One of Three Views included in the 2013 Swanepoel TRENDS Report
STAN HUMPHRIES, Chief Economist, Zillow
Where Are We?
Home values reached their post-bubble trough levels in late 2011 after almost five years of the greatest housing recession since the 1930s. In October 2012, according to the Zillow Home Value Index, they increased 1.1 percent from the prior month and 4.7 percent from year-ago levels. It also marked the twelfth consecutive month of home value appreciation, confirming a housing market recovery.
While the real estate market showed brief signs of stabilization in 2009 and 2010, during the time when Federal homebuyer tax credits of up to $8,000 were available to buyers, this policy-induced stabilization proved artificial and transient, and the market correction continued apace after the tax credits lapsed.
This time stabilization appears to be driven more by market fundamentals, which have come back into alignment as a result of the natural market correction. Chief among these fundamentals is affordability, fueled both by huge resets in prices and by historically low mortgage rates. Between 1985 and 2000 Americans spent, on average, about 20 percent of their household income on mortgage payments. That percentage fell to 13 percent by the second quarter of 2012; 35 percent below the pre-bubble average.
Of the nation’s 25 largest metro areas covered by Zillow only Chicago experienced monthly home value declines in October 2012. Additionally, 21 of these top metros experienced year-over-year value increases.
Negative Equity
The large decline in home values has led predictably to widespread negative equity in the U.S. As of the third quarter of 2012 roughly 14 million homeowners were still underwater. Of all homeowners with or without a mortgage, 20 percent are underwater (roughly one-third own their home free and clear).
The robust appreciation experienced in many regions during that period, when home values notched their strongest quarterly gain since 2006, pushed negative equity levels down from 30.9 percent in the second quarter. Much of that appreciation occurred in hard-hit areas like Arizona, Florida and California. However, “underwater homeowners” still owe $1 trillion more than their homes are worth.
- More than 42 percent of underwater homeowners (11.9 percent of all homeowners with a mortgage) owe 20 percent or less than their home is worth.
- On average, U.S. homeowners in negative equity owe $73,163 more than what their house is worth; 42.5 percent more.
- Roughly a quarter of homeowners with a mortgage are underwater but 90.3 percent of them remain current on their mortgage payments.
The plight of negative equity is not equally distributed across the nation. High rates of negative equity have accumulated in states such as California, Florida, Nevada, Arizona and Georgia where home values have fallen dramatically from their peak—some of the hardest hit areas of the housing recession. However, many of these hard-hit regions also experienced strong home value appreciation in the third quarter of 2012 on the back of high affordability and shortages of for-sale inventory.
The Rental Market
Even as the housing market picks up steam again the rental market remains strong. As of October 2012 nationwide rents were up 5.4 percent year-over-year, and they rose on an annual basis in all but three of the largest metros surveyed. Overall the Zillow Rent Index covers 449 metropolitan areas and it indicated year-over-year gains for 294 metropolitan areas in October. Las Vegas, however, appears to be an exception among the top 30 metros. Its rents declined on a year-over-year basis by 1.8 percent while its home values steadily appreciated, currently growing at an annual rate of 8.6 percent.
Elevated foreclosure rates are keeping rental demand high, which in turn is continuing to draw investors into the marketplace to purchase distressed inventory and convert it into cash flow positive rentals. The large investor presence in hard-hit markets like Phoenix, Miami and Las Vegas has contributed substantial demand to the purchase side of the market, thus stabilizing home prices. In fact, these markets are now experiencing acute inventory shortages, particularly in the lower price tiers, which are most attractive to investors.
While renting has looked more attractive than owning in recent years—while home values have been plummeting—the reset in home prices has now created an environment in which owning is more financially advantageous than renting in many places. We regularly compute a “breakeven horizon” for cities and metro regions, which indicates the number of years before buying is more financially advantageous than renting. At the precise breakeven horizon one is financially indifferent concerning buying versus renting. It considers all the costs associated with buying a home (e.g., down payment, transaction costs, maintenance and price appreciation) and renting the same home (e.g., rental payments and rent appreciation). For the third quarter of 2012, 152 out of 257 metros (59 percent) have a breakeven horizon of less than three years. Among the 30 largest metros New York has the longest breakeven horizon at close to 5 years, making it a better place to rent for many people. On the other hand Detroit has a breakeven horizon of 1.7 years, the lowest horizon among the top 30 metros, making it an attractive place to buy for most consumers.
Looking Forward
Nationally, we believe that housing has finally turned a corner and is showing signs of a consistent and durable recovery, driven by strong fundamentals such as high affordability; measured either relative to rents or incomes. Our home value forecast calls for 1.5 percent appreciation nationally from October 2012 to October 2013. Most of the 256 markets for which we produce a forecast have already hit a bottom, with only 19 not projected to reach a bottom within the next year. Among the top 30 metros only New York has not yet reached a bottom. Forty of the 256 markets covered are forecasted to experience home value appreciation of 3 percent or higher.
Negative equity is on a downward trend and is already below 30 percent nationally. The year-end “fiscal cliff” (read all the details on the “Fiscal Cliff” in Trend #9) is a risk factor in our forecast as it will likely create uncertainty with consequences for consumer confidence and employment growth and, if not successfully navigated, will create real disruptions in the economy. We know from the previous debt ceiling debate that general economic uncertainty can sap consumer and employer confidence, which affects job growth and household formation, in turn impacting home sales.
In general, we continue to believe that high levels of negative equity paired with higher than normal unemployment will keep foreclosure rates higher than normal for at least the next 2-3 years. In some markets we believe this combination will temper near-term price appreciation and lead to a U-shaped recovery in home values.
However, in other markets we believe the trajectory of home values will look more like a step-function characterized by cycles of price spikes and plateaus. In these markets negative equity-induced supply constraints in combination with mainstream buyer demand and robust investor demand will lead to the short-term price spikes we’re now seeing in Phoenix and Miami. These price spikes will free some homeowners from negative equity, allowing them to sell and thereby easing supply constraints and dampening prices until the cycle is repeated.
Downside risks to our outlook are that the pace of foreclosures increases more than expected, job growth becomes more sluggish or we have a political train wreck on the budgetary and tax issues going into 2013. However, we remain optimistic that low mortgage rates, high levels of affordability, rising rental prices and slowly improving conditions in the overall economy will combine to keep the housing recovery on track. We expect that both existing and new homes sales will be strong in 2013, tempered only by low inventory levels (versus anemic demand).
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