The year of the strategic mortgage default
It would be easy to write a 2010 real estate forecast by repeating the industry line that “the new year will mark a turnaround for real estate values; those who act fast will be able to get the best buys.” Real world facts, at least in San Diego, seem to indicate otherwise.
There are reasons why another, more ridiculous, down-leg may be in store for the San Diego real estate market in 2010. Five and seven year interest adjustments came with the adjustable home loans if we can recall. The top of the San Diego real estate market occurred in the summer of 2005, so a huge number of loans are set to adjust next year. Interest rate shock will not be a negative factor since the only good thing is that interest rates are near all-time lows. What will catch homeowners will be the 'reality check' factor. How many homeowners will suddenly wake up to the fact that their home is now worth tens of thousands of dollars less than their mortgage balance? If anyone believes that their San Diego home's value will return they must be naïve.
A study by researchers at Northwestern University of Chicago observed that as many as one in four defaults may be strategic. Owing much more than the current value of their homes or being, "under water," is the reason for homeowners to become strategic. Real-estate information company, First American Corelogin, gauges that 5.3 million U.S. households have mortgage balances of at least 20% higher than their homes' value, and 2.2 million of those households are at least 50% under water. The problem is most deep in Arizona, California, Florida, Michigan and Nevada.
So, whether or not you believe the San Diego real estate market has bottomed, the reality is, it will take many years to recoup equity losses many have endured. 2010 may go down as the year of the strategic mortgage default because of this homeowner awakening.
Talking-heads who claim the U.S. housing market has "bottomed," or even that it will "bottom" in 2010, don't have the slightest grasp of fundamental economics. Government and the vast majority of media are using the old tactic of trying to talk us out of this downturn. Any bit of positive new is over-emphasized while the terrible, realistic conditions are hardly noted.
The government has spent trillions of dollars and has not made ca significant impact on the problem. Government saved Wall Street banks, at least for now. Will government platitudes actually turn around our economy? The administration thinks so. They are closing their eyes and wishing really, really hard that it does.They also should remember to click their ruby-red heels three times to insure success.
The best parallel to our current situation continues to be the Great Depression. In 1930, we had a 50% stock rally and abundant “green shoots” before the market turned down in a relentless decline. This time the government intervention is much larger, but so too, is the credit bubble.
Many agree the real unemployment rate is 17.5%. How can the housing market improve until unemployment dramatically improves?
Property values only go up if there is an increase in demand. That is NOT happening. The birth rate of the US is just enough to sustain our population, nothing more, and it would be negative without immigration.
Another major factor affecting San Diego real estate demand, is that the severity of our current home value decline seems to have broken the back of the myth that you could not lose money purchasing residential property in San Diego or California. Until the devastation to San Diego home values, fades from the collective consciousness, demand for housing will be a fraction of what it was.
Those who invest in real estate and expect values to appreciate need to face the fact that by mid-2010 there is a high probability we will be in a rising interest rate environment, which will boost costs on mortgage loans substantially. We all know it is now much more difficult to qualify for a mortgage even with some of the lowest interest rates in history. What will happen when interest rates move up? Will the government again step in with some type of subsidized interest rate/qualifying program (much like the sub-prime debacle)?
On 10-1-08 I published: #1 EZ Fix to The U.S. Housing Market, where I suggested an easy way to stabilize the real estate market. My idea was for the government to grant investors who buy and hold homes for at least three years, but no more than seven years, 100% exemption on any capital gain they may realize. Well, perhaps because this was a low cost idea involving ‘investors’ it never gained any traction. But, I still believe it would be a sure-fire fix to our housing doldrums.
Here in California the largest state tax rate just passed; there is talk of additional state tax increases. That, coupled with our already high electric, water and gasoline taxes, portends California homeowners’ disposal income is headed for oblivion! Further combination with the administration’s new health care costs and Cap & Trade's dramatic impact on utility costs, only the hope & change commissars will be able to afford California detached homes. The California masses will be, out of necessity, forced to live in huge apartment complexes. The California standard of living will take a huge hit, but look on the bright side ... mass apartment complexes will reduce commuting, contain urban sprawl and cut down on carbon emissions! Perhaps, most importantly, the extra taxes will insure the California public workers pension plans will continue to provide lottery-sized benefits into the foreseeable future.
Higher rates to support currencies will intensify deflation. Intensifying levels of bankruptcy and foreclosure due to salary decreases and job loss will intensify deflation. A century of inflation is coming unwound in a decade.
In an academic paper titled, “Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis,” written by Brent White, a law school professor at the University of Arizona argues that those who are underwater in their loans should just leave.
By leaving, it could potentially save them thousands and it won’t be long until they recuperate financially. Defaulting “strategically” can entice more walk-aways by buying all the major items they may need in the near future, such as a car or even a house, right before they take a hike. As long as you stay current with other mortgage lenders, one could potentially have a good credit standing in 2 years after the walk-away.
In my 7-27-09 post titled: San San Diego Homes – WHEN IT PAYS TO LET THEM FORECLOSE! I noted that: In the Northwestern University study, among those without moral reservations, 63% of those homeowners with a negative equity of $300,000 or more would let the property go into foreclosure.
In my 9-22-09 post titled: Foreclosures – Strategic Defaults Double I noted that: Strategic defaults … financially it’s a logical, legal, defensive decision to make. Why throw good money after bad? No more property maintenance, taxes, insurance, etc. With rent prices falling and rental vacancies rising, it makes perfect sense to bail out and have more disposable income at the end of the month. Survival is the name of the game.
So, based on the strategic default statistics and Professor White’s ideas, there is a good likelihood that 2010 could go down as the year of the strategic mortgage default.
While the highly distressed markets like San Diego, will continue to be pressured by foreclosures and myriad other headwinds. The smaller more conservative metros will benefit from the incredibly low inventory levels and should start to see a rebound in new construction activity in the coming year.
All real estate markets are local. This is the one area with which I agree with the National Association of Realtors. Therefore, I can only venture an view on the San Diego California residential real estate market. San Diego housing will remain a risky deal in 2010 that will yet again be dominated by government intervention. Until both the Federal and State governments get out of the housing market, a real bottom will not happen, thus San Diego housing values will continue to decline well into the next year. The one exception to my forecast could be the low end of the San Diego housing market. The low end properties have demonstrated a base building through the second half of 2009. I expect this favorable trend to continue into 2010.
There are many factors that affect San Diego real estate values. For years now I have ended my opinions for the following year’s San Diego housing outlook with this statement: “I hope my forecast ends up totally off-base and the market proves me wrong.” Though I'm a realist, and with that said, I personally would not bet against what I trust will be the 2010 outlook.
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