The Short Tunnel for Real Estate's Recovery

The overused "light at the end of the tunnel" symbolizing the arrival of the real estate recovery may just have gained some credibility as we enter the last half of 2012.  Or at the very least, the tunnel's gotten much shorter.  The guarded optimism that the downward cycle is over is being supported by some very encouraging news on a number of different fronts. While it’s still premature to proclaim the official demise of the housing crisis, encouraging trends developing over the first six months of the year may portend overall good news for the real estate industry for the last six months of the year.

A housing market described so often as distressed for the past four years is currently getting relief that is constant, sustained, and showing measurable signs it’s providing a cure.  Predictions that lenders would ramp up foreclosures at a rapid scale in 2012 as a result of a landmark settlement with states simply haven’t materialized.  Aggregate foreclosure starts, especially in non-judicial states, dropped over 18% on an annual basis.  The widespread acceptance of short sales by both lenders and borrowers have served a dual purpose in keeping borrowers off the foreclosure rolls and preventing properties from ending up as REO on lenders’ balance sheets.  Moreover, the distressed borrower of 2012 is more qualified, educated and proactive than in years’ past to take advantage of lender solicitations and government programs to modify their loans.  As a result, mortgage delinquencies are at all-time lows, and more borrowers are avoiding Notices of Default.

The non-distressed sector provides some of the best signs of a sustained recovery as well.  In short, buyers have returned.  When bargain-price homes weren’t enough to jumpstart sales, record-low interest rates enticed buyers back to the market.  In fact, selected markets have even seen the return of multiple offers on properties, and the scarcity of housing product is contributing to modest appreciation of home values in selected areas.  We are certainly experiencing this market improvement in our immediate area in the western San Fernando Valley and the Westside of Los Angeles.  In a direct parallel to the distressed borrower of 2012, the prospective homebuyer of 2012 is better prepared for the responsibility of a long-term mortgage commitment and making more prudent choices regarding what they can afford and the right type of loan program to finance the purchase.

Investors have reason to smile as well as they furnish housing for a specific niche of the market not able to take advantage of the aforementioned buying market.  Today’s rental market is booming, generating strong returns for both multi-family and single-family property investors.  The forward-thinking all-cash buyer of SFR bargains in 2010 and 2011 foresaw the environment would be more conducive to generating revenue through renting as opposed to flipping. This strategy has been extremely popular in 2012.  Moreover, the slowdown in new apartment construction during the height of the housing crisis paved the way for a shortage of available units now that has brought back demand.  Low vacancy rates and higher rents prevail.  As a welcome footnote, new building starts and permits for new construction are on the rise to feed the appetite for new rental units.

Yes, for all practical purposes, it appears that real estate’s recovery has begun.  But at best, it is a fragile recovery that can be derailed by any new bumps in the economy.  Job and GDP growth, key metrics indicating economic stability, have improved but at tepid pace.  And a rash of recent near-defaults of foreign economies poses a lurking threat to ours.  Any unexpected economic shocks caused by unemployment, poor retail performance, European recessions, or any combination of these factors will serve to undermine real estate’s stronger performance this year.  The good news is that after six months of shrinking foreclosures, lower interest rates, more buyers returning to the market, rising rents, contracting REO inventories, and new construction activity, we’re significantly through the tunnel. The positive momentum of the first two quarters in 2012 may just be enough to propel real estate through any new headwinds it could encounter for the rest of the year.  

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.