Real Estate: Catch A Falling Knife

Tales of a real estate recovery are just that—tales. I’ve been reviewing the data on residential and commercial real estate and things aren’t getting better, rather they are continuing their negative trends. There are pockets of housing recovery, but on a national basis, home prices are still declining. While Commercial real estate (CRE) prices may be bottoming, there is nothing to drive that market and it still has a long way to go.

Residential Real Estate

Lenders Processing Services (LPS) came up with some sobering data in their November report regarding housing from its data base of 40 million mortgages:

• Total U.S. loan delinquency rate (loans 30 or more days past due, but not in foreclosure):  8.15%
• Month-over-month change in delinquency rate:  2.7%
• Year-over-year change in delinquency rate:  -9.6%
• Total U.S foreclosure pre-sale inventory rate:  4.16%
• Month-over-month change in foreclosure presale inventory rate:  -3.0%
• Year-over-year change in foreclosure presale inventory rate:  2.0%
• Number of properties that are 30 or more days past due, but not in foreclosure:   4,144,000 (A) 
• Number of properties that are 90 or more days delinquent, but not in foreclosure:  1,809,000
•  Number of properties in foreclosure pre-sale inventory:  2,116,000 (B)
• Number of properties that are 30 or more days delinquent or in foreclosure:  (A+B) 6,260,000
•  States with highest percentage of non-current* loans:  FL, MS, NV, NJ, IL
• States with the lowest percentage of non-current* loans:  MT, SD, WY, AK, ND

*Non-current totals combine foreclosures and delinquencies as a percent of active loans in that state.

The S&P/Experian Credit Default Indices showed a  third consecutive monthly increase in national default rates in November.

“As we indicated last month, the weight of first mortgage default rates tends to drive the trend in the national composite,” says David M. Blitzer, Managing Director and Chairman of the Index Committee for S&P Indices. “First mortgage default rates rose for the third consecutive month, leading the same pattern for the composite. Since August, first mortgage default rates have risen from 1.92% to the 2.17% November rate, or 0.25 percentage points. The composite has also risen in each of those three months, from 2.04% to 2.22%.  …

“Looking at the regions, all five saw their rates increase.  Los Angeles saw the largest increase, moving from 2.15% in October to 2.53% in November, which is a fairly significant 0.39 percentage points.  Miami was not far behind, moving from 4.16% to 4.47%. These are two markets where we have seen some recent weakness in other housing statistics. Again, while there may be some cause for concern if this upward trend continues. [sic] Other recent housing statistics point to the same relative weakness, so these statistics align with the overall current picture of the economy.”

The hot markets (Orlando, Tampa, Jacksonville and Miami) appear to be cooling:

Top real estate markets in the United States are beginning to cool down, according to Clear Capital, a provider of housing data and valuation services. The markets are still growing and improving, its latest report finds, but not at the rates seen in recent memory.

“Even though as a whole, this group hasn’t experienced returns this low since June 2011, each of the 15 markets continued to post quarterly gains,” the Clear Capital report states. “The overall performance of the group has stabilized and tightened, with only 3.1% separating the highest performing market, Washington, D.C., from the 15th place market, Cleveland.” …

“The strong upward price movement for these Florida markets has correlated with a 12% drop in REO saturation over the last year at the state level,” the report says. … Atlanta is now the market feeling the most acute drop in housing. The city is down nearly 20% year-over-year and the REO saturation rate is reaching 43%, second only to Las Vegas and Detroit.

Zillow, which tracks its own data and attempts to predict what the Case-Shiller Report will say, reports that the 20-City Composite Home Price Index (non-seasonally adjusted, NSA) will decline by 3.5 percent on a year-over-year basis, while the 10-City Composite Home Price Index (NSA) will show a year-over-year decline of 3.2 percent. 

On the other hand, home remodels continue to grow, as reported by BuildFax:

The index, which began in 2004, rose to 147.6, up 40% from 105.8 in October 2010. The index stood at 141.4 in September, which was also a high. … The company found the average project cost of a major remodeling project for 2011 was $39,460, down from an index high of $43,808 in 2004. The average project cost of a minor remodeling project in 2011 was $10,968, down from an index high of $12,623 in 2006.

Where is all this remodeling occurring?

In October, the West (53.6 points; 52.5%), the Midwest (21.4 points; 20.2%) and the South (9.5 points; 10.6%) experienced year-over-year gains from October 2010. The West (9.6 points; 6.8%), the Midwest (7.6 points; 6.2%), the Northeast (1.2 points; 1.6%) and the South (.4 points; 0.4%) had month-over-month gains. The Northeast dropped 3.5 points (4.5%).

Western homeowners who remodel must be those who have low cost bases, don’t wish to move, and either pay cash or can get a home equity loan. In California, long-term home owners have property taxes frozen in the year of purchase (plus 1.1% annually), thus keeping many homeowners put. 

Another interesting idea came up about the future of the housing market from John Burns Real Estate Consulting. They note that student loan debt is so high—$865 billion, an average of $25,000 per student— that it is impacting young folks’ ability to buy homes.

According to John Burns, almost 6 million 25- to 34-year-olds now live with mom and dad. This number is up 26% from 2007.

The current rate of home ownership rate for this demographic stands at a 10-year low for under 30s. The rate for 30- to 34-year-olds is even worse, at its lowest rate in 17 years. …

This[debt] number is greater than all credit card debt outstanding, and second only to mortgages in terms of total national debt.

Commercial Real Estate

CRE is still weighed down by excess inventory (malinvestment) and maturing debt. The refinancing issue is the probably the greatest problem as banks are not willing to lend on the easy loan terms which initially financed many of these projects. Thus as these loans mature, either the owners must come up with more capital or the bank must reduce the loan or foreclose.

It seems that CRE prices have found bottom, but it depends on the type of property. The overall trend improved in the MIT/Moody’s price index latest data, showing a rising trend from April 2011 through August 2011:

To put a spin on things, apartments are still improving, retail is mixed, office is flat, and industrial is declining.

Almost all reports are saying that 2012 will be a tough slog for CRE. For example, both Deloitte and PricewaterhouseCooper were projecting “ CRE fundamentals are expected to navigate a slow and uneven path to recovery that will be heavily influenced by evolving U.S. and global economic conditions.” They project modest GDP gains in 2012. We are projecting flat-to-declining GDP in 2012 which would result in a more negative impact on CRE. 

Any chart you look at is still miserable as compared to the peak in 2008 when values started to collapse. Sales transactions are still only about one-half of what it was at the peak:

The other thing is default rates. This chart from CoreLogic shows the rate of “distressed” properties for CRE in the top 10 statistical areas:

There is a vast improvement since the peak in September, 2008, but it is still high and the decline has more or less flattened out since the beginning of 2011. The CMBS market has been improving over the past four months according to Fitch and Trepp.

What these data do not measure is the rate of delinquencies for the B Class and less properties. These are the loans that plague most local and regional banks who finance small business enterprises (which hire one-half of America’s workforce). These numbers too seem to be improving; if we look at data of write-offs by these banks (chart below), the level has declined, similar to the trend shown in the above chart:

Continued improvement is a relative thing. In the market that I am familiar with, Los Angeles, CRE is still in the doldrums, tenants are hard to come by, and rents are not improving. Most of the improvements nationally are in A Class properties in large MSAs. In general, except for areas like NYC and Washington, D.C., rents aren’t improving that much and values remain depressed. That scenario is unlikely to change in 2012.

One thing driving this is debt. There is still a huge amount of CRE debt that needs to be refinanced—it doesn’t peak until 2013:

And delinquency rates are still high: