Dark Clouds Lurking Behind Silver Linings in California

I had the privilege of participating in a panel discussion focusing on the state of the California housing market a few weeks ago in Sacramento.

One of the best parts of my trip to Sacramento for this panel was the trip back to the airport, but that’s another story.

The panel itself was also good. Titled “Solutions for a Sustained Housing Recovery,” it also included Trulia chief economist Jed Kolko, Richard Green, director and chair of the USC Lusk Center for Real Estate, and Douglas Holtz-Eakin, President of the American Action Forum, which sponsored the event.

You can watch the entire panel discussion in the video above (my panel starts at about the 46th minute), but I’ll quickly outline my presentation below.

My thesis was basically this: there are certainly silver linings showing up in the California housing market, but dark clouds continue to lurk behind those silver linings, making this nascent recovery extremely fragile.

The three silver linings I talked about, along with the dark clouds lurking behind each:

1. Falling Foreclosure Activity: California foreclosure activity has been on a nearly three-year downward trend. Starting in December 2009, the state’s foreclosure activity has decreased on a year-over-year basis in 32 out of 33 months.

    Fewer foreclosures is certainly a sign of health in the market, indicating fewer homeowners are struggling to make their payments or strategically defaulting because they are so hopelessly underwater on their mortgages. Fewer foreclosures also helps alleviate downward pressure on home prices going forward.

But the dark cloud lurking behind that falling foreclosure activity is stubbornly high foreclosure rates despite the long-term downward trend. The number of properties with foreclosure filings each month this year in California is still averaging nearly five times the national average, and the state’s foreclosure rate continues to rank consistently among the five highest nationwide.

2.  Fewer foreclosure sales: these distressed sales are where the rubber meets the road when it comes to how foreclosures impact the housing market. The silver lining is that California is seeing fewer of these distressed sales, with the number of sales involving properties in some stage of foreclosure in the second quarter of 2012 down 22 percent from a year ago — following five consecutive quarters of increasing foreclosure-related sales.

The dark cloud is that foreclosure-related sales still account for 40 percent of all residential sales in California. On top of that another 17 percent of residential sales in California were short sales on properties that had not started the foreclosure process — and those sales increased 39 percent from a year ago. That brings the total share of distressed sales in the state to about 57 percent — far above the 5 percent share of distressed sales that we’ve seen in more healthy, balanced markets.

3. Rising foreclosure prices: somewhat related to No. 2, this may be the best silver lining of the bunch. The average price of a California property in some stage of foreclosure or bank owned (REO) in the second quarter of 2012 was $248,676, up 4 percent from the average price in the first quarter and also up 4 percent from the average price in the second quarter of 2011.

This shows strengthening demand, particularly for distressed properties, in California. Demand that is strong enough to push average prices on these distressed properties higher. We’re certainly hearing about this anecdotally, with stories abounding of well-priced distressed properties in decent condition attracting multiple offers — sometimes above the asking price.

One dark cloud here is that this could potentially be a false bottom if banks push through more backlogged foreclosures delayed by foreclosure prevention efforts and possibly documentation snafus. That’s much less likely in California, where the foreclosure process has remained relatively streamlined at under a year, than other states where the average time to foreclose has ballooned to more than two years and even close to three years in places like New York and New Jersey.

The more serious dark cloud in California is simply that it will take several years of steadily rising home prices to lift many folks underwater, completely restoring the housing market to balance. RealtyTrac data indicates that more than 2 million California homeowners are seriously underwater, owing at least 25 percent more than their homes are worth. That means more than one in four homeowners with a mortgage are seriously underwater, and in some markets such as Modesto, Stockton and Merced close to half of all mortgages are underwater.

Those underwater homeowners represent a big part of the market that will likely not be participating much in buying or selling over the next few years, keeping the state’s housing market in check. A worse-case and admittedly less-likely scenario would involve those underwater homeowners deciding to walk away from their mortgages in greater numbers in the near future, creating a new wave of foreclosures that could threaten to pull down home prices again.

Related News
Face to Face with the Foreclosure Crisis
Foreclosure Activity Drops to 5-Year Low in September
Low Foreclosure Supply Pushes Sales Lower, Prices Higher

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