If you’re feeling optimistic right now, thinking that the real estate market will be rebounding soon based on the past couple of months of strong performance, well, I urge you to skip this post. No need to spoil a perfectly good mood with gloom, especially on such a beautiful summer day as today.
As I’m not an economist, despite looking very much like one, I’m just going to share a few things I’ve read in the past couple of days that make me a wee bit jittery. Back in May, I wrote that there were some worrisome signs for the housing market. These signs don’t make me any more hopeful.
Mortgage Delinquencies Up
First, according to LPS, mortgage delinquencies are up as of May 31 to 9.2%, and shadow inventory is up thanks to an all-time high being reached in an ignominious category (h/t: Calculated Risk):
According to the Mortgage Monitor report, the percentage of mortgage loans in default beyond 90 days increased slightly, while both delinquency and foreclosure rates continue to remain relatively stable at historically high levels. There are currently more than 7.3 million loans currently in some stage of delinquency or REO.
The report also shows that the average number of days for a loan to move from 30-days delinquent to foreclosure sale continues to increase, and is now at an all-time high of 449 days, resulting in an increase in “shadow” foreclosure inventory.
After a two-month decline, deterioration ratios increased, with 2.5 loans rolling to a “worse” status for every one that has improved. The number of delinquent loans that “cured” to a current status declined for every stage of delinquency, except in the “greater than six months delinquent” category. This improvement was likely the result of trial modifications made through the Home Affordable Modification Program (HAMP) that transitioned into permanent status. (Emphasis mine)
It now takes, according to this report, 449 days to go from 30-days delinquent to foreclosure sale. That’s 14 1/2 months! That there is one helluva extend-and-pretend game.
Furthermore, the deterioration ratio increased after two months of decline — so in March and April, it appears that fewer loans were going bad, but that’s also gone south again.
Office & Retail Vacancies Up
Again, thanks to CalculatedRisk, we find that U.S. office vacancy rate is up to a 17-year high at 17.4%:
Office vacancies in the U.S. rose to the highest level since 1993 in the second quarter as the sluggish economic recovery damps demand from corporate tenants, Reis Inc. said in a report.
The vacancy rate climbed to 17.4 percent from 16 percent a year earlier and 17.3 percent in the first quarter, the New York-based research company said today in a statement. Effective rents, the amount tenants actually pay landlords, fell 5.7 percent from a year earlier and 0.9 percent from the previous three months, according to Reis.
So we have high vacancy rates and depressed rents in commercial office space. From the happy people at REIS, we also get the retail report (by way of Reuters):
Retailers shuttered more stores in U.S. shopping centers during the second quarter, further delaying a rebound in the struggling retail real estate market, according to research firm Reis Inc.
Shopping centers and strip malls have been pounded harder than other types of real estate, hurt by weak consumer spending, anemic job growth and an oversupply built to serve new housing that never materialized.
The Reuters article goes on to mention that “retail rents are not expected to return to 2008 levels until 2016”. Yowza.
It’s the Unemployment
All three indicators, to me, are related to employment — or rather, the lack thereof. Delinquencies rising at this point suggests either (a) that the borrowers are having real financial difficulty, or (b) more and more borrowers are exercising strategic default. Office leasing depends almost entirely on whether there are human beings who need office space. Such people are called “employees” at most companies. And of course, retailers depend on shoppers, and the unemployed make awful shoppers.
But unemployment rate dropped in June to 9.5% from 9.7% in May, right?
It appears that there is pretty solid evidence that the official unemployment figures are unreliable at best, and quite possibly misleading at worst. For example, here’s Bloomberg reporting on the views of Bill Gross of PIMCO and David Rosenberg of Glusskin Sheff & Associates:
“That’s [the drop from 9.7% to 9.5% unemployment rate] a statistical illusion because you had this precipitous fall-off for the second month in a row in the labor force and without that, the unemployment rate would have gone up to 10 percent,” Toronto-based Rosenberg said during a radio interview on Bloomberg Surveillance with Tom Keene. “You can go as high as 16.5 percent, if you count the unemployed and under- employed.”
But Lawrence Yun (my doppelganger) of NAR believes that 1m new private sector jobs will be created in 2010, and another 2m in 2011:
Through May of this year 495,000 net private sector jobs have been created; NAR’s forecast for employment growth is about 1 million additional net new jobs over the balance of the year and another 2 million in 2011.
“If jobs come back as expected, the pace of home sales should pick up later this year and reach a sustainable level of activity given very favorable affordability conditions,” Yun said.
Who to believe?
On the one hand, I’m inclined to be optimistic about the economic recovery. I certainly hope we have a rebound. Mortgage, office, and retail numbers are all, in a way, lagging indicators of weakness — it may be that companies are hiring again, shoppers are flocking to malls, and people are getting current on their mortgages, and we’ll see that in the statistics in the second half of the year.
On the other hand… the jobs numbers for June were not good. Of particular concern is the fact that long-term unemployed (unemployed for six months or more) is now 46% of the total unemployed. That’s a new record. How many of the mortgage delinquencies are from these long-term unemployed? There are no stats available for that, but I wonder if there’s a correlation.
Real Estate in a Deflationary Environment
The combination of the above — high unemployment, high delinquencies, high office and retail vacancies — points towards a deflationary environment. This despite the Fed pumping in money into the economy just as fast as it could (the Fed Funds rate was cut to 0.00% in 2008, and remains between 0.00% and 0.25% as a target even now).
In fact, banks have virtually ceased to function as financial intermediaries since 2008, preferring to use the zero cost of money provided by the Fed to finance purchases of Treasury securities instead of supplying loans to households and small businesses. After a financial crisis, banks become much more risk averse, as is manifest in their willingness to lend only to the government instead of to households and businesses. That development is deflationary because it means that a sharp boost in the monetary base engineered by the Fed does not translate into faster monetary growth at a time when the precautionary demand for money has been boosted by elevated uncertainty.
Although inflation or even hyperinflation may be headed our way in the long run, Malkin makes some compelling arguments. In the next few years, we may indeed be in a deflationary cycle.
And guess what deflation does to the real cost of debt, even responsible 30-year fixed mortgage debt?
Expecting a surge of consumer demand for housing and mortgages (no matter what the nominal interest rate) without s significant drop in home prices strikes me as overly optimistic, if Malkin’s thesis holds.
Seatbelts. Buckle them. We might be in for a rough second half.