How Reducing Foreclosure Inventories Impact the Real Estate Recovery

Nearly halfway through 2012, the real estate industry is making headway in finding prescriptive solutions to return to some state of stability. An improving economy and increased government involvement in modulating anti-foreclosure programs has caused many real estate pundits to declare the housing crisis near its end. And while these factors play a pivotal role in restoring equilibrium to the market, what could be the most significant indication that the” light at the end of the tunnel” is not just a myth is the slow and steady erosion of the inventory of distressed properties on the market.

It’s no secret that the saturation of distressed assets on the market has driven home values down, underwriting standards for new mortgages higher, and prospective buyers out of the market during the first years of the housing downturn. As the dust of 2011 settled, however, we saw the emergence of certain forces continuing into this year that are helping to shrink the numbers of distressed assets. Lower distressed home values gave rise to the all-cash investor with a voracious appetite and deep pockets for bargains. The government even stole a page from the investor playbook by piloting a bulk REO to Rentals program in 2012. Investors are enjoying healthy returns as a result of the popularity of single-family residential housing over multifamily housing, and are on the lookout for more deals.

Ironically, the banks themselves proved the next major force that emerged as a key factor in reducing distressed inventories. Or more accurately stated -- a shift in bank policy toward previously-disdained workout solutions. Banks finally did the math that everyone else did and realized it was cheaper to accept a lower value through short sales than let a property languish on its asset sheets. Banks not only embraced short sales, they proactively reached out to distressed borrowers to consider short sales as a way out with huge incentives in store for them if they sold. Moreover, other workout solutions such as deed-in-lieu or “cash-for-keys” programs gained favor with lenders as they sought more drastic solutions to reduce existing inventories. One lender is even experimenting with a long-overdue twist to the deed-in-lieu solution by taking back title and renting the property back to the distressed homeowner at a rate lower than their mortgage payment.

The combination of private investors and lender initiatives, with a healthy dash of regulatory pressure has resulted in such an alarming decrease in housing inventory that values on non-distressed properties have not only bottomed out, but risen in select markets. And while not nearly approaching the volume of the housing boom in the last decade, multiple offers on properties have returned. Shrinking foreclosure inventories coupled with other key indicators such as falling mortgage delinquencies and more promising employment statistics seem to reflect a healthier real estate sector.

What does this mean for real estate professionals? Agents, brokers, and other ancillary real estate service providers should see increased activity compared to 2010 and 2011, but to make the most of new opportunities must be able to handle complex transactions involving distressed assets. Any investors that have been sitting on the fence waiting for a true bottom to hit to find even more bargains may miss their window of opportunity if they don’t throw their hat into the ring now as the availability of discounted properties as investment vehicles will become harder to find. And as conditions improve, more sellers will be enticed to bring their homes to market demanding (and holding out for) a higher asking price. While a renewed sellers’ market with stronger pricing would of course be the best scenario for housing, investors will have to shift their strategy to take advantage of the market.

There’s indeed reason for renewed optimism that the worst of the real estate downturn is in the rear view mirror. The road ahead for real estate should prove less treacherous in the next cycle if travelled with a cautious strategy that includes finding more ways to liquidate distressed assets from the marketplace.

Consumers: The Missing Fundamental

"Market fundamentals" are often cited when evaluating the real estate industry. Indices measuring home values, cap rates valuing commercial properties, office vacancy "absorption rates," REO inventory, are great examples of accepted standards used by the industry to measure success. What's missing from this list is the influence consumers and small business have on core fundamentals, and they could arguably be the most critical component in driving the real estate recovery.

Let’s start by looking at the distressed homeowner segment as one example of how consumers are contributing to the recovery. Armed with more information and options than ever before, borrowers are confronting and no longer running from delinquencies. Their proactive efforts to modify loans, refinance underwater mortgages to lower rates, and accept a short sale as a foreclosure alternative are having a positive effect on containing non-performing assets held by lenders. At the other end of the spectrum, consumers with less debt and on more stable financial footing are feeling more confident in their ability to handle the obligations of a mortgage. Realtors, builders, and loan originators alike should soon see their numbers improve as more buyers are enticed into the market by low rates, more affordable homes and evidence of an improving economy.

Fundamentals in multi-family real estate are also improving thanks to the rise of the latest “renter nation,” a new generation of younger and more transient households not interested in the overhead of a mortgage. As a result of this new demand, developers and investors with positions in multi-family projects are seeing a much needed jump-start in apartment construction.

And finally, as more consumers get back to work, small business expands in pace with current economic growth, and construction of new office product is at a standstill, office vacancy rates will continue to contract and generate more healthy returns for owners / investors in the office and retail sectors.

The real question at this point is, as consumers and small business are in the drivers’ seat of the recovery, what can the industry and government policies do to ensure the recovery moves forward?

• Let’s start with government policy. Efforts should continue for crafting workouts for borrowers who could afford to keep their homes under loan-modified circumstances, and toward removing barriers for short sale or other foreclosure alternatives for homeowners who cannot afford to keep their homes.
• Realtors should better adapt to service a market heavily-influenced by distressed properties. Short sales and REO sales are projected to dominate the market through 2012. Major stumbling blocks in 2011 were protracted short sale negotiations and pervasive litigation. As expertise is required, realtors should partner with specialists familiar with the unique lender-buyer-seller process to facilitate more efficient, litigation-free sales.
• Investors and developers have an opportunity to step up to meet the growing demand for affordable rentals through new multi-family projects, and by participating with GSEs in bulk REO purchases and converting them to rentals to meet the demand for affordable housing and limiting the “for sale” inventory.
• Lenders need to step up the most. Without the flow of credit, the system simply stops working. Lenders must not only be a reliable source of capital for the investor class, they need to loosen restrictions for consumers as well. Easing restrictions and making loans more accessible and financially-viable to today’s new class of buyers and business owners who understand the responsibilities required of long-term credit commitments, is the glue that will make this recovery stick and move forward.

So goes the consumer and small business, so goes a recovery in real estate. This “fundamental” concept cannot be ignored.