by Sean O'Toole
I am long overdue to give you all an update on what is happening in theforeclosure market in California. Starting a company has been allconsuming, but that is no excuse; the iTulip community has been afantastic resource for me, and updating you on what I'm seeing atforeclosure ground zero is the least I can do.
To that end, here are the top ten things you need to know.
- September foreclosure data are way off.National headlines declared foreclosures were down 8% in September.Problem with that reporting is that there were only 19 business days inSeptember vs. 23 in August. Using daily averages, foreclosure volumewas up 5 to 28% depending on the measure you use (Notices of Default+5%, Notices of Trustee Sale +28%, Sales at auction +18% - Stat's from www.ForeclosureRadar.com.
- Foreclosure data do not take process delays into account.There is a minimum of a 90 day, and typically a 120-150 day, delaybetween notice of default and the sale of a property at auction. Whilesales at auction are now at $200 million per day in California, theycorrelate with notices of default filed four to five months ago.Notices of default have increased 58% from five months ago. Expect asimilar increase in auction sales in the next five months--or perhapsworse, as the percentage of defaults that end up at auction has beensteadily increasing.
- ARM resets haven't happened yet. Despite all the talk aboutthe problems with ARM resets over the summer, if you look at the resetcharts we really didn't see big increases in resets until this month.Given that CA's foreclosure process is typically a minimum of sixmonths from the first missed payment, don't expect to see the first bigwave of foreclosures from ARM resets until March or April of 2008. Notethat the next peak in resets is March 2008, and the foreclosures fromthat won't occur until Q3 or Q4 of 2008.
- The main stream media talk about the credit crunch in August being an indication that the worst is over. Ridiculous.Again we won't see the impact of that in the foreclosure market untilQ1 2008. We are just beginning to see the impact of the credit crunchon the non-foreclosure market. New and resale home sales in CA are downto 24,460 in September, a 26.4% decrease since August, which nowrepresent the lowest transaction volume since DataQuick began tracking it in 1988.Note: the current wave of credit tightening severely limits the abilityof those in foreclosure to refinance or sell - virtually insuring asignificant increase in foreclosures in four plus months.
- Much like government employment figures, current housinginventory level data, despite being ridiculously high, are grosslyunderstated. No doubt many people are waiting for the market toimprove in the spring before selling, especially in affluent areas. Thebelief is that this is temporary and conditions will improve after theFed lowers rates and we get through the winter. I've been hearing thissame argument since late 2005. At some point many of the believers willlose their faith, or be put in a position where they have to sell.There is massive, pent up, un-counted supply.
- Congress will make matters worse. Every effort on CapitalHill, no matter how well intentioned, exacerbates the problem. Taxrelief for homeowners in foreclosure eliminates a final barrier forthose who have struggled to keep going. Paying for the tax relief byreducing the tax breaks from the two of five year rule on secondaryproperties will kill demand for second homes, one area that hasmodestly helped keep sales up. As for government moves to tightenlending standards, that would have helped in the 2002 to 2005 period.The market has already self-corrected considerably and some of thecurrent proposals are draconian and can only send the market crashingfaster and harder.
- Recently announced mortgage relief programs make for great headlines, but don't expect much. Thereis nothing the Fed can do either. Take mortgage interest rates to 0%and most of these "home owners" still either can't afford the paymentsor don't want to, now that they know home prices are falling. Also, ahigh percentage of foreclosures now are on speculative homes; why keeppaying payments on a property that isn't cash-flow positive and isunderwater. In much of Califorina, even in areas where we have alreadyseen 25-35% price declines, the cost of home ownership is still 50% to100% more then the cost of renting, even with mortgages at zeropercent. What's left, 50+ year amortization schedules? Isn't that howwe got here in the first place?
- Builders continue to build. This is absolutely nuts, butthere is a rush on to complete units before things get worse. Iunderstand this from the builders' perspective - they've spent millionson infrastructure and the only way to recoup that cost is to build andsell homes. Much like GM, it is cheaper to sell cars at a loss thanclose the factory. But add this inventory to the resale inventory andit creates huge oversupply. Worse, builders have been the primarydrivers behind declining prices. They are aggressively discounting tothe point where the resale market simply can't keep up. This has beentrue in places like Stockton since late 2005 where discounts of 40%from the peak are not uncommon. I had a two bedroom, 1200 square foothme in Stockton in early 2005 that I thought I'd be able to sell for$350,000. After some delays I put it in escrow for $320k. A builder putup a sign saying new homes from the high $200,000's. I lost my buyer.Finally got it sold for $280,000. I just visited those new homes. I canget a brand new 1,700 square foot, four bedroom home for $265k, and themodel home has $75,000 of furniture and smells like fresh bakedcookies. Builder discounts will continue to be the primary driverbehind price declines, and price declines will continue to be a primarydriver behind foreclosures.
- Median home price reports in the main stream media make conditions appear much better than they are.While Shiller attempts to look at changes in individual home pricesrather than the median, the bottom line is that housing data areatrocious. Note that prices could decline 20% across the board and youcould still easily have a 10% increase in the median price data. Infact this is not only possible but likely. All accounts are that thelow end has been hit harder than the high end. A simple shift in themix of what is selling can have a huge impact on median prices. Add tothat the fact that until recently loan standard tightening increases infees and credits were being built into prices at an increasing rate,skewing final prices higher than the actual value of the homes.
- Given the current trajectory of foreclosures, the current andfuture negative impacts to demand, pent up and continued buildersupply, and the delays in the market's visibility to what is reallyhappening, this market contraction has a long way to go. I predictat least a 50% increase in foreclosures, and likely a doubling inproperties sold at auction with a peak no earlier than Q3' 2008.
