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Bottom of The Real Estate Market is Not Here Yet!

Posted Wednesday, April 22, 2009

RealtyTrac reported a big jump in foreclosure actions in the first quarter of the year with most of the increase due to a surge in March. Nationwide, notices of foreclosure are up 9.2 percent from the fourth quarter of 2008 and 23.6 percent from the first quarter of 2008. Notices were issued at more than a 3.2 million annual rate in the quarter. Assuming an average of 2 notices per house, this implies 1.6 million houses will be in the foreclosure process over the course of the year.

California saw the sharpest uptick among the major states. Its first quarter numbers were up 35.1 percent compared with the fourth quarter of 2008 and 36.0 percent compared with the first quarter of 2008. At an annual rate, foreclosure notices were given to 1 in 58 households in the state. Nevada and Arizona have even higher foreclosure rates, with notices being given at a rate of 1 in 27 households in Nevada and 1 in 54 households in Arizona.

Clearly the jump is due to the fact that several major lenders, including Fannie and Freddie, have ended moratoriums on foreclosure that were put in place during the holiday season and left in place as banks waited to see President Obama's housing plans. Now that these proposals have been put on the table, banks are moving ahead with foreclosures with a vengeance.

This is seen most clearly in California where 124,900 notices of default (NOD), the first step in the foreclosure process, were issued in the first quarter. This number accounted for slightly less than 80 percent of the NODs issued for the whole country in the quarter. This huge issuance of NODs implies a huge surge in distress sales in California in the second and third quarter of this year as banks either move ahead with the foreclosure process or arrange short sales of the houses.

This should cause the already rapid rate of price decline in many of the former bubble markets to increase further. The rate of price decline may soon exceed 5 percent a month in markets like Los Angeles, San Diego, and San Francisco, offering potential homebuyers an enormous incentive to delay their purchases. In markets where the median home price is still close to $400,000, at these rates of price decline, potential homebuyers can easily save themselves $20,000 by deferring their purchase a month. With a growing supply of distressed sales and strong incentives to defer purchases, the market is clearly not near a bottom.

As noted previously, there was considerable confusion created by February construction data that showed a large increase in housing starts compared with January. Careful analysis of the data showed that this increase was almost certainly attributable to worse than usual January weather. This analysis was confirmed by the March construction data released last week. While not all of the February upturn was reversed, in almost every category the March data was worse than the December data.

While analysts should always be careful to examine monthly data for aberrations, especially in winter months where weather often has large impacts, it was foolish to look to housing starts for evidence of the beginning of an upturn in the market. Starts will not increase until the enormous inventory of excess supply has been eroded and prices have begun to stabilize. There is no indication that we are anywhere near that point.

With foreclosures running at an annual rate of more than 1.6 million, there will be a huge flood of distressed sales on the market all through 2009 and likely continuing into 2010. Currently, the economy is shedding almost 700,000 jobs a month. Tens of millions of other workers are either working shorter hours or are fearful of losing their own jobs. In addition to increasing foreclosures and distressed sales, the labor market situation will severely limit the demand side of the market.

In this context, only the most foolhardy builders would push forward with major new development projects. Unless the failed bankers all end up owning construction companies, there will be no uptick in construction until the inventory of unsold homes has been substantially reduced.
By Dean Baker