Recessions are times when the economy runs out of steam for months on end and sometimes longer. And yet – strangely – recessions are not always bad for real estate. Real estate is often a financial safe haven in times of economic distress, something to consider as the COVID-19 recession continues in 2021.
Two years ago RealtyTrac, a leading source of investor leads and real estate data, looked into recessions and their residential real estate impact. The expectation was that general slowdowns would produce out-sized real estate declines but that did not turn out to be the case. Instead, the results were mixed.
The most recent recession – #5 on the chart – was the worst of the bunch for real estate.
That’s hardly a surprise given that it was literally “the mortgage meltdown,” a recession that largely stemmed from the widespread use of toxic financing, including so-called option ARMs, negatively-amortizing loans, and NINJA loan applications – applications where lenders did not verify income, jobs, or assets. The result was millions of foreclosure notices and the worst real estate market since the Great Depression.
But what about the current recession? Are there any clues that suggest how real estate might fare?
“Market conditions are nothing like they were during the last recession,” said Rick Sharga, Executive Vice President with RealtyTrac. “There are reasons to be cautiously optimistic despite massive unemployment levels and uncertainty about government policies under the new Administration. But while anything is possible, it’s highly unlikely that we’ll see another foreclosure tsunami or housing market crash.”
What do we see at this point? Here’s a brief rundown.
The Banking System
At this moment the banking system seems fundamentally sound. This was not the case in the last recession when the banks and Wall Street teetered on the brink of failure and some $700 billion in bailout money was set aside under the Emergency Economic Stabilization Act of 2008.
As a result of new rules and laws passed after the mortgage meltdown banks today are much better positioned to weather tough times. In the third quarter, says the FDIC, year-over-year results were not as strong as 2019, but an overall profit of more than $50 billion was hardly a sign of distress.
No less important, depositors added more than $2 trillion to bank accounts during the first two quarters, one reason for historically-low interest rates and unusually-strong bank liquidity.
The Mortgage System
After the last recession the Congress moved to reduce risk in the mortgage marketplace for borrowers, lenders, and investors. The result was the Dodd-Frank Act, legislation that requires lenders to verify the ability of borrowers to repay a mortgage, limits fees and charges for most home loans, and bans a variety of “gotcha” clauses. In the third quarter, says the Mortgage Bankers Association, “independent mortgage banks and mortgage subsidiaries of chartered banks reported a net gain of $5,535 on each loan they originated.”
More importantly, despite widespread unemployment and business closings, the mortgage marketplace remained remarkably stable at year-end with few foreclosures. Part of the reason, of course, are various foreclosure moratoriums, but even prior to the pandemic, foreclosure activity was running at half of historically normal levels. ATTOM Data Solutions reports that in November there were just 10,042 U.S. properties with foreclosure filings — default notices, scheduled auctions or bank repossessions. That’s down 14 percent from October and 80 percent from a year ago.
Real Estate Equity
What happens when the foreclosure moratoriums end? Will we see a huge foreclosure surge?
Median residential home prices in November were 14.6% higher than a year ago according to the National Association of Realtors (NAR). Homeowners have substantial equity. In many cases it will be possible if necessary to quickly sell a home for enough money to pay off the mortgage and prevent a foreclosure.
Increases in real estate home values are widespread. A November study by ATTOM Data Solutions found that 28.3% of all mortgaged homes in the third quarter were equity rich, an expression which means mortgage balances were 50% or less when compared with the market values for individual properties. The number of equity rich homes is actually higher than a year ago despite the pandemic and widespread unemployment.
On the other side of the coin, ATTOM also reported that only about 6% of all mortgaged properties were underwater, meaning that loan balances were at least 25% greater than estimated market values.
The idea here is not that foreclosure levels will remain steady. Instead, it’s believed that foreclosure levels will rise as moratorium programs end. However, because homeowners have so much equity massive foreclosure increases similar to the levels seen in the mortgage melt-down are not expected.
Weekly mortgage rates fell significantly in 2020. Freddie Mac says the typical 30-year mortgage was priced at 2.66% at year-end, a record low and substantially below the 3.72% rate recorded at the start of January 2020. Such rates increase affordability and make homes more salable.
What we’ll see in 2021 is arguable. The National Association of Realtors recently polled 23 leading economists and they predict that mortgage rates will average 3.0% in 2021 and 3.25% in 2022. The long-term average mortgage rate – about 8% – is nowhere to be seen. The view here is that lower rates are in our future given the combination of massive cash stockpiles (supply) and relatively little demand as well as some $18 trillion invested worldwide with negative rates according to Bloomberg News. These low mortgage rates will continue to drive homebuying demand, and give distressed homeowners the opportunity to sell their properties in order to avoid foreclosure.
The reason for exceptional 2020 price increases is simply a lot of demand chasing little supply. There is very little available inventory and not much more is likely to come online. The 23 economists polled by NAR predict that new home starts will decline by about 30,000 units in 2021 but then rise by 90,000 units in 2022. Such numbers are nowhere big enough to significantly impact the national marketplace.
The combination of ongoing demand, interest rates at or near historic lows, and little inventory are likely to make this recession less damaging than what we saw in 2008. Like other recessions before it, real estate and the general economy may not be in sync during 2021 – something for which property owners are likely to be thankful.