A Freakonomics-inspired approach to framing questions, plus on-the-ground experience and anecdotal evidence, points to a different conclusion about the 16% plunge in pending home sales. Conventional wisdom views this plunge as a direct result of the coinciding period in which we collectively held our breath for the official announcement that the $8k tax credit would be extended to April… even though the equity market consensus expected a much smaller decrease.
Home shoppers are generally pretty confused about the whole tax credit thing. And since they do not recoup it anytime soon in the form of a lump sum, the benefit seems somewhat intangible. Most clients have even stopped asking about it.
I have another theory about why pending home sales decreased. But understanding the context fist requires some background.
Two years ago, we had record foreclosures. Since then, loan defaults have only been increasing. Inventory of homes for sale has been decreasing, but the number of homes actually being sold have remained flat or decreasing. This means there are a whole bunch of homes out there, not (yet) on the market, with mortgages in default.
Now, I don’t want to spend too much time in this article explaining why banks don’t always automatically foreclose on homes that are in default. But I will address one good reason for this briefly for the benefit of folks who don’t eat, sleep, and breathe this stuff like so many SA enthusiasts.
When a bank forecloses on a home, it triggers an accounting loss on their books, which over time impacts their share price negatively. Additionally, too many foreclosures at once floods the market, thereby putting more downward pressure on home prices, which undermines the value of the bank’s portfolio, which consists, at least in part, of a whole bunch of homes that are in default, causing a vicious cycle.
If the value of a bank’s portfolio drops too far, then the very solvency of the bank comes into question. Raising capital to satisfy reserve requirements in this type of environment becomes, in itself, a self fulfilling death spiral. Throw in the implicit government support to avoid political backlash of displacing folks from homes on Main Street and you get at least an idea of why there is a shadow inventory “out there”.
One last thing, and then I’ll get back on track. To put the scale of shadow inventory in perspective, I recently posted a SA article called, The Forthcoming Prime Mortgage Meltdown. In it I wrote, “I can’t seem to find any good statistics on shadow inventory, so until someone shows me something better, my front line experience will rule, which tells me to estimate that only about one quarter of the toxic inventory has even been dealt with by foreclosure and subsequent resale. Mark to market relaxation aided this. The government moratoriums aided this. And mainstream media aided the groupthink that the recovery cavalry is on the way. It is not.”
While the article stimulated quite a bit of commentary, no one challenged the estimated statistic.
In my area in 2009, 71% of detached homes sold below $500k. 65% of detached homes actively listed for sale now are priced above $500k. What stands out to me is that most of the homes actively listed for sale that will realistically be sold are lower-end homes. In other words, the market is top-heavy.
Nearly all lower-end homeowners watched their values get crushed so significantly that they can no longer sell at break-even or better. This means, they either keep on living there, paying upside down mortgages… or they walk. Consequently, the overwhelming majority of listings that come up for sale are either bank owned (REO) or dependant upon bank approval for a short-sale.
For the better part of 2009 folks were scooping up REO’s and steering way clear of short-sales, because 2008 proved that only about 15% of short-sales ever end up closing, and most of them get reincarnated as an REO anyway. The few short-sales that did actually close were nightmares from start to finish and the banks ended up nickel-and-diming every party along the way.
The tax credit did stimulate a media frenzy about anticipated demand, and in this sense it took away the negative stigma of buying real estate. Rates dropped around 50 basis points, which added some wind to the sails. Then something weird happened. Banks stopped foreclosing.
And there were no more REO’s.
The few REO’s that did come online attracted 20+ offers within days of going live. Buyers started to get disillusioned as their many offers kept getting rejected. Agents started to scramble to keep them motivated, and so they revisited short-sales as a final card left to play. If the REO’s were going to the full cash investors, then there was no hurry anymore, so we might as well put offers on multiple short-sale listings.
The need to conveyor belt the offer writing process helped push a new technology called “e-Signature” into a critical mass of acceptance. And in this way, agents turned the tables on the banks “shotgunning” offers on multiple listings without even viewing them in person. Whereas up until now it was considered bad etiquette to make more than one offer at a time… agents realized the banks were treating the buyers like numbers so why not return the favor.
The large short-sale segment of the market that was previously getting the cold shoulder, suddenly got traction, and so “pending home sales” spiked, as measured by signed contracts on homes “going to escrow”.
Now the MLS did introduce a new category of status called, “contingent”, and these short-sale listings should have been labeled as such, while they sat in purgatory awaiting approval by some anonymous overworked bank manager. But it’s hard to retrain thought patterns en masse… especially those of real estate agents… and so, many short-sale listings remain in “pending” status to this day.
Anyway you look at it, pending home sales were never a good metric to use in the first place. And they are still not a good metric to use today. But it does serve as a great example of what happens when we look for technical data to paint a picture that contrasts with the fundamentals that underpin the truth. And I fear it’s the first in a very long line of examples as the whole facade starts to crack.