We can expect to see the U.S. housing market cool off [1] as we move into 2014 for a number of reasons–some economic, some specific to the housing market itself. And the implications are significant for companies in the default services industry.
First, demand is relatively weak:
- The recovery is too weak to stimulate demand from traditional homebuyers–labor force participation rates are too low (the unemployment numbers are a mirage), too many workers are in low paying and/or part time jobs to be able to afford to buy a home, and wages have been stagnant, and falling, in the middle class.
- The first time homebuyer market, which fuels the whole ecosystem, is at historically low numbers–the 25-35-year-old cohort is staying home with mom and dad in record numbers and their unemployment rates are stubbornly high; many can't afford to buy, many can't meet the new requirements for loans; some have just decided not to buy right now.
- Institutional investor activity, which drove a lot of the 2013 price increases, is beginning to weaken a little bit, and the focus has shifted into lower-priced markets, where investors can buy properties in the $85,000 - $150,000 range in order to rent them out profitably.
Second, credit is tight:
- The new regulations that went in place on January 10, 2014 will make it more difficult for the average borrower to get a loan. Even the Consumer Financial Protection Bureau (CFPB) acknowledges that 8 percent of the loans issued in 2013 wouldn't qualify this year–that works out to between 300,000 to 400,000 fewer eligible borrowers. And it's likely that lenders will tighten up further until they're comfortable operating within the new rules. Eventually, non-bank lenders will re-enter the market with non-agency loans, opening up lending to a wider audience. But this won't happen until private capital comes back to the secondary market.
- Fannie and Freddie are likely to drop their loan limits sometime this year, which will mean borrowers in higher priced markets will have to qualify for jumbo loans; they're available, but the down payment requirements and qualifications are going to be too steep for many borrowers.
- Loans are more expensive–FHA raised its premiums, which has a huge impact on the first time homebuyer segment, and interest rates will continue to go up this year, which makes affordability an issue.
Third, a lot of the price increases we saw in 2013 were due to circumstances that won't be repeated:
- Investors accelerated home price appreciation, particularly in hard-hit markets, by gobbling up most of the available inventory of foreclosed and distressed homes. This segment had the highest increase in prices last year, and probably inflated the overall numbers (said another way–non-distressed home prices didn't go up nearly as dramatically as distressed home prices did). There's fewer of these properties coming to market, and the ones that do come to market will have last year's price increases built in, so we won't see as big an increase as last year.
- We've probably seen most of the "rebound" effect that we're likely to see: Markets that had the biggest price increases in 2013 were the markets that had the biggest price decreases in the bust; most of them have recovered to where they're more or less at "normal" levels now.
- Much of the price increase in 2013 was due to extremely limited inventory in all three categories of homes (new homes, existing homes and distressed homes); inventory levels, while still somewhat lower than normal, are all starting to tick up a bit, which will take some of the pressure off.
So 2013 was clearly a seller's market, and probably the last time we'll see the combination of historically low interest rates and lower-than-normal home prices for a while. In 2014, we'll probably see about the same volume of sales (about 4.9 to 5 million existing homes, and between 400,000 to 450,000 new homes) and much more moderate price increases–probably somewhere between 3-5 percent.
In the meanwhile, on a positive note for the housing market (but a mixed blessing for companies in the default services industry), delinquency and default rates continue to decline. Foreclosure starts [2]are at the lowest levels since 2007. And most of the loans entering foreclosure are seriously delinquent—with borrowers often not having made a payment in two years or more.
With about 340,000 REO properties, slightly under 1 million homes in foreclosure, and another 1.5 million to 2 million loans seriously delinquent—but virtually no loans from the last three years going into default—it will take another 18-24 months to work through the backlog of distressed loans and get back to more or less normal levels.
Considering all of this, it's incumbent upon servicers, asset managers and the professional service firms that support them need to re-think their value propositions and business models, and prepare to shift their focus as the housing market makes its way down the long, slow road to recovery.