Lately, there has been much made of the current “housing recovery,” with many thinking that the market turn around has begun and that the end is near for short sales. I could not disagree more, and here’s why:
Has the market recovered?
According to Steve Berkowitz, CEO of Move, Inc., which operates realtor.com®, “Where we have seen significant volatility in many markets — including double-digit declines in inventories as well as increases in median price for both yearly and monthly views — we are now looking at a housing market that is less heated and moving closer to normalcy. Future home-price increases may be driven more by market demand than inventory shortages.” As for pricing, Core Logic has released estimates of near 12% in price growth in 2013, but also shows a distinct cooling trend for 2014, with lower priced property leading the slowdown at just 2% price growth. This can be attributed to rising interest rates, a slowdown on investor participation, changing short sale rules, and expanding inventory. It is this last market segment –Inventory, which I believe holds the key to determining how 2014 will play out.
The inventory scam
Anyone active in real estate sales can tell you that inventory can be tight in some segments, and this has lead to increased prices. Increased prices sets the tone that the market is rebounding and this “good will” feeling about the market can go a long way to changing people’s perceptions about the market, encouraging many who are waiting on the sidelines to jump back in. While the price increases are encouraging, they have a long way to go to erase the equity losses of the last decade. Clearly, any housing market restart is tied to inventory, and this is why I think that the current market rebirth is an illusion. The “shadow inventory” that has been much speculated about is real, and when it is revealed, it will erase one of two segments of the market that is propping up growth, the other being artificially low rates. My definition of “shadow inventory” is simply inventory not reflected on the market, most notably the MLS. There are many reasons for shadow inventory, including those in some sort of foreclosure work out program, such as a loan modification, those who are actively litigating foreclosure, and those who have simply given up trying to short sale due to agent short sale incompetence or lack of success with their lender (which many times gets the blame when short sales are mishandled by the agent). The biggest reason for shadow inventory though, and one that is most troubling, is the property that has already been foreclosed and taken back by the lenders. In many cases, it could be months, or even years before these properties hit the market. The reason for this is that the servicers who foreclose will end up conveying those properties back to the investor, and in the last year, many of those investors have been dumping property back to Government Servicing Entities, or GSE’s such as Fannie Mae and Freddie Mac, and HUD. This process takes time, but there is another, more sinister undercurrent to the consolidation of the distressed property market to the GSE’s.
The GSE market monopoly
While our collective focus has been turned towards the economic recovery as a whole, the GSE’s, and Fannie Mae in particular, have been quietly and thoroughly attempting to monopolize and control every aspect of the US mortgage and real estate market. They now control, or seek to control, all aspects of the purchase finance market. Simply said, if you are attempting to get a mortgage, you will have to abide by Fannie Mae purchase guidelines and both HUD and Freddie Mac now seem to march lockstep with whatever Fannie is doing. Conversely, Fannie is now seeking to control all aspects of the real estate sales markets, setting standards and guidelines on how all property is valuated and sold. The new GSE short sale guidelines, while certainly streamlining the process, are far more restrictive in how sellers are determined to qualify, how the property is listed, how the property is valued, and how the buyers purchase. Moreover, control over what the seller and buyer can and cannot pay for mortgage and sales related services, as well as what the buyers can and cannot do with the property after it is purchased complete a very troubling picture of just how far GSE control is established. In short, anyone buying or selling or valuing or financing real estate in the United States now is beholden to GSE, and particularly Fannie Mae rules.
Both ends playing against the middle
Back in November, new GSE guidelines took effect that promised a great streamlining of the short sale and deed in lieu process, and for the most part they have. I have seen short sale times fall dramatically, and with the proper set up and preparation, it is no big deal to get an approval in less than 60 days. There is a catch, however. The GSE’s greatly tightened short sale qualification standards. At one point, in 40% of the short sales I closed, the sellers were not delinquent. Now, this has been virtually eliminated. Guidelines are also cracking down on hardship, and they are actually reading and researching hardship letters and rejecting many hardship scenarios. Conversely, new GSE purchase guidelines are now coming out that will make it exponentially harder to qualify for a mortgage. Some of the news rules coming out are the lowering of the maximum LTV to 95%, tripling FHA purchase costs and required insurance, and the coupe de grace, severely tightened underwriting and secondary marketing guidelines. As it stands now, when a mortgage originator underwrites a loan to GSE guidelines, they agree to purchase the loan back from the GSE if there is a default within the first 12 months. In other words, a loan originated by Bank of America, then sold to Fannie Mae would have to be bought back by Bank of America if the loan went into default within the first year (this time can vary.) Under the new rules, if the GSE determines that the proper due diligence has not been completed, and the originator had any reason to believe that the borrower was a default risk; they could be liable to buy back the loan FOR THE ENTIRE LIFE OF THE LOAN. Think about that. This means that if you ever missed a payment, ever were late on a credit card or car loan, ever did a short sale, ever bounced a check, your mortgage lender will now fear approving you because they would be liable to buy back the entire mortgage if you went into default 20 years down the line. Add in rising mortgage rates and you have a nice shiny bullet right between any housing recovery’s eyes.
Another landmine to the housing recovery is the perception of property value. As we all know, an appraisal is an opinion of value, and this can vary widely. In most areas, I can find very low comps and very high comps for the same property. This is problematic because on the short sale side, buyers use the lowest comps to justify buying a distressed property. The director of short sales for Fannie Mae, Tim McCallum, recently revealed that Fannie no longer considers short sales and REOs as distressed property, and therefore will value them no differently that normal retail property. This includes the ludicrous practice of not considering short sale or REO comps when valuing these properties, as if these other sales didn’t exist. This is a very big statement, because the market definitely distinguishes between the two and buyers will simply not pay full market rates for the hassle of dealing with a short sale or buying a run down REO. On the flipside, mortgage lenders, underwriting to GSE guidelines, absolutely consider distressed comps, and routinely undervalue their appraisals. So, we have on the sales side, controlled by the GSE’s, inflated values, and we have on the purchase side, also controlled by the GSE’s, the refusal to lend at these inflated prices. This is not the recipe for a comeback. But wait, there is some purchase gold at this tunnel end, and that is the reckless and risky Fannie Mae “Homepath” and Freddie Mac “Homesteps” purchase loans that disregard appraised values and allow 100% financing. Sounds suspiciously like the same risky speculating that got us in trouble in the first place, yeah?
How does this affect the market for 2014?
Real estate professionals have long buried their heads in the sand as to what the GSE’s are really doing. This is a mistake. When this much control is exerted by these entities, how long will it be before they start deciding that 6% commission is too much? Think it is fantasy? Ask the attorneys, who have repeatedly seen allowable attorney fees cut, now down to $1,500 or less. If you are the only game in town, you get to make the rules to your advantage, and this is the very definition of a monopoly.
Add to this increasing mortgage rates
Add to this tightened short sale qualifications
Add to this GSE control over what buyers and sellers can and can’t do in all aspects of the transaction
Add to this short sale property overvaluation by the GSE’s
Add to this Purchase undervaluation by the GSE’s
Add to this hyper restrictive purchase guidelines
Add to this the inevitable implosion of risky Homepath and Homesteps loans
And finally, add to this the “Shadow Inventory” being quietly held off market by these GSE’s. What will happen when the prices propped up by artificially lowering inventory expires after the GSE’s start to list these shadow properties? They cannot hold them forever. Still think that 2014 will be the year we go back to the good old days? Still think that short sales will go away? Think again.