Foreclosures Benchmark US Home Prices

Source : The Business Times, January 29, 2009

Distressed homes generate almost half of existing homes' sales in December

(NEW YORK) The US housing industry has seen the future, and it is foreclosures. The data released on Monday by the National Association of Realtors (NAR), in which distressed homes generated almost half of total sales of existing homes in December, sent a clear signal that those homes are setting prices.

Unsold lot: Despite the plunging prices that are moving so many foreclosed and distressed homes, about 850,000 foreclosed homes are sitting on the market right now

Yet for most of the US housing downturn, which started in 2006, the price-setting power of distressed homes was not as overwhelmingly apparent as it is today.

As recently as May, D.R. Horton Inc told analysts that foreclosures were not yet a significant part of the vast majority of its markets, although chief executive Don Tomnitz did say foreclosures would come to have a negative impact.

That cautious tone has darkened as the volume of people losing their homes swelled and forced banks and other lenders to lower prices. 'The snowball is now an avalanche,' said Meritage Homes spokesman Brent Anderson, adding that the spike in home sales is a double-edged sword. 'Nobody likes prices to go down, but it has to happen to clear inventory.'

In south-eastern California's Inland Empire, foreclosures have accounted for 75 per cent of sales since September, said Tom Eggleston, who used to run a private homebuilder and now has a business helping banks sell foreclosures.

The tipping point for the Inland Empire came when banks holding those properties lowered prices to a full 75 per cent off the mortgage. In Denver, Colorado, the necessary reduction on the banks' part was not so dramatic. Bank-owned homes in that market proved compelling for investors once banks had accepted a 40 per cent cut to the mortgage.

The typical investor getting into this business is a local who usually buys commercial real estate and sees commercial as oversupplied and residential as a source of bargains.

At Denver's current rents, Mr Eggleston said, an investor who buys a home for US$220,000 can make about a 9 per cent net profit - after taxes and management expense - while waiting for prices to stabilise, at which point the property can be sold. 'In these markets the rental of single-family homes has remained pretty robust,' Mr Eggleston said. 'People are out of homeownership but need more than apartment-sized dwellings.'

Despite the rapidly plunging prices that are moving so many foreclosed and distressed homes, about 850,000 foreclosed homes are sitting on the market right now, according to research firm RealtyTrac, which for 2009 tentatively projects about a million additional actual foreclosures and about two million more homes in some stage of the process.

The market's total inventory of homes for sale in the United States is about 3.7 million homes, or 9.3 months supply at current prices, according to the NAR.

Nobody knows exactly what percentage of the market is distressed homes because many auctions and short sales - where the lender agrees to sell for less than the mortgage's value - do not appear in the NAR's data sources. But whatever the number, it is big enough to lower prices further.

The US housing downturn's roots lie largely in rampant risky lending practices that fuelled the housing boom by generating demand from aspiring homebuyers who previously could not get a mortgage. Many of them defaulted, dumping an excess of supply on the market and triggering a plunge in prices.

Indeed, the Standard & Poor's/Case-Shiller Home Indices released on Tuesday revealed prices of US single-family homes fell a record 18.2 per cent in November from a year earlier.

Bank sales were responsible for some of that decline. They have a strong financial incentive to clear these units off their balance sheets as soon as possible, and are therefore 'an increasingly important factor in setting the new market clearing prices for homes', wrote Raymond James analysts Paul Puryear and Buck Horne in a client note.

Banks, they said, have been known to price homes at about 20 per cent below the asking prices of similar new homes in their markets. UBS analyst David Goldberg expects an additional 5 per cent to 10 per cent drop in new home prices. Below that level, he said, the big publicly traded builders won't start construction as projects would increasingly generate negative free cash flow. As this occurs, construction activity will slow further.

'We'll probably see the builders shrink their footprints to some extent moving forward,' Mr Goldberg said. 'But the bigger outstanding question is, 'Can they generate cash on new projects?' - Reuters