at market value. The volume of “at risk” properties exceeds the market’s ability to absorb new inventory.
Ultimately, it is the government (taxpayer), that will bear the consequence of mortgage meltdown. Many of the entities which made these loans are no longer in business. Surviving institutions who bought bad loans from the failed banks did so with public financing and government guarantees.
Fannie Mae and Freddie Mac own, or guarantee, over fifty percent of the nation 12 trillion dollar mortgage market. Both entities were publicly traded companies, implicitly backed by the “full faith and credit” of the United States Treasury. In September of 2008, both entities were deemed insolvent and placed under conservatorship of the Federal Housing Finance Agency (FHFA). Effectively, the Federal government is now the guarantor for the majority of mortgage debt in the United States.
Now, consider that 25% of residential properties which have a mortgage are in a negative equity position. While the amount varies by state, these mortgagees are upside down $65,000 on average.Generally, default rates rise as cumulative loan-to-value ratios-increase.
Obviously, the government / taxpayer carries the bulk of the exposure as values continue to decline. Conversely, every dollar in appreciating home value removes one dollar of risk. It is from this perspective that we anticipate future intervention plans to be developed.
FHFA is currently seeking collaboration from industry participants on how best to manage through an over supply of inventory. Traditional methods of liquidating distressed property may be a thing of the past.A strategy of sales to investor pools for rental housing seems more likely. Restrictions on resale of these properties, until such time as the market can absorb the additional inventory, seems fundamental to success.
Like it or not, the federal government is now the largest residential property owner in the United States. We expect to see them protect their investment regardless of how they got there.
THE CAPITAL REGION IS UNIQUE
Ours is a crisis of confidence. We remain acutely aware, on a daily basis, of the dismal economic climate with which this country is faced. Each Thursday, for example, we learn that there were approximately400,000 new jobless claims filed during the past week, and we know that 9.1% of people seeking jobs in this country don’t have one and can’t find one.
Each day, we are reminded how fortunate we are that our businesses and our homes are located within the Washington, D.C. Metropolitan area. We enjoy comparatively robust economic conditions which would not likely meet recession criterion on a stand-alone basis.Although we participated in the housing bubble, our statistical trends turned positive twelve to eighteen months ago.
Over half the families who buy homes in our region move here from more than fifty miles away and their moves are job related. Unemployment in Virginia is 6.5% while Maryland stands at 7.1%. Both statistics outperform the 9.1% national number by almost a third. Our economy is growing. Home values are increasing.We are in a unique and favorable circumstance. While it seems a bit self-serving to say this, real estate is “On Sale” in our nation’s capital. If you are here, or if you are on your way here, please take advantage of that. You should not base your home-buying decisions on market conditions in other parts of the country.
INTEREST RATES, DEBT SERVICE AND LENDING
The interest rate one secures when purchasing a home is equally important to the negotiated purchase price. As shown in the graph to the right, a $1,000 payment in 2007 was able to service approximately $150,000 in mortgage debt. In 2011, that same $1,000 payment services a $205,000note. Effectively, your monthly investment will buy $55,000 more in 2011 than it did in 2007. Today’s interest rates remain at an historically low level…for now. With fixed rate programs in the low four percent range, we are again seeing a flurry of refinance activity. In 2008, a $100,000mortgage required a monthly payment of $770. That same mortgage at today’s rates requires only a $500 payment. These rates will not be around forever and the payment differential is significant. Many remain under the impression that a substantial down payment is required to buy real estate. Federally insured loans are generally available with as little as three and one half percent down payment. There are widely available grant and development programs that work in conjunction with the primary loan which effectively finance one hundred percent of the purchase price. Programs vary by county but we will be pleased to help if you are interested in exploring these opportunities.
A humbled, yet motivated buyer profile is returning to the market. Underwriting guidelines for government loans will not insure a loan for a buyer who was involved in a foreclosure or short sale within three years of the anticipated closing date of a proposed new purchase transaction. At three years and one day, these buyers can purchase a home with as little as three and one half percent down payment. Considering the number of foreclosures and short sales that occurred in 2008 and2009, we expect buyer side activity levels to continue their increase.
The steep decline in value between 2006 and 2010 resulted from an oversupply of inventory in relationship to the number of ready, willing,and able buyers. Supply and demand, right? That sounds simple, but because of inexperience, institutions were not prepared to manage the inventory side of the equation. Foreclosure was a seldom used alternative since homes consistently appreciated in value. While some institutional leaders had experienced previous recessionary cycles, they did not anticipate the depth and duration of this one. What may have worked in the past was ineffective and even counterproductive in this environment.Institutions rightfully foreclosed on defaulting borrowers and resold the homes at distressed values. In areas comprised of planned unit developments, those distressed “comps” had a negative impact on the value of every other home in the neighborhood. It was not uncommon to find a dozen distressed homes on the market within a given subdivision. Values declined significantly. Due to the amount of inventory they control, the federal government is in a unique position to interrupt this cycle. Faced with the substantial risk of further decline, meting out inventory at levels which the market can absorb is a strategically sound approach. Keeping property occupied with cash flow after foreclosure certainly makes more sense than selling at distressed levels or holding and maintaining the property while vacant. Every indication shows we will see some variation of this strategy employed in early 2012. The entity that owns the most residential property in this country cannot afford continued decline. They have the resources and influence needed to manage supply and demand. Clearly, their best interest is to make certain the bottom is behind us.
SO WHEN DID WE HIT THE BOTTOM?
It depends upon where your reside within our region. The graph to the right comes from George Mason University’s Center for Regional Analysis and is compiled using data from our Multiple Listing Service. The Greater Washington, D.C. Metropolitan Area hit its lowest value in February of 2009 from its peak level in June of 2006. The average decline in that two and a half year time span was about 38%. Since the bottom in February 2009, values have appreciated on average by 32%but remain 18% below their peak value. There are two variables that determined how well, or poorly, specific areas within our region performed throughout this cycle. Those are“Jobs” and “Proximity to Jobs.” The reason the Northern Virginia markets have outperformed suburban Maryland areas is the labor market. The graph below compares unemployment rates in the United States to those in our area.
REGIONAL VALUE TRENDS
The country has always differentiated those living “inside the beltway” from others that reside in the Northern Virginia area. While usually intended to describe a life perspective, it also defines an area with good proximity to quality jobs and lifestyle amenities.Proximity, as it relates to inside the beltway, has value. The “bottom” is following the same geographic pattern as did the market on the way up. As prices increased between 2000 an 2006,families were willing to deal with longer commutes to achieve a more spacious lifestyle. When values fell, a similar lifestyle became affordable again closer to the beltway. Markets beyond a 75 minute commute to the District, or those lacking public transportation access, continue to lag the core market.
IS RECOVERY SUSTAINABLE?
Northern Virginia performance is largely due to fundamental advantages relating to a business friendly climate. By offering a lower tax burden, less regulation,and lower development costs, Northern Virginia has been successful in attracting federal contracting entities. Between 1980 and 2010, federal contracting increased from 1.7 billion dollars to 38.5 billion dollars annually. We also have strategic advantage relative to local, domestic, and international transportation access. Our entire region is positioned well to be attractive to the sectors where jobs are being created. We are home to the world’s most respected educational institutions. Our employer base produces much of our country’s innovation and is the bridge between academia and industry. Each year, our economy becomes more diverse by attracting non-federally dependent business.
I HAVE BEEN THINKING OF MOVING…
The Grand Slam opportunity is for the family ready to retire from Falls Church, Virginia, to a warm weather climate like Florida, California,Nevada, or Arizona. If there is a mortgage involved, the one being paid off here likely has a higher interest rate than the new one there. Mortgage costs in those markets can go down by as much as eighty-percent. It seems clear that our area real estate values have stabilized and even appreciated modestly. Don’t expect twenty percent annual increase, but those that buy today will do very well over the next ten years. If you are not living where or how you want to live, now might be the time to change that. There will continue to be some level of distressed inventory for years to come. At whatever pace the distressed inventory is introduced nationally, expect it to be significantly less in our region. Those waiting for another tsunami of foreclosures will be disappointed. Unlike a poor stock purchase, homes provide shelter. If you own one long enough, and care for it properly, it may pay dividends. Homes are where cherished memories rest. If you don’t have one, now might be a very good time to change that.
If you are considering a real estate transaction, thorough analysis and competent representation are essential. We are in a transitioning market. There is potential for profit, as there is risk of loss. If we understand the underlying facts, we can continue to make good business decisions logically and without emotion. I am a real estate professional and accept responsibility for keeping my friends, neighbors, and business community informed as to all aspects of things affecting the real estate portion of their holdings. If your home is currently listed for sale, this is not a solicitation. If you have a real estate question, I will be happy to answer it, or find the answer. If you have a real estate need, I will appreciate an opportunity to compete for your business. Our team is very good at what we do…our results demonstrate that. Don’t settle for less.
Todd Hetherington, CEO, NM Management, Inc.