Is 2009 the Time to Run or Invest in Real Estate?
Part I: Is The Obama Housing Plan Enough?
As we look toward the future and attempt to project the landscape of luxury investment real estate over the coming months and years we need to examine the planted economic seeds for progress.
The good news is that in the places the Federal Reserve has acted, they have achieved positive results. They have at least temporarily stemmed the crisis of the financial institutions. Solvency issues with some banks is still an issue but no longer are we going to bed wondering which investment bank will blow up tomorrow, and whether our investments are physically safe. The Fed has been able to reduce the LIBOR and two year swap spreads significantly, and has created enough liquid in credit markets that banks are lending again, albeit at prohibitive quantities and at higher than necessary costs.
The above is not enough and the global recession continues. Real estate and equity markets are stuck in a depressed deflationary spiral. There doesn’t seem to be a growth catalyst anywhere in the world except for the US government and their endless balance sheet of liquidity.
The Federal Reserve has committed, by any means necessary, to saving the US economy and financial system. Further, the Obama administration is just as committed to the cause of job creation and economic growth. There are several large, sweeping actions that need to be implemented, in 2009, across key areas to bottom the deflating US primary residential real estate market, and to put the economy back on a track of growth and prosperity.
Below is a review of the US government’s first step, announced 18-Feb-09, designed to directly attack one of the core issues affecting the US primary residential real estate market.
Problem #1:
US Primary Residential Real Estate Foreclosures
The rate of foreclosure in the US primary residential real estate market is too high and is increasing. The foreclosure rate needs to be decreased drastically and restored to a normalized pace.
Problem Effect:
Continued Cycle of Real Estate Price Erosion
Increased rates of foreclosed homes adds inventory to the already huge glut of primary residential real estate (approximately 12.2 months inventory), causing a sustained supply imbalance against demand. This causes continued price erosion and foreclosure increases.
Presently Proposed Action:
Act I: The Obama Housing Plan
The Obama Housing Plan released on, 18-Feb-2009, is designed to provide relief for up to nine (9) million home owners. The plan is composed of several parts and is aimed at the modification of conventional mortgages for a select few real estate owners that are current with their mortgages, and many in default status. The exact detail of how the plan will be executed has yet to be communicated, but the main objective is clear. First, allow defaulting real estate owners to modify their current mortgages to lower fixed rates at a level not to exceed 31%-38% of their income regardless of their current situation with respect to loan to value ratios and price depreciation.
Second, allow real estate owners that have been “playing by the rules” and paying their mortgages consistently and on-time to refinance their higher interest loans to ones with lower interest rates and at a lower principle. Only if the owner has a mortgage owned by Freddie or Fannie they will be eligible to have an appraisal of the property and receive a new mortgage written for up to 105% of the market appraisal.
For example, Frank buys a house in 2006 with a $400,000 mortgage. He wants to refinance the house to take advantage of lower available rates but the house is now only worth $300,000 (25% decline). With the new plan, Frank will be able to refinance up to $315,000 for his new mortgage. The $85,000 of debt from the first mortgage is wiped out. The plan lacks any clarity as to what happens to the $85,000 or if there are any future penalties to Frank for accepting this debt forgiveness.
Banks, especially those that are receiving TARP money will likely be forced to comply with the new plan. The thought is that although the bank will be receiving less money via the interest on a specific loan and forgiven principle, this “loss” will be more than off-set by a much reduced number of foreclosures. It is still not clear if the plan stipulates a specific interest rate to serve all real estate owners or if any further stipulations or restrictions exist that would prohibit anyone from taking advantage of this plan.
Expected Result of Obama Housing Plan:
Less Foreclosed Homes
Although the Obama Housing Plan seems geared to most serve those that are in default status or close to it, if fully successful, the plan could save at least seven (7) – nine (9) million real estate owners from foreclosure. This is at least half of the 13.8 million (27% of nearly 52 million US homeowners with a mortgage) people that according to Moody’s economy.com currently own a mortgage that is worth more than their home. The plan doesn’t include provisions for defaulting jumbo loans, people with multiple mortgages (i.e. second homes) nor is it clear what happens to the forgiven principle...but this is a first step.
We will have to wait and see how the rules and regulations look and exactly how it will be executed before the plan effects can be accurately measured. Please stay tuned for more on this.
Another Result:
Indirect Economic Stimulus
Refinancing at a lower rate makes more cash available to homeowners in lump sums and allows the satisfaction of home debt obligations at lower monthly costs. This creates surplus funds available to be spent in other places. This could create unexpected and indirect economic stimulus through spending on important items and fixing up houses in need of repair.
Is It Enough?
The Obama Housing Act alone will not bottom the US residential housing market. At the onset, the plan isn’t all-inclusive enough or broad enough to bottom the market alone. However, if the proposed Obama Housing Plan is able to lessen the tide of foreclosures and keep millions of soon to be foreclosed real estate owners in their homes, it will certainly be a step in the right direction. There are tons of questions to be answered and much of the plan’s success will depend on its final rules, regulations and its execution.
To get the primary residential real estate market to bottom and to get back on the path of growth and prosperity we will need further drastic action with respect to job growth as well the ability of our financial institutions to lend capital more freely and less expensively to all qualified parties.
Our next e-letter will focus on the expected upcoming actions that will be aimed at addressing these critical economic components.
Happy Reading!