Solving The Supply-Demand Imbalance

Solving The Supply-Demand Imbalance WORD ON THE STREET: As we sit here today in the sixth year of the worst housing crash since the Great Depression, many have suggested that we have become a ‘renter nation’ and that the American Dream of homeownership is dead. I do not believe this to be the case. Our great nation is still forming new households, and I expect population and household growth to support building activity at levels nearly triple the current pace.

Currently, Zelman & Associates is forecasting 11% household growth for the current decade supported by 8% population growth, which I believe should eventually translate into a normal level of 1.4 million to 1.6 million total housing starts per annum. For reference, this year, I estimate that total housing starts will be roughly flat from 2010, at 590,000 units.

However, I expect single-family starts to hit a new post-World War II low of 420,000 units – down 11% from 2010. To put today's depressed levels in perspective, the current level of total starts would compare to 1.06 million in 1982, when unemployment was as high as 10.8% and 30-year fixed mortgage rates were in the 16% to 18% range. I do not expect housing starts to get back to over 1 million units until 2014.

With that said, there has clearly been a disconnect between longer-term demographics and the near-term reality. I estimate there are currently 2.5 million ‘excess’ vacancies that need to be absorbed before a return to ‘normal’ building levels can be justified. For reference, seasonal homes accounted for only 14% of the excess, while the other 86% is defined as for-rent, for-sale, sold, rented or the ambiguous catch-all category of ‘other.’ These vacancies have to be absorbed before new construction returns to normalized levels.

I expect seasonal vacancy rates to decline from the 2010 level but remain slightly ahead of the 1990 and 2000 rates. For non-seasonal units, I expect a significant decrease in the vacancy rate to levels more consistent with the preceding 50 years, as unoccupied, distressed properties transfer to more financially sound investors that seek a rental yield and other household formations absorb the units.

Our sustainable vacancy-rate forecast of 9.5% in 2020 would compare to 9% in 2000 and 10.1% in 1990, and imply that 1.44 million units that are currently vacant would be occupied by the end of the decade, net of new intentional vacancies, partially satisfying incremental housing demand.

Furthermore, the number of excess vacancies has the potential to move even higher, given the current pipeline of 4.1 million loans that are either in the foreclosure process or at least 90 days delinquent as of July, according to Lender Processing Services. While some of these late-stage delinquencies and foreclosures in process would already be included as vacancies, many of the dwellings remain occupied by the delinquent borrower.

It is worth noting that I do believe a material portion of these 4.1 million borrowers that are presently at least 90 days delinquent or in the foreclosure process will be ‘cured,’ mainly through modification efforts. Specifically, when calculating today's shadow inventory, I assume a 20% to 25% cure rate on these loans, as the effectiveness and sustainability have continually increased on newer vintage modifications. On the other hand, I am not incorporating the 2.5 million loans that are 30-89 days delinquent, or any future early-stage delinquencies that will ultimately flow through the process.

I believe the most powerful tool that Washington can provide is a rental program to dispose of these vacant real estate owned properties and future foreclosures in an orderly manner. The most efficient and cost-effective way to achieve this goal is for the government-sponsored enterprises to ease financing terms and expand financing options to investors that would purchase properties at low loan-to-value ratios and pursue a single-family rental strategy.

Over the past five years, the single-family rental category has been the fastest growing residential asset class. From 2005 to 2010, single-family rentals grew at 21% versus just a 4% increase in total housing units. In the hardest-hit markets, such as Nevada, Arizona and Florida, single-family rental units increased 48%, while apartment units were virtually unchanged.

Facilitating an orderly transfer of these distressed units should also have a favorable impact on pricing. Given modest improvement in the economy, record levels of affordability and a reduction in inventory, home price deflation has diminished in the first seven months of this year.

In fact, prices of traditional homes, excluding foreclosures and short sales, were down just 1% on a year-over-year basis in July, according to CoreLogic, versus a 5% decline for the total market, suggesting double-digit pressure for distressed sales, which currently account for approximately one-third of all transactions.

The second piece of the equation is demand, which remains at all-time record lows when measured by sales activity. Despite favorable affordability and historic low interest rates, this has not been enough to move buyers off the sideline. Nevertheless, according to the University of Michigan Consumer Sentiment Survey, 72% of respondents believe that now is a good time to buy a home.

Furthermore, a recent survey by our firm of 1,500 renters conducted in five markets showed that 67% of those surveyed want to become homeowners over the next five years, with 82% of renters in the key 25-34 age group expressing their desire to buy a home.

So if people want to purchase a home and think now is a good time to do so, why aren't they acting on those desires? The answer, I believe, is twofold.

The first issue is the weak condition of consumers' balance sheets, which are still laden with high levels of net debt and negative equity. Indicative of these challenged consumers, our renter survey showed that just 33% of respondents were able to come up with the minimum 3.5% down payment necessary to purchase a median priced home using Federal Housing Administration financing today.

The second issue is uncertainty, which I believe is a nationwide problem negatively impacting home sales and prices given the volatility created by prior tax credits, fear of job loss and mixed messages sent by the government around future housing policy.

However, regional differences are significant, with major dichotomies dependent upon levels of unemployment, distressed inventory, negative equity, delinquencies and vacancies.

Nationally, one of the most significant problems prospective home buyers face today relates to stringent underwriting criteria, magnified by strict credit overlays being imposed by banks due to unknown risk related to putbacks or other future unexpected government burdens. As a result, many qualified home buyers are being turned away. Creating a business environment that would encourage banks to remove these stringent overlays that are above and beyond already-tight lending criteria would be a catalyst to spur housing activity.

In closing, housing has historically been a significant driver of recessions and recoveries. Currently, residential investment represents just 2.2% of gross domestic product, representing an all-time trough and well below the long-term median of 4.4%, suggesting that the industry has been a significant headwind on economic growth. Housing's recovery is essential to the overall success of a broad economic recovery, and without it the economy will continue to languish.

Ivy Zelman is CEO of Zelman & Associates, a research firm that specializes in housing and mortgage market analysis. This article was adapted from testimony Zelman delivered during a Sept. 14 Senate Banking subcommittee hearing titled ‘New Ideas for Refinancing and Restructuring Mortgage Loans.’ To read Zelman's complete testimony, click here.


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