Emerging Inflection Points as Real Estate Continues Down the Road to Recovery

As results continue to roll in on the state of real estate, there’s good news on all fronts.   Few now doubt the return of stability to housing.  Here’s a short list of notable gains in the past twelve month period:

• A dramatic drop in foreclosure starts
• Lower REO inventories and a shrinking "shadow inventory"
• The exodus of the all-cash buyer having been replaced by the return of the average consumer
• Increased demand (and revenue) for multi-family and single family rental units

 The most promising news is that the appreciation in home values is so solid that even the S&P / Case Shiller Home Price Index has now officially acknowledged it in its recent reports.

 

These are all encouraging developments that, barring significant setbacks in other areas of the economy (job growth, GDP) should sustain the recovery. It’s important, however, to watch for upcoming inflection points in isolated parts of the industry where progress in one sector has direct impact on another sector.  The recent trend of rising home prices is a good case in point.  

Multiple factors contribute to the current low supply of housing product, including reduced inventories of distressed properties as a result of bulk purchases, lower REO inventories, and sellers sitting on the sidelines.  As prices to continue to rise, watch for the inflection point when more sellers list properties.  Potential sellers are not just playing a wait-and-see game for a better return on their investment. Despite the current wave of loan modifications and refinancing opportunities, a significant cross-section of homeowners still owes more than their homes are worth.  Appreciating home values combined with principal reductions, loan modifications, refinancing, and other borrower relief programs should bring about a tipping point that will introduce more homes into the sales pipeline.  The perception that prices are rising could be enough to coax homeowners with entry-level homes to bring them to market to fill that important affordable niche of homes.

Short sales present another interesting scenario of an upcoming inflection point for the disposition of distressed assets.   After our many years of experience as well as lobbying with local politicians, short sales have come of age in 2012, finally gaining full support of lenders and servicers. With increased lender incentives, additional regulatory guidelines streamlining the process, limits on junior lien indebtedness and allowing even more borrowers to qualify, short sales are helping thousands to avoid foreclosure and reduce the flow of properties back onto bank and GSE balance sheets.   The inflection point: when the discount to lenders for selling off a bank-owned property matches or exceeds the discount for short selling the property before it’s foreclosed.  Recent data shows a margin of 3% between losses lenders incurred for foreclosures (25%) and short sales (22%), and the gap is narrowing.   However, when all is said and done, if REO enables lenders to start recouping losses faster than do short sales, the cycle could turn again.

Renting versus buying in today’s environment is probably the best-known example as an inflection point in today’s market.  Given the strong demand for housing generated by displaced families (a result of foreclosure or short sales) and new households that didn’t meet lenders’ strict underwriting standards to qualify for a mortgage, the rental market boomed.  Owning a home seemed improbable, if not impossible.  But rents have increased at such a pace that now, buying a home for many consumers pays off only after three years of ownership.

The recurring impact of home prices on all of these scenarios creates potential inflection points. 

 

If all factors come to play to nurture an environment that allows for the measured, consistent, and healthyappreciationof home values, the real estate secor should enjoy a long cycle of positive growth. It's clear that the dircion of home values has a powerful impact on affecting change in number of critical sectors in the real estate industry.