July 16, 2012 by Leave a comment

But what will happen when REO hits the market?

I’m on record as not buying the idea that the housing market is recovering.  Indeed, I don’t really believe that the market has even bottomed out, I think we will see another 5-10% decline in values before it is all said and done.  I see very little in the fundamental underlying economic conditions in this country that would cause me to feel otherwise.  Unemployment is still high, which depresses the demand for homes.  A low rate of household formation, which is tied into joblessness and the country’s massive student debt burden is at the lowest point in decades, and isn’t showing signs of recovery (further depressing demand for homes).  The economy appears to be slowing, as does hiring, which will also serve to keep demand for homes low.

In addition to factors depressing demand, there are factors that should cause the supply of homes on the market to increase.  According to Laurie Goodman of Amherst Securities, there are 2.8 million Americans who are 12 months or more behind on these mortgages.  The vast majority of these homes will eventually find their way to market as repossessions or short sales.

Despite all this, we’ve seen recent increases in home prices.  These home price increases appear to be the result of an artificial constraint on supply.  Specifically, a vast number of repossessed homes are being held off the market and sit in shadow inventory.  On Friday, Teke Wiggin of AOL Real Estate wrote an article discussing this phenomenon (‘Shadow REO’: As Many as 90% of Foreclosed Properties Held Off the Market, Estimates Suggest).  I learned of the article when I read this post by Dave Dayen at FireDogLake this morning (it’s worth reading, his stuff is always quite good).  According to the AOL article, data from CoreLogic suggests that only 10% of all REO is currently listed by owners.  RealtyTrac says that the number is somewhere around 15%.  In essence, listing the homes would force lenders to take massive losses, more or less marking these properties to market:

“When a lender carries an REO on its books, it is allowed to value the home at the price that the foreclosed-on borrower originally paid for it. Once the lender sells the home, it must book a loss: the difference between the original purchase price and the current value. And since home values have fallen by nearly a third since the housing bust, that translates into huge losses for the bank.

“They’ve already taken a loss on the loan,” Khater said, “but they’re going to take a loss on the asset once they dispose of it.” Adding insult to injury, REOs typically sell at a 33 percent discount.”

Of course, this doesn’t even take into account the impact that these REO properties would have on the market as a whole:

“”Each REO that comes through has a domino impact on properties that are very close to that property,” Khater said.

In fact, if lenders turn their REO release valve to full blast, the deluge of foreclosures cascading onto the market could plunge the country into a recession, said Thomas Martin, president of consumer advocacy group Americas Watchdog.

“If they let the dam essentially break. It could be a catastrophic disaster for the U.S. economy,” he said, predicting that some major banks would fail and home prices would nosedive by 20 percent.”

One way or another, these houses will come to market (unless they are snapped up by investors before it gets to that point, but I don’t think there will be enough investors to put a serious dent in the shadow inventory).  And when they do come to market, they will drive down home prices.  Other than allowing the repossessions to trickle onto the market very slowly over a long period of time, I don’t see how this is problem that can be avoided.


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