Why Renters Rule U.S. Housing MarketTopic: Real Estate news
The collapse in housing and the 33 percent plunge in house prices since 2006 are favoring renting over homeownership. This trend will dominate the housing market for the next four or five years, and put additional pressure on a weak economy.
Policy makers in Washington continue to have a soft spot for homeownership. Many recent government actions can be viewed as attempts to keep people in their homes, even owners who clearly canít afford them. In addition to specific plans such as the Home Affordable Modification Program, or HAMP, and the Home Affordable Refinance Program, or HARP, the Obama administration is trying to revive the moribund housing sector by encouraging mortgage lenders and servicers to refinance loans at lower rates.
This reduces interest income for banks, which are now compelled by the Dodd-Frank law to retain 5 percent of the credit risk on lower-quality residential mortgages that are securitized and sold to others. Furthermore, banks are reluctant to refinance loans that Fannie Mae and Freddie Mac (NMCMFUS) then guarantee and put back to the lenders if they find any defects. The White House plan is a tough sell.
As banks deleverage and mortgage activities increasingly involve unwanted loans, the ability to deal with refinancing has diminished. Four banks now control more than 60 percent of the mortgage market, and many mortgage servicers have reduced staff or been slow to gear up to handle delinquent mortgages and refinancings. Except for those who qualify for HARP, refinancing is highly unlikely for 8 million owners who are underwater -- owing more than the value of their homes -- because new terms are treated as new loans. Those who have positive home equity face dramatically tightened lending standards, a clogged refinancing system and new fees that can wipe out the savings from refinancing.
Almost 90 percent of mortgages today are only originated because of guarantees from Freddie Mac, Fannie Mae and the Federal Housing Authority, and all three have raised their fees substantially. As a result, many of the 20 million borrowers who could cut their mortgage rates by more than one percentage point through refinancing are unable to benefit.
-- Second Mortgages: Refinancing underwater borrowers is tough when they have second mortgages that also have to be renegotiated, or if mortgage insurers have to agree to the new loans. Many borrowers canít qualify for refinancing because of tightened lending standards. Fannie, Freddie and the FHA have strengthened their requirements because of pressure from the administration to avoid more losses on bad mortgages. High credit scores are needed to refinance outside HARP, along with two years of tax returns, proof of income and recent evidence of assets such as retirement and brokerage accounts.
During the housing boom, appraisals for house purchases were generous. (And why not? Everyone was certain that house prices would rise indefinitely.) Cooperating appraisers were often recommended by real-estate brokers and mortgage lenders who wanted the deals to go through. After the house-price collapse, however, appraisals became very conservative, as lenders pressured appraisers to make low estimates.
-- Postponed Foreclosures: Foreclosures (HOMFCLOS) have been curtailed for several years, mainly because the administration essentially told lenders and servicers to hold off while they attempted mortgage modifications. Those efforts largely failed. Then the industry voluntarily imposed a moratorium while it was caught in the robo-signing flap, in which documents were approved without proper examination. More recently, lenders and servicers have been trying to avoid throwing people out of their homes as the industry worked out the recently announced restitution with the federal government and state attorneys general for troubled mortgages. As a result, foreclosures in 2011 fell significantly from 2010, and in the third quarter were the lowest since 2007.
Sadly, these efforts to keep people in houses they canít afford are simply prolonging the process of repairing the housing mess and getting rid of excess inventories.
These measures are the opposite of the successful program led by the Resolution Trust Corp. to clean up the savings-and- loan mess two decades ago, when loans, other assets and whole financial institutions were sold off quickly to private buyers, at very low prices. As we discovered then, large inventories of distressed assets overhang the market and depress prices. To rejuvenate markets, initial sales at low prices are needed to attract buyers and lead to higher prices.
-- Sagging Homeownership: Despite all the efforts to keep people in their houses, homeownership is falling. It dropped to 66 percent in the fourth quarter of 2011, compared with a peak of 69.2 percent in the fourth quarter of 2004. Meanwhile, the 33.5 percent drop in median single-family house prices is the first nationwide decline since 1930s.
Foreclosures, high unemployment, tight lending standards and lack of money for down payments are playing a role. In the second quarter of 2011, at least 3.6 million mortgages were delinquent and at risk of foreclosure; that could climb to 5 million with further house-price declines and if the recession I forecast for this year takes hold.
The FHA reported that 711,082 single-family loans it insured were seriously delinquent in December 2011, up 3.2 percent from November, and up 18.9 percent compared with December 2010. That pushed the seriously delinquent rate to 9.59 percent in December from 9.34 percent in November and 8.65 percent in December 2010.
Many people who are technically homeowners are really renters. They put little if anything down. In many cases, the equity is negative when, for example, home-improvement loans piggybacked on first mortgages and brought total indebtedness to more than 100 percent of the house value. Many also planned to refinance their mortgages with cash-outs due to appreciation before their mortgage rates reset upward or, in some cases, even before they skipped enough monthly payments to be foreclosed.
-- Rent-Free Renters: Since 2006, 3.1 million people are essentially living rent-free by not paying their monthly mortgage payments. Assuming a monthly mortgage bill equivalent to the national average of $1,721 per person, these nonpayers have increased their purchasing power for other items by $65 billion at annual rates, or the equivalent of 5.6 percent of after-tax income.
That is a big number, but then 12.5 percent of residential mortgages are past due or in foreclosure. This may be an important reason that consumer spending has held up as well as it has in this recovery, despite all the pressure to increase the saving rate and reduce debt. Nevertheless, as heavy foreclosures resume and ex-homeowners are forced to pay rent, this free money will evaporate.
-- Ripple Effect: When house prices were rising, Americans were eager to keep their houses. So the mortgage was the first bill they paid each month, even if that meant they postponed payment on credit cards, cars and student loans. Now, with house prices falling, mortgages are paid last or not at all, especially by the mortgage-holders who are underwater and may be strategically defaulting.
If historical trends hold, the total homeownership rate will return to its earlier base level of 64 percent by the fourth quarter of 2016. Continuing the average annual growth in households over the last decade of 891,000 would increase the total number by 4.5 million by the fourth quarter of 2016. This is enough to increase the number of new homeowners by 550,000 even with that further drop in the homeownership rate.
But it also means the addition of 3.9 million new renters, or 780,000 per year. This doesnít suggest that we are becoming a nation of renters. Instead, it reflects the elimination of the widely held belief that house prices always rise and the end of loose lending practices that drove the homeownership rate to its 2004 peak. In fact, the reversal to falling prices and the extraordinarily tight lending standards may push the homeownership rate below that 64 percent norm; it would now be 60.9 percent if all those with mortgages that are delinquent or in foreclosure become ex-homeowners.
-- Affordability (AFFD): There are many, including the always bullish National Association of Realtors, who believe that homeownership is bound to rise because houses are now so affordable. In calculating its housing affordability index, the association assumes that a family with median income buys a median-priced single-family house with 20 percent down and finances at the current 30-year fixed mortgage rate. The collapse in house prices and decline in mortgage rates in recent years have more than offset the weakness in median family income, which, according to the Realtorsí group, dropped from $63,366 in 2008 to a $60,824 average for the first 11 months of 2011.
Nevertheless, it is impossible to compare the current attractiveness of buying a home and the conditions in the 1990s and early 2000s. Unemployment rates were much lower then, and house prices were rising as they had been since the 1930s. Financing a mortgage was easy with little or nothing down and spotty credit. Then, huge house-price declines and widespread foreclosures were unthinkable.
-- Weak Earnings: Furthermore, real weekly earnings are falling in what is supposed to be an economic recovery, even as payroll employment growth has been modest. Long-term unemployment is now becoming common, with 43 percent of the unemployed out of work 27 weeks or more and the average length of joblessness at 40 weeks. Job openings have been rising, but hiring is little changed because many of the long-term unemployed, and the newcomers to the job market, donít have the required skills. Manufacturing output has revived, but it has been accompanied by the resumption of rapid growth in output per employee, which means production advances have arrested but not reversed the long-term downtrend in manufacturing employment.
Realistic housing affordability is also subdued by the 10.7 million underwater homeowners who cannot move to different, perhaps more expensive houses and thereby free up starter houses for new homebuyers. A recent study reveals that underwater borrowers are 30 percent less likely to move than renters or those with positive home equity.
-- Expensive Houses: Despite the collapse in prices, homeownership is still expensive relative to rentals, even as apartment rental rates rise and vacancies decline. Moodyís Analytics Inc. calculates a ratio of home prices to yearly rents at 11.3, down from the bubble peak of 18.5, but still higher than the 1989-2003 average of 10. Youíd expect house prices to be lower than average in relation to rents, not higher, now that prices are falling.
Rents have to be higher for landlords to offset the eroding value of their properties. The decline in a rental houseís price is just another cost like taxes and maintenance. In any case, the house price-to-rent ratio is only relevant to the few who can qualify to buy.
In past decades, houses have sold for about 15 times rental income. That was true of the post-World War II years, when owners of rental properties expected inflation to enhance their 6.7 percent return, not including maintenance costs and property taxes. If Iím right about the outlook for slow economic growth and falling house prices, houses and apartments are more likely to sell below 10 times rental income.
The consumer retrenchment and recession I foresee for this year will only add to the lack of affordability of owning houses and to the attractiveness of renting. With it, unemployment will rise, while incomes will fall further. As employment drops, the duration of unemployment will rise, labor force participation will fall and median single-family house prices will decline an additional 20 percent. That will definitely make ownership less attractive even if it raises the Realtorsí housing affordability index.