Sarah Jarvis Team at One South Realty

at One South Realty

Mortgage Lending

It’s (Still) All About Inventory

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For those of you who know me, I don’t think the following will come as a surprise to anyone:

  • I follow a lot of bloggers 
  • I read a lot of articles 
  • I listen to a lot of podcasts

The bottom line is that I spend considerable time nearly every day consuming information on all things real estate. 

And in my time researching the market, I have come to one irrefutable conclusion. 

If you only want to follow one metric to understand how your market is doing, follow ‘inventory.’

Inventory is a Calculation

Now, when I say ‘inventory,’ I am using the term in a very specific way. 

Inventory, when used in real estate, refers to a specifically calculated metric that effectively measures the ratio of buyers to sellers.

Why is it so important? Two reasons:

  • Inventory measures the market currently, unlike closed sales which measure the market 45-90 days in arrears
  • Inventory is strongly correlated with price movements and can be used to forecast price appreciation –– but more on that in a moment

Definition

Inventory is defined as follows: it is the ratio of ACTIVE homes for sale relative to the number of homes that have been ABSORBED (gone under contract) in the last 30 days. The measurement is stated in terms of ‘months’ or ‘months of supply’ and answers the following question –– How long would it take us to run out of homes to buy if nothing new hit the market?

Inventory = Availability (Sellers) / Absorption (Buyers)

Example: 1,000 homes for sale / 500 homes pending in the last 30 days = 2 months of inventory. 

Make sense?

Inventory Comprises All

Inventory is the ultimate measure of any market.

Why? Because it combines all market inputs into one simple ratio.

Every input either impacts the number of buyers or the number of sellers:

  • Building costs? That is a seller side input
  • Credit scores? Buyer side
  • Interest rates? Mostly Buyer side … but interest rates can impact how many homes a builder can build, too.
  • Jobs? Buyer side.
  • Lot supply? Seller side.
  • Building codes. Seller side.
  • Rents? Buyer side.
  • School ratings? Buyer side.
  • Commutes? Buyer side.

I could go on and on, but you get the point. 

Any and all factors that impact the market manifest themselves in the inventory calculation by either creating more or fewer buyers or sellers.

Inventory and Appreciation

Robert J. Shiller - Wikipedia
Robert Shiller, Nobel Laureate

Nobel Laureate Economist Robert Shiller (and author Irrational Exuberance), has dedicated much of his work to the study of real estate.

Most real estate pros are familiar with the Case-Shiller Index, which looks at median home prices –– both nationally in the aggregate, and in 20 different metros, individually. The Case-Shiller Index, introduced in the early 90s, is considered the gold standard of home price appreciation measurements.

But in addition to the national measurement of home prices, he also created a matrix that plots inventory levels against price appreciation / depreciation.

As you can see, the correlation between the two is rather obvious –– when inventory drops, prices not only rise, but by a somewhat predictable amount. And when inventory rises, price growth slows –– or even falls –– depending on how far inventory rises. 

Show me the inventory count in any market segment and I can tell you an awful lot about how that market is behaving.

Observations

A few observations jump out at me –– which I feel are critical to note as the market is changing:

  1. Housing inventory tends to hover between 3 to 5 months historically (in other words, 3 to 5 months of inventory is what most consider to be a ‘normal’ market) 
  2. Prices flip from rising to falling anywhere between 6 and 10 months
  3. At no time in history have prices fallen with inventory less than 6 months, and even have risen with as many as 8 months of inventory
  4. There are far more instances of rising prices than falling prices

Why are these observations so important to note? Because we are so far from the critical inflection points, despite what the news and other media outlets might have you believe.

So Let’s Look at Our Market

Calculating inventory is not difficult –– if you know what you are doing, it takes about 30 seconds.

Pick a segment (say Zone 22 / Western Henrico between $400K and 600K) and count the active inventory (see screenshot below):

And then count the number of homes that have gone under contract in the past 30 days (see screenshot below):

As you can see, there are currently 26 active listings and 36 homes have gone under contract in the past 30 days (I pulled the info on 7/16/22.)

26 active / 36 pending = .72 months

If you then go to the Shiller matrix, you can see that at .72 months, the expectation of appreciation is still approaching 2% per month (roughly 18 to 24% per annum.)

In other words, still quite robust.

Yeah, But…

I know the counter argument is that as rates rise, the buyer pool will shrink. Yeah, I don’t disagree, but I think the buy side of this ratio is by far and away the less important of the two. 

Right now, we have the following conditions governing our market:

  • Home building is still lagging behind demand for reasons relating to labor availability, material availability, and lot availability. The collective deficit of housing has been growing since 2011 and we are still not building enough houses to keep up with demand, much less chew into the deficit
  • Building costs have increased so quickly that realistically, it is darn near impossible to build a single family home for less than $500K –– and generally it is closer to $600K
  • All of the people who bought and refinanced their home at 2.5 to 3% are now far less likely to move and re-enter the market with a mortgage rate in the upper 5s to 6% –– meaning the excess inventory needed to push down prices will not likely come from the resale side
  • Investors have accumulated a tremendous number of median priced / affordable homes and are similarly unlikely to bring them to market with rents rising at the pace they are
  • The least risky form of construction is to build apartments or other multi-family rentals, and many large homebuilders have already begun to shift their focus to building ‘for rent,’ further depressing single family detached construction

And thus, the likelihood of an inventory spike (think 2008) is extremely low and will remain low for the foreseeable future. Building isn’t going to provide the solution and now resales will also become far more scarce for the reasons discussed above.

As a matter of fact, I think the inventory issue is more likely to get worse than better once the market settles in and the Fed stops trying to squeeze out inflation –– but I seem to be in the minority in that opinion. I guess time will tell.

Don’t Mistake What I am Saying

Does .72 hold true for all markets? No, of course not.

Every market and every segment has its own set of dynamics.

Furthermore, just because inventory is low does not mean prices will rise at the maximum rate. If you notice on Shiller’s index, a market with 4 months of inventory can appreciate anywhere from 3% per year to closer to 12% a year, so it varies quite a bit.

Here is a sample of inventories across the RVA region:

  • Western Hanover (Zone 36) at $600K is currently 4.3 months due to several new neighborhoods where construction is prevalent
  • Downtown neighborhoods (Zone 10) at $800K is 1 month
  • Forest Hill Corridor (Zone 60) is pretty much 1 to 2 months at all price points
  • Goochland (Zone 24) at $600 / 700K is closer to 9 months, mostly due a lot of construction.

So don’t mistake this blog for saying that the market isn’t subject to adjustments, only that far more segments than not are still in extremely low inventory conditions and the ability to add new housing at scale and at affordable prices is next to impossible.

Summary

Look, it is easy to believe in the idea of that which goes up, must come down. 

But this idea of gravity and prices ignores the underlying inputs –– Millennials paying record rents are trying to become owners despite the fact that there aren’t enough houses to go around. 

Sorry, I don’t care that mortgage rates have doubled. Mortgage rates have not fixed the fundamental problem –– in some ways, the increase in mortgage rates have made the problem worse by shifting the buyer pool down the price gradient where even less housing is available, but I digress.

No, the real problem, which we are not currently seeking to solve, is that we can’t build houses fast enough or cheaply enough to satisfy the demand. The layers of regulation at all levels (federal, state, local, neighborhood) have made homebuilding an incredibly compliance-based endeavor –– and I don’t see any of the regulatory oversight of homebuilding becoming less problematic … ever.

Besides, this problem is not new. We tend to forget that housing prices were rising quickly well before COVID –– as a matter of fact, the affordability issue was easy to see coming.

How easy? We wrote this article in 2016.

So keep your eyes on not just inventory in the aggregate, but in your area and price band specifically. Odds are, unless you live in an area where new construction is prevalent, your inventory count is still 2 months or less –– meaning that your prices are in no danger whatsoever.

And to the buyers, if you are waiting for a market correction, I think you may be waiting for a while. Yes, competition has thinned to some extent, but as long as housing supply stays below demand, prices will continue to climb.

Free Beer, Inflation, and Real Estate

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Feels a bit odd right now doesn’t it?

  • We have war going on.
  • COVID is lingering / re-surging. 
  • Supply chains are still nowhere near functioning properly.
  • Inflation is raging.
  • The Fed has proclaimed inflation is ‘Public Enemy #1’ and seems hell bent on wringing it out of the system, regardless of the damage it does.
  • Mortgage rates have come close to doubling in the past 90 days. 
  • The stock markets have shed trillions in collective value.
  • Crypto is down by more than half.
  • NASDAQ is down about the same.
  • And the Supreme Court is now leaking documents.

Did I miss anything?

Real Estate

So I did miss one thing –– real estate. 

Right now, if you read the blogs and reports coming about Q1 of 2022, you will hear nothing but things like ‘prices set new record’ and ‘inventory at all time lows.’

But if you also ‘doom scroll‘ Twitter, or listen to CNBC, you hear a far different story. Inventories are rising, traffic is down, and price reductions are becoming far more common.

So which is it? Is real estate going to continue its torrid price rise despite rising rates, rampant inflation, and all of the other upheaval brought to us compliments of Covid and Putin?

Or should we brace ourselves for 2008 Redux?

Here is what to watch.

Lending Update

On January 1, 2022, the 30 year mortgage rate was hovering around 3%. 

By May 15, 2022, the 30 year rates stood at 5.5%.

Not only did the rates nearly double, the rate at which they jumped was particularly jarring –– never in the history of the capital markets have rates ever risen this quickly. 

And, yes, it is having an impact.

Qualifying vs. Underwriting

But while most of the messaging is that buyers now no longer qualify, in reality, what it means is that they simply qualify for less. The uninformed conflate mortgage rates with underwriting –– and they are two different things. 

Underwriting removes people from buying pool because of things like credit scores or how income is counted –– rising rates simply move a buyer down the ladder.

That is a key distinction. 

Unlike 2008, when buyers were removed from the buying pool because the loans went away, today, the rising rates has made owning more expensive. The buying pool is still the same size, they just qualify for less.

The takeaway here is that the most intensely contested segment of the market –– the entry point –– won’t change that much. 

Might we see weakness at higher price points where homebuilding is more common? Perhaps, but unless we see a spike in additional homes coming to the market at or near the median price points, the buyer / seller imbalance is so dramatic that I still don’t think we will see much slowdown. 

Inflation

Low rates didn’t just drive housing prices higher, they pushed all asset values higher.

Additionally, the response to COVID (give everyone money to stay home) flooded the system with free excess cash.

So what happens when you give away money and drop rates to nearly zero?

Remember ‘The Hangover? ‘ Yeah, that.

Inflation.

When COVID hit and we went into lockdown, the Fed flooded the system with currency in an attempt to keep everyone flush with cash until we got the pandemic under control.

It can be argued that the stimulus had the desired effect –– at least initially.

The Monetary Hangover

But free money is a lot like free beer, it sounds like a great idea at the time but comes with a severe hangover later –– especially if you keep drinking it well past when you know you should.

Well, now is later and we drank WAY too much. 

Currently, Inflation is just over 8% and the cost of goods and services are far higher than pre-pandemic, with not a lot of relief in sight. 

Killing Inflation

The good news is that the Fed has already begun to change its policies in order to stave off inflation. The bad news is that it only really has two levers to pull and both have the impact of driving up ALL forms of interest rates –– mortgage rates included.

As most everyone now knows, rates shot skyward faster than at any point in history –– from roughly 3% at the beginning of the year to 5.5% by mid-May.

While the last week or so has brought some stability to the mortgage rate environment, it hasn’t meant that rates have decreased, only that they flattened for a little while to allow the market to assess the impact of the last rate jump.

Until data shows that inflation is slowing dramatically, expect rates to keep ticking up. 

The 3% Mortgage’s Legacy

Which brings us to the unanticipated –– and extremely problematic –– part of the hangover.

Pretty much anyone who purchased a home prior to January of 2022 has more than likely refinanced their mortgage as rates dropped –– and is now sitting on a +/-3% mortgage. Depending on the study you read, something like 75% to 80% of all mortgage debt is now at or below 4%.

Think about it –– who in their right mind is going to give up that rate? And then turn around and buy into a market with 5.5% rates and less than 1 month of inventory? 

I doubt there will be many –– and therein lies the new problem. Inventory is already at record lows, and now anyone with a 3% mortgage is probably not going to sell unless they absolutely have to –– further depressing inventory.

The economic idea that rising prices leads people to want to sell, at least in this case, is not accurate. The increased cost of capital is proving a far stronger deterrent than rising prices are an incentive.

Gotta be honest, I didn’t see that problem coming.

Inventory

So despite the idea that people with 3% mortgages are unlikely to sell, the rise in rates and the crash of the stock markets is removing liquidity (a.k.a. –– the free money) from the system.

As a result, housing inventories are starting to rise nationwide –– albeit at radically different regional rates. When the cost and availability of money changes, demand is impacted.

So how is Richmond being impacted?

A view inside of our MLS. When you exclude the new housing inventory (which is inflated by homes that are ‘To Be Built,), then you see that we are still well below pre-pandemic levels.

When we entered the pandemic (March of 2020,) we were already experiencing some of the lowest inventory conditions ever. Most of the US was in what would be considered a strong seller’s market with somewhere between 2 and 3 months of inventory.

After a brief lockdown-induced pause, the Great Migration buying frenzy bagan and inventories started to drop from ‘lowest of all time’ to ‘is zero inventory actually possible?’

For Richmond, we spent the large majority of the pandemic measuring our inventory in weeks, not months –– and that has not changed. As this blog is written, we are still less than a month (.80 to be exact) despite the rate jump and other economic headwinds. 

We created a chart to show how market conditions are a continuum. By tracking inventory, you really know just about everything you need to know about where the market stands.

So when inventories start to rise (and it is inevitable that they will,) realize that even pre-pandemic levels aren’t enough to fundamentally change the market. 

I’ll start to pay attention when we have 3,000 -4,000 homes for sale, not when we move from 500 to 600.

Rents, Migration, and Millennials

‘So I will just wait for the market crash and buy a home when prices fall and rates pull back,’ has been a common refrain amongst every renter who has tried and failed to buy a home. 

The biggest generation in US history is just now entering the housing market. and we are woefully unprepared for it

I am sorry, that was a poor strategy. 

Right now, rents are up somewhere between 20 and 30% depending on your market, vacancy rates are effectively zero, and the leading edge of the Millennial Generation is just now maturing home buying age.

And did I mention that Richmond’s population is growing at some of the fastest rates in the country? In the time period following the arrival of COVID, Richmond’s growth rate has exploded –– mostly due to migration from regions of far higher costs of living. 

All of the other financial stuff aside, the fundamental issue is that we don’t have enough places for people to rent OR own, and it is spiking the cost of both. 

Congratulations, Richmond! All of the good stuff we have been saying about ourselves finally paid off. People from all over this great land heard our message and moved here –– now if they could only find an affordable place to live…

Summary

I get it, you can’t (almost) double the mortgage rate in 90 days and not have an impact. 

I expect at some point we will see rates of price increases slow somewhat, especially if we don’t get the cost of gas and food down. 

But regardless of all of the complexities of modern monetary policies and inflation, the fundamentals that underpin housing are quite simple –– how many buyers are seeking housing versus how many sellers have one to sell?

Think building is going to help offset demand? Yeah, might need to rethink that.

Right now, the number of purchasers so far outweighs the number of sellers that I don’t really care much about rates, or the economy, or inflation, or Ukraine, or COVID. 

We don’t have enough of any kind of housing to satisfy the demand that is already here. 

This problem has been steadily building since the devastation of the construction industry on the heels of 2008. We should not be surprised that we are here.

Is Your Realtor Buying Property? (Or just telling you to?)

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I am sure you have heard a Realtor say it –– ‘It’s a great time to buy or sell real estate!’

Yeah, it is rather obnoxious.

Admittedly, I don’t like the statement either, it feels not only very self-serving, but very thoughtless. It really isn’t saying anything at all –– just a recommendation to do something –– which flies in the face of legitimate thoughtful advocacy (but I digress …)

That said, it does beg an interesting question, what is YOUR Realtor doing? Are Realtors buying right now with prices as high as they are? Are they dumping everything they own thinking the market is about to tank? Are they telling you to buy but others to sell? Are they recommending what is good for you, or for them?

The bottom line is: Does their advice match their behavior?

Let’s discuss.

The ‘Agency’ Problem

The ‘agency’ problem is basically defined as follows –– it is when the representative for an individual (Realtor, stock broker, attorney, etc.) makes money regardless of whether the deal works out for the individual represented.

​​Don’t tell me what you think, tell me what is in your portfolio.”

Nassim Taleb –– Skin in the Game

In other words, if you buy a stock, or home, or car, and the value goes down, does the representative that recommended you buy it (the agent) feel the same financial pain? If they do not, then you (probably) have an agency problem –– one where the only the client suffers from the bad advice, not the agent.

As a very much younger version of myself, I remember a sage developer once telling me that he would be more than happy to build what I said he should, provided I covered his losses if it didn’t work out. And while I was taken aback by the statement initially, I quickly came around to understand what he meant. 

If he followed my advice and I was wrong, he was the one who lost –– not me. It was simply a way of saying, ‘Put your money where your mouth is.’ 

I never forgot the lesson.

Are We Buyers or Sellers?

So it begs the question, are agents buying or selling right now? And being even more specific, are WE buying or selling right now?

The answer is, yes, we are.

Wait, what, you said ‘yes’ to both. Are you buying OR are you selling?

The answer is more specifically, yes, we are doing both.

When We Are Sellers

We are selling a few things in our portfolio for various reasons, but they are not related to an expectation of a market crash.

Our house in OBX had extraordinary sunset views.

We are doing what is best for our portfolio.

The Beach House

We recently sold a vacation home we had owned for many, many years (in full disclosure, I LOVED the place, but it was time to let it go.)

Why did we sell it? For two reasons:

  1. We had a floating rate mortgage on the home, and due to the nature of vacation (2nd) homes, refinancing the property into a fixed rate mortgage was not feasible. We saw indicators that mortgage rates we due to rise and we didn’t want the exposure to an increased mortgage payment, regardless of the appreciation potential (or sunset!)
  2. The home was due for many deferred maintenance items that would have required significant capital investment. In other words, we had some expensive repairs on the horizon that would have required a lot of cash that we did not want to lose access to.

And so we sold it –– in a weekend.

Replacement and the 1031 Exchange

We then used a 1031 tax-deferred exchange technique to shelter the gains, and then bought both an office property (near Willow Lawn) AND a single family rental home in Kilmarnock (near the River) ––  and we were able to secure long term fixed-rate financing at a very low rate. 

From a strategic standpoint, we were able to remove a poorly financed property from our portfolio (that also was extremely unpredictable in its yearly maintenance costs) and replace it with two low maintenance properties financed at a 3.1% fixed rate.

And did I mention we actually upped the cash flows at the same time?

Great outcome.

So, yes, we technically sold one property (which made us a seller) but subsequently purchased two others to replace it (which made us buyers.) And we did so to reduce the risk in our property portfolio for reasons relating to mortgage finance, cash management, and tax impact –– not for fear of a market crash.

The Family Rental

In addition to the sale / purchase referenced above, we are also considering selling a property that we had owned for years as a single family rental (it is currently under contract.) 

The reasons we are doing so have less to do with a bet on the market dropping (we will simply go and buy something else similar with the proceeds, so we are still betting on appreciation) but more for a reason related to family. The home was leased by a family member and when they moved out, it felt better for all parties involved to find a new owner. 

So the reason we are selling is not to take money off the table in fear of a market collapse, it is due to a what is best described as a ‘non-economic’ reason.

The fact that we will be purchasing a home to replace it indicates our belief.

We are Naked Buyers, Too

OK, not actually naked per se –– I mean we are also buyers even we when don’t have things to sell.

In the past few years, we have added to our portfolio, over and above replacing the properties we sell.

Specifically, we have purchased a home with each of our eldest children, and are actively seeking to purchase more for investment purposes.

What did we buy, you ask? One is located in the ‘VCU Bubble’ and will always rent well (so the downside is extremely limited,) and the other is a super cute brick cape cod in the near west end (again, location and size make it very low risk.)

And yes, just like our clients, we had to win a bidding war ($40K over ask, btw) with a waived inspection clause in order to secure it –– what is good for the goose is good for the gander, right? We get the pain and uncertainty of the process.

Why put ourselves through the pain of a bidding war and the risk of potentially buying something with a lot of repairs in a market that seems overpriced? Because we are bullish on housing and we wanted to make sure that our kids had a chance at ownership in the same way that we did when we were their age.

So, yes, we are putting our money where our mouth is and we are making the same bet with our own children that we are asking our clients to make.

Other Strategies

We are also actively seeking land to develop or properties in need of renovations.

Buying housing does not scare us.

In addition to residential property, we are also looking for small office properties where we can find ‘value-add’ opportunities such as building on more space, carving off lots for development, and / or undertaking aesthetic upgrades.

We are lucky in that we have the benefit of experience to see how all forms of properties can be improved and thus our search box is bigger than most, but we are still buyers –– regardless of the asset class.

Again, we see demand well outstripping supply for the foreseeable future and nearly all forms of ownership (especially when financed at today’s rates even though they are up 25% from last year) are still a phenomenally safe play. 

The Bet We ARE Making

So to answer the question above, are WE buying or selling? The answer is that we are only sellers when we can replace what we sell.

And when we do sell, we are selling for reasons NOT related to a market crash, but rather for other strategic reasons, and we are replacing what we sell using the 1031 tax deferred exchange provision in our tax code. 

In other words, we don’t want to relinquish property at this juncture and give up the potential appreciation on any portion of it because we see more upwards pressure on pricing than we do the opposite. 

As a matter of fact, with inventory levels hovering where they are currently, the monthly appreciation is expected to be 2-3% per month (and no, that is not a misprint.)

Furthermore, we see not just property values rising, but rental rates rising as well. 

Focus on the Facts

Regardless of the events in Eastern Europe, or the interest rates, or inflation, or COVID –– the housing stock of our country is shockingly below where it needs to be and the 20 – 40 offers per listing indicates that demand is nowhere near abating (and yes, we track the number of offers, it is a phenomenal measuring stick for market momentum.)

As a matter of fact, since the beginning of 2022, the increase in interest rates has not impacted pricing whatsoever –– despite the predictions otherwise.

Am I being myopic and ignoring market crash indicators that will become obvious after the fact? Perhaps, but having lived through 2008, I am acutely aware of the conditions that caused that market to crash last time and none of those conditions exist today. 

When your market is 5M houses undersupplied, it is hard to see how things change.

The bottom line is that we see pricing continuing to escalate, with only a soft landing and flattening when the market returns to balance sometime in 2026 or 27 if we are lucky –– not the 30% drop of 2008. The lack of inventory makes a huge adjustment highly unlikely.

So just to reiterate, my money and my mouth are in the same place –– and we lived through 2008.

Have? Have Not?

The bottom line is that property ownership is increasingly becoming the dividing line between haves and have nots.

It isn’t fair, but it is an unfortunate reality (you can read more about my opinions here.)

The policies and decisions that led us to this predicament are long standing and incredibly tough to reverse. And even if they are ever reversed, the time required to build enough homes to satiate the demand is well over the horizon –– especially at the market’s entry price points. 

Housing has never really been, nor should it ever be, a short term thing –– like 1,000 shares of Apple or Bitcoin. You buy housing to own it for a years.

So yes, we are both buyers and strategic sellers –– but more than anything, we are owners and will continue to be so for the long haul. 

2022 Market Housing Market Forecast

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Each year, we try to push out our thoughts about the housing market in the coming year.

2022 is no different.

The presentation we did this year we feel is one of the most important ones we have ever done.

Why?

Because the market conditions are quite frankly, unprecedented.

At no time in our history have we had so many extreme inputs to the market –– from inventory to stimulus to mortgage rates to inflation to migration –– everything.

To offer you a taste of what is in the presentation, here is a sample of what we see coming:

  • prices should continue to increase –– even possibly spike again
  • mortgage rates should rise
  • inventory conditions will continue to be near historic lows
  • migration to our region has never been higher
  • 2008 vs 2022 price analysis
  • new housing difficulties

And so much more…

Enjoy!

The Coming ‘Wave’ of Foreclosure

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I am beginning to hear a lot of chatter about foreclosure right now. 

Spoiler alert –– don’t worry.

One of Biden’s first acts as President was to extend protection to homeowners experiencing hardship due to COVD

As we transition from one administration to the next, we are beginning to see where this administration stands on many issues –– and being someone who makes a living in real estate, Biden’s housing-related policies are of particular interest.

Unsurprisingly, in one of his first acts as President, Biden extended both COVID-related forbearance protection and the foreclosure moratorium in an attempt to keep those who lost jobs from being unceremoniously tossed out into the street for non-payment of their mortgage.

The System Shock

When COVID hit and we went into lockdown, it cost a lot of people their jobs.

For a slew of others, COVID may not have cost them their jobs, but their pay decreased sharply when their industries were decimated.

The spike in initial jobless claims (March 2020) still blows me away in its severity

When you have that many people become unemployed (or underemployed) as rapidly we did (see the unreal spike in the chart above), everything is impacted –– and housing was, of course, not spared. 

In the period immediately following the lockdowns, people started to make tough decisions about how to allocate their savings into an extremely uncertain future –– and not making a house payment became a choice many had to make.

Enter ‘forbearance.’

Forbearance

COVID has forced us to learn so many new terms –– ‘flatten the curve,’ ‘herd immunity,’ ‘mRNA,’ and ‘contact tracing’ to name a few. ‘Forbearance’ is yet another one and now at the front and center of COVID housing news.

Without getting too deep in the weeds, mortgage forbearance is basically the ability for a homeowner to (legally) stop making payments to the mortgage servicer for a period of time without fear of losing the home in foreclosure. 

Forbearance does not absolve the borrower of the debt, it just basically says ‘We both know that I can’t pay you right now because of COVID, but I will start paying you again when I have a job and we will work out how to make up the payments I missed.’

Right now, those who report the news are acting as if the two are one and the same.

It is as unfortunate as it is uninformed.

Foreclosure (vs. Forbearance)

While the words sound similar, they mean different things in the same way that ‘lose your house’ means something way different than ‘mortgage relief.’

Forbearance is temporary relief in making your mortgage payment –– foreclosure is the legal process that a lender must go through in order to seize your home for non-payment of your mortgage. 

When you are (legally) in forbearance, you don’t have to pay the bank, but you cannot have your home taken through foreclosure. If you stop making your mortgage payments but are not protected by some type of forbearance agreement, then the bank can take the home from you.

Note –– forbearance does not mean the same thing as mortgage delinquency or pre-foreclosure. Just because a borrower is in forbearance does not mean foreclosure is immenent.

Asset–Based Lending

2008 notwithstanding, lending money against an asset like housing is one of the safest forms of lending imaginable.

Why?

Borrowers tend to pay their mortgage above all other types of debts (credit cards, medical bills, student loans, boats and other do-dads, or other non-essential expenses) because being homeless sucks and foreclosure eviscerates your credit.

Thus, banks love to loan money against REAL assets –– and a house is a real asset (think REAL estate.)

Besides the fact that borrowers tend to make mortgage payments come hell or high water, there is an asset securing the loan:

  • If I, as a bank, extend you credit to buy a home and you don’t pay me, I can take your home and resell it to get my money back.
  • If I, as a bank, extend you credit to pay household expenses or Netflix (i.e. –– a credit card) and you don’t pay me, I can’t really take the food you have eaten or the movies you have watched and sell them to get my money back. 

And thus the reason that loans secured by assets are at lower rates than loads not secured by assets.

Appreciation = Protection

So not only are houses real assets –– houses tend to appreciate in value.

Yes, 2008 showed us that houses don’t ALWAYS go up in value, but for the large majority of history (including every year for the past 10 years,) housing values have marched forward in a stable, if not spectacular, manner.

The equity created by the simultaneous reduction of debt and appreciation in the price creates additional value in the home –– and that is critical to understanding the real risk to the market we are in.

Forbearance is Up, Foreclosure Will Not Be

Right now, the message being delivered by news and media outlets is forbearances are up sharply (which is true) and that the moratorium on foreclosure has been extended by presidential decree (which is also true) –– which, for the person who doesn’t follow the market in great detail, sounds ominous. 

It shouldn’t.

Foreclosures happen when TWO conditions occur:

  1. the owner cannot make the mortgage payment AND
  2. the house is worth less than the debt

Without both, foreclosure is unlikely.

If the debt owed > home value, the homeowner will have to write a check to the bank for the difference between the debt and the sales price when they sell it.

If the debt owed < home value, the homeowner will collect a check for the difference between the debt and the sales price when they sell it.

That is a massive difference.

Using real numbers:

  • if a home is worth $400,000 and the debt is $500,000, then the owner is incentivized to allow foreclosure and stick the bank with $100,000 loss
  • if a home is worth $400,000 and the debt on the home is $300,000, then the owner is incentivized to sell the home and pocket the $100,000

It is all about incentives. 

Homeowner Equity

So if foreclosure happens when the home is worth less than the debt, where do we stand right now?

From the Urban Institute (urban.org)

Using the chart above, when the yellow line falls below the blue line (negative equity), people are far more likely to get foreclosed on. When the yellow line is above the blue line, then the owner will sell the home and pay off the mortgage.

Right now, there has never been more collective equity in the US home market.

Do you really think foreclosure is going to be an issue?

Summary

I get it, we are still paying for the debacle that was 2008. The public sentiment is that when prices rise fast, bad things are about to happen. People remember the pain, but they don’t understand the reasons.

2008 was bad for sure, but the conditions that created the housing crisis of 2008 DO NOT EXIST TODAY.

Depending on whose research you want to believe, the current available housing under-supply is as severe as the housing over-supply was in 2008-2010.

Does that put it in perspective?

In our last blog, we wrote about how pricing was not likely to head down anytime soon, and (good news) foreclosures tend to move inversely with home price appreciation.

Right now, the lack of housing is pushing pricing higher as rapidly as in any other time in history and as equity increases, delinquent homeowners sell in lieu of electing foreclosure –– and this condition is unlikely to change in any meaningful way for the foreseeable future.

Articles such as this disingenuously deceive the reader in an attempt to garner clicks.

Yes, events that are not easily predicted can bring rapid changes to any market –– and will always be a threat –– but the threat to today’s housing market is not too many foreclosures. 

Will there be a few additional owners who end up losing their homes when forbearance ends? Yeah, perhaps. But you won’t notice.

Don’t let those who are uninformed frighten you about some coming wave of foreclosures.

They are –– in a word –– wrong. 

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