Clouds over the recovery: even as prospects for the economy improve slowly, the outlook for housing sales and home prices remains weak. Some say a double-dip in home prices is already here.

Author:England, Robert Stowe
Position:Cover Report: Valuation Trends - Cover story

"Caution ahead" is the word to the wise for those in the housing sector. Full recovery remains three or more years away. For now, housing market bears see a double-dip going well into 2011. The bulls see, at best, a market bouncing along the bottom before moving up modestly late next year, with the potential for an improved pace of recovery in 2012. * Sales of new and existing homes began to weaken over the summer with the expiration of the tax credit for homebuyers, then were further weakened by a slowing economy. Worries began to rise for a double-dip. * "Yes, the housing market is double-dipping," says Mark Zandi, chief economist at Moody's Analytics, West Chester, Pennsylvania. "Certainly that's been the case with respect to sales and starts, and now I think we're seeing it in prices. House prices are weakening, and I expect more price weakness well into the next year," he adds. "So, I think it's fair to say the housing market is double-dipping." * What are the factors driving this decline? Zandi sums it up as: "The weakening of the job market. The job market is still very soft. It's weakened a bit since the spring. Of course, that's served to hurt consumer confidence, which is the key to a big purchases like buying a home." * "The backside of the third housing tax credit has also been a factor," Zandi adds. The tax credit ended June 30 for purchases with contracts made prior to April 30. "People moved [purchases] forward to take advantage of the credit, and that has hurt the market in the wake of the credit," he says. * And consumers remain cautious. "There are probably potential buyers waiting to see if there is going to be a fourth tax credit. Home sales and construction fell back in August and September. House prices have declined. Then, in the case of house prices in particular, we're seeing the share of home sales that are distressed tend to rise. The percentage of sales that are foreclosures or short sales is increasing. As that share is rising, house prices are going to fall," explains Zandi.


He also expects home sales and housing starts to remain essentially flat through next spring's selling season. "Then I would see some modest improvement through the year" of 2011, Zandi says.

"I don't think we'll see significant improvement in sales and construction until 2012, but by the second half of 2011 we'll see some improvement--just a bit."

Distressed properties the wild card

The pace at which the nation is able to dispose of distressed properties--those in foreclosure or real estate-owned (REO), plus those where homeowners owe more than the homes are worth--remains a key unknown.

The foreclosure crisis burst back on the front page in late September, when news broke that Charlotte, North Carolina- based Bank of America and other large banks were suspending sales of foreclosed properties due to the discovery of flawed foreclosure-processing documentation. Many foreclosure-related documents were apparently robo-signed without people reviewing them for accuracy.

Most large banks have resumed foreclosure processing after having reviewed the accuracy of their documents and taken new steps to make sure the process meets all legal standards going forward.

Zandi expects much of the improvement in sales to come from rising levels of distressed sales. The foreclosure paperwork problem has slowed down that process, and its successful resolution will determine the timing of the bottom of the second dip in housing, according to Zandi.

With higher levels of distressed sales, Zandi expects "further declines in prices through most of next year as the distressed share of sales rises," he says. The share of distressed sales will peak in the second or third quarter--most likely the third quarter, he says.

Zandi's forecast of the peak for distressed sales is one he makes with only "little conviction" because of uncertainties surrounding the pace at which banks can successfully correct flawed documentation of foreclosures.

"If the [robo-signing issue] turns out to be a bigger problem, it could delay sales for a long time," he says. "If it does, then we'll see actually stronger house prices near-term and weaker prices longer-run" when distressed properties are ultimately sold. "So, the timing of the bottom of house prices is very uncertain, given issues like the robo-signing issue."

"I say with a great deal of conviction that prices are going lower. I don't say with conviction the precise bottom," the housing economist explains.

Zandi predicts prices will fall another 8 percent from the second quarter of 2010 to bottom in the second quarter of 2011. That will represent a 34 percent price decline from the peak in the first quarter of 2006 to the trough in 2011, he says.

As most would expect, the states with the highest foreclosures "will be the places with the most severe price declines--Florida, Arizona, Nevada, central valley of California, parts of the Midwest and the Atlanta market," says Zandi. There will be further home-price declines greater than the national average of 8 percent in those particular markets.

Among the distressed states, the outlook for Florida is among the worst, according to Zandi.

"The other issue in Florida is that the job market is particularly bad," he says. The outlook for Florida housing sales and prices will depend on construction, tourism and migration of older households. "All those things are under a lot of pressure," he notes.

"Mobility is significantly impaired by the fact that there are so many underwater [borrowers]. This proportionally hurts parts of the country that rely on in-migration, like Florida," Zandi points out. Florida, a state that has seen a perpetual in-flow of people, is, in fact, currently suffering from out-migration, he adds.

Hitting bottom, again

New York-based Standard & Poor's (S&P) concurs that home prices are likely to see another 8 percent decline in prices from current levels in the S&P/Case-Shiller Home Price Index. "I think they will probably come down to a bottom sometime early spring," which will take prices "to about where you were in April 2009, which was the low point," says David Wyss, senior economist at Standard & Poor's.

If you measure prices in terms of the Federal Housing Finance Agency House Price Index, S&P predicts the drop will be less and will occur a little later than next spring.

As for home sales volume, Wyss says we are seeing an "abnormal trough" in home sales that is a result of the "abnormal boost" that took place in the spring. "Now we are going to see things stabilize and gradually recover" to an annual pace of just over 5 million in 2011, he says.

While the foreclosure-documentation crisis is "a bit of a wild card," Wyss says, "my presumption now is that the foreclosure thing will be settled, and it will prove to be much less of a deal than it has been built up to be." This means that foreclosures will go back up again.

The foreclosure data most often cited are typically foreclosure filings. "That is not what really counts for sales. What really counts is when it becomes REO," Wyss says. "And that lag between foreclosure filings and actual foreclosure has been getting longer and longer" because of the rising volume of foreclosure proceedings, he says. "The courts are clogged. The banks are clogged. Everybody's clogged."

Because of the steady flow of foreclosures and REO properties, distressed sales will remain high, according to Wyss. The Case-Shiller Index, which is comprised of all sales, includes distressed sales. "This probably biases down" the Case-Shiller Index, he adds. "In almost every city, the biggest decline [in home prices] since the peak is in the bottom third of properties."

Underwater borrowers

How much shadow inventory is represented in the pipeline of foreclosures and expected short sales of homeowners underwater? "Obviously that's one of the questions" that needs to be answered in order to determine...

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