Vice President of Carrington Holding Company, LLC
Bruce Norris is joined again this week by Rick Sharga. Rick is the vice-president of Carrington Mortgage Holdings and one of the country’s most frequently quoted sources on foreclosure, mortgage, and real estate trends. Rick has appeared on every major network and news show in the country, and he has even briefed government organizations such as the Federal Reserve and Senate Banking committee on foreclosure trends. Prior to being with Carrington, Rick was senior vice president of RealtyTrac, which is responsible for marketing and business development.
Bruce and Rick touched on the subject of low interest rates and affordability. Bruce heard Leslie Appleton-Young do a talk and mention that these interest rates are at 50-year lows. Bruce asked her where she got these statistics from, and she said it was from one of the data providers. Bruce called the provider and asked them where they got their information, and they told him that was as far back as their data went. Bruce thought this was an interesting comment since sometimes we really don’t have data that goes far back enough. He and Sean O’ Toole went to Washington D.C. to the Library of Congress and pulled up microfiche from 1850 to the present. They looked at the Sunday advertisements for real estate interest rates. No one alive has seen these interest rates.
Bruce said this was all interesting since for him this sets off an interesting scenario regarding affordability. You have had a lot of price increases, but the affordability is still very high. Even with the price increases we have seen over the last year to 18 months, we are really only back nationally to 2003 price levels. Essentially, an entire decade of home appreciation vanished. LPS and CoreLogic both put out recent reports on affordability; and the LPS study suggested that if interest rates don’t go up, with current income levels prices could go up almost 35% and still be within the normal range of home affordability levels. CoreLogic’s report was similar in that they said home prices could go up another 22% even with a marginal rise in interest rates.
It clearly is an amazing time to be able to buy in terms of affordability. The catch is how few people how few people actually qualify for the loans. This is a little bit of a Catch-22, but what is interesting is that it usually comes around as loan programs do not produce losses. Bruce said he would think that when we look back at 2011/2012, we are going to discover that was the safest batch of loans ever written. The performance we have seen on loans in the last 2-2 ½ years is better than historic averages. The delinquency states of loans after twelve months are below 2% for the last three years’ worth of loans. Normally, you have a percent of your loans in foreclosure and about 4% that are delinquent. They are performing roughly twice as good as you would expect them to perform.
Bruce said you are also given a ratio because normally the ratio is two delinquencies for every foreclosure. When you have price increases, those delinquencies very rarely result in a loss. What fed some fuel to the real estate boom back in the early part of the 2000s was that home prices were rising ridiculously fast. However, even if somebody got themselves into trouble they were able to get out by simply selling the home at a profit. It really was not until home prices flattened out that all of this became as apparent as it was. You look at your portfolio and see that everybody is qualifying with their eyes closed and we still are current.
Somebody wrote a book in California about a crash coming, and it seemed pressing at the time. You look at the numbers and realize the funny part that you wrote it and don’t even know what a collateralized debt obligation is. The funny part is there were huge financial institutions in New York that were issuing them, and they didn’t know what they were either. It turned out there was only a handful of people who actually knew how to bet against the income that was so obvious if you took time to look at it. The solution that keeps coming out of a certain group of politicians is we need more regulations and regulatory control. The regulators missed all of this, and this was really one of the reasons why the fallout was as bad as it was. It was not just the value of the homes or the mortgages issued against the collateral, but it was all of the exotic financial products that were layered on top of it that really added to the enormous losses.
Rick has been at the forefront about reporting statistics, and he has talked about shadow inventory. Whatever definition you put toward it, which has changed over time, it does not really look like it is going to have the impact that we once thought. Rick said he has been wrong a fair number of times in making predictions, but early on he said shadow inventory was not going to be the big problem that everybody thought it was going to be. It just seemed incredibly unlikely that the entire financial services industry would suddenly release hundreds of thousands, even millions, of distressed properties into the market all at once. All we would see would basically be a smoking pit of rubble where there used to be a housing market.
If you look at the number of REOs that are not listed for sale, properties in foreclosure not listed for sale, and homes where the borrower is seriously delinquent, you see those numbers go from about 6 million down to about 3 million today. The housing market is very interested in buying distressed properties. There were about 1 million short sales last year and half a million REO sales. You can see that distressed inventory being absorbed by normal demand over the next few years without really causing any major repercussions. The flip side is that as long as we have that backlogged, it does keep housing prices from accelerating even more rapidly because there is always that shadow of distressed priced properties waiting to come to market.
What relieves this better than coming onto market as a distressed inventory is a price increase that does not make it underwater. The really amazing part is how few underwater borrowers are actually delinquent. The overwhelming majority of people that are upside down on their loans are still making their payments on time. With home price appreciation, a single percentage point increase puts a whole slew of people from negative equity to positive equity, and this relieves a lot of the pressure. In California, if we had a 20% price increase, half of the upside-down people would have no more problems. This is a huge deal and completely changes the dynamic in the housing market. It also has to change the payment patterns if there are going to be somebody who was thinking of defaulting. It is encouraging to see a price increase against your loan get pretty close to breaking even. If you have already hung in there for as many years as it has been upside down, you are still going to make the payment.
History will most likely indicate that the majority of people who did default on those kinds of loans probably did so because there was a life event. It was not just because they were upside-down, but something else bad happened. From what analysis they have been able to see, this does seem to be the case in most instances.
Bruce asked Rick what he would say was the main reason we have had price increases. Rick’s answer was simply that there is no inventory. This is classic supply and demand economics if you look at what is available on the market. In some California markets, there is less than a month’s supply of homes available for sale. For those people looking to buy and those looking to take advantage of today’s low interest rates, there is a lot of competition for so little supply. This drives up prices. The other factor is that the mix is changing a little, so we are not seeing 40-50% of the sales being deeply discounted distressed properties. We are starting to see some higher-priced properties moved as well, and this changes the numbers pretty dramatically.
Bruce said he was always looking for these deeply discounted properties in the last couple years, and he still does not understand the discrepancy between what he sees in the marketplace and what seems to be a big discount when your chart shows the difference between an REO and an equity sale. Those discounts do not represent the same discount as what is showing. Rick said Bruce is a lot more precise in his calculations, and he looks at one specific house compared to another specific house that is the same model and size. If you are looking at large data pools, what you wind up doing is blending everything together. Rick knows from working on some of the reports in the past that if you simply did something like adjusting the numbers for price per square foot as opposed to flat costs, you would end up with less of a discount. A condo was measured against a mansion, so the numbers became at least something of a gauge. The discounts were either going up or down, but most people did not get 30-50% discounts on property.
Rick said there are three ways you can get inventory in the market. You can have new homes, existing homes for sale, or distressed homes for sale. Nobody has been building new homes for the last five years, so new home inventory right now is at about a 40-year low. There are simply not a lot of new homes to go around at the moment. We have been in a position for the last few years where 25% of homeowners were upside-down on their loans. They did not want to sell those properties at a huge loss, so we do not have a lot of existing inventory on the market. Partly because of things like the robo-signing scandal and legislative maneuvers, we have seen foreclosures take much longer to process and get to market. Once they get to market, they are getting sold off pretty quickly. An anomaly right now is that all three categories of housing stock are at unusually low periods.
Bruce asked Rick if he sees any of this changing in the next twelve months. Rick said he does because we have seen foreclosure starts increase over the last couple months, and we have also seen building activity and housing starts both go up in the last few months. Rick said he could see a situation where a year from now we may have a little bit too much inventory for what is available in terms of loans. However, there is not enough where we will see a huge falloff in home prices. We are seeing a softening, then acceleration, then this starting over again. Bruce wondered if when Rick says we are avoiding a huge fallout in price that he believes we will have at least a flat price. Rick said he does not think we will continue to see prices accelerate at the rate they have been both this year and last year. Certain markets will probably be outliers, but Rick looks at it as being a saw tooth recovery. We are going to see prices go up and down, and generally trend upwards. However, it is not going to be a straight shot up.
Bruce specializes in a part of the country where this could be one of the outliers. We have seen the most highly accelerated prices in the markets that had the most precipitous fall off from the peaks. If you are looking at San Bernardino, Riverside, or somewhere else in the Inland Empire where prices literally fell off a cliff, you could see sustained home price increases in those markets. It is other markets that are going to behave a little more traditionally.
Bruce looks at the inventory levels, and he sees that they are a third of what they were a year ago. Bruce wondered how you would get this tripled since this would literally be to get back to a six-month inventory. To go from two to six you have to triple, and Bruce does not see how this is possible. Rick said it probably is not, so it will take longer for that area to normalize. You are starting to see some home building getting started again, and some of these distressed properties will come to market. The other thing that will happen over time is as home prices go up, fewer and fewer borrowers will be upside down. There have to be some borrowers in those situations who would have already sold their house and, if they had a chance, re-enter the market. You will most likely not see an immediate tripling, but over time you will see all three of those categories start to fill back up again.
Bruce wondered if they will be repeat buyers who will sell and go on to another home. This has not been happening in the last few years. Those people have been doing short sales, taking a loss, and they are gone. Rick thinks we are also going to see increased household formation, which is going to provide more renters and homeowners over the next couple years as parents decide it is time to kick their kids out of the basement. What is interesting is that there is definitely the generation that is dating everything late. What is funny is Bruce has heard people speak on how this generation does not even want what the other generations want. You come to find out that at about thirty, they do the same thing as the prior generation.
Rick said he remembers in the ‘60s you could not trust anybody over 30, and now he does not trust anybody under 30. This is also tied into employment. If you looked at the recent homeownership rate report that came out; the group that had the lowest percentage of homeownership was the 35 and under group. Rick believes only about 43% of them were homeowners. This was a huge drop from the national averages. Rick thinks they are waiting longer, but this is also the group that has the highest unemployment in the country. Until they are gainfully employed and in a job they want to stick in for a while, they are probably not going to be anxious enough to sign up for a 30-year mortgage.
Bruce asked Rick if he thinks college debt is as big a deal as people are saying. Rick said what is interesting is that the only category of consumer credit spending that is going on is student loans. Rick thinks it is a mitigating factor when it comes to the length of time it takes a younger person today to buy a home since they do have to get that college debt paid down. It is a debt that will follow them forever. Bruce asked why we can’t sell them the house with nothing down in California. Then they can own it for two years and pay off their debt. Have them start a business that has to hire five people. Rick said you could have them default on the house, then pay them $20-$30,000 to leave. Then they could use that to defer the student debt.
Bruce asked Rick what he expects in price movement. Rick said if you are looking at median prices nationally, we are probably looking at somewhere in the neighborhood of a 4-5% price range increase this year over last year. California is obviously going to be higher than this, but he does not have any specific numbers on what they are expecting in California. One of the categories Rick brought up was the construction of new homes. It is like when you have an interest rate hike and someone says interest rates went up ½ a percent. You say to yourself that it is all the way up to four, but to Bruce and Rick this is laughable to have something that is under 6. When you say construction of new homes is up 25%, it may be up this amount but it is down by 90%. It is going to take a long time to come back.
Rick Sharga said at the peak of the boom they were selling 120-150,000 new homes a month across the country. We are at a 40-year low in inventory and a 30-year low in sales. Whether we are talking about home price appreciation or new and existing home sales, we have to keep this recovery in context. This is not 2005 again. Home prices are all the way up to 2003 levels. New home sales are up to a third of what they used to be. Inventory levels are a third of where they are in a healthier market, and we are still going to sell 2 million properties less this year than we did at the peak. We are off the bottom and coming back. Although it feels better, we are not yet where we need to be to really call this a successful recovery.
Bruce asked Rick what he would call a successful recovery. Rick said the obvious ones are you look at sales volume as one metric, and until you are up over 5 ½, approaching 6 million units a year, it will be hard to believe that you would be at a real recovery. The other is you look at inventory levels. Until you have a steady 6 months’ supply of inventory, it suggests you are going to have a lot of the volatility we are seeing today. Bruce said the truth is you never have a 6 month supply of inventory once you start a price increase, specifically in California. This is why Bruce looks at charts and does not really know about caring about the average, but he can say that when you have price increases in California you have a real hard time having inventory increase.
Rick talked to the Chief Economist at a conference a couple weeks ago, and they have a metric out right now where they say the housing market is 56% back to normal. Somebody asked when it was 100%, to which he laughed. He acknowledged that it is really never at 100%. Sometimes it is at 101, other times it is at 73. It is kind of a floating number. The other number he looks at is on the distressed side of things. With foreclosure activity being where it is, it feels a lot better than it did back in 2010. However, we are still running at 3-4 times normal levels, so this is another metric to watch in terms of where the market is and how much further it has to go.
Sometimes the California Association of Realtors will do a presentation showing that Riverside is still in the 45 percentile of some type of forced sale, whether it is a short sale or a foreclosure. Normal is probably 5%, so even at the improved levels we are about 5-10 times that level. This shows the very serious localization of real estate trends. We talk about national tendencies, but it really comes down to a local market and what is happening in Riverside and San Bernardino. It is very different than it is across the border in Orange County, even if you split it between the north and south counties. Rick looks at broader market trends to see if everything is going the right direction.
What is interesting is that when Rick mentions us being back to 2003 price levels is if you convert that to a payment level, that is more revealing in the sense that you look now at what percentage of income is being required to buy the median price home. Getting back to the affordability discussions, it is probably about half of what it was at the peak of the real estate boom. The affordability levels are at, if not all-time lows, they are at least as good as they have ever been.
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