Continued Deflation at the Mid to High End is not Good News

In California, increasing numbers of  Foreclosures on higher priced residential housing is forcing the hand of sellers, many of whom have capitulated to market pricing in order to get their home sold and move on. Since there have been a few more sales at the higher end, the median home price appears to be increasing, but don't be fooled by statistics. A ton of foreclosed property is sitting in inventory at the financial institutions and they are releasing it as slowly as possible, presumably in order to maximize values at the time of sale. Short sales are still not working very well and the gap between sellers expectations and Market Prices has never been wider. Will capitulation at the high end by sellers be the tipping point for much lower values in Bubble States?

For some time on YouTube there was a video from "Realtor Jim" that demonstrated that properties at the high end or those purchased at the peak of the bubble are being foreclosed by lenders or in many cases, still occupied by borrowers who clearly cannot afford the properties or who have simply chosen not to make payments based on current loan amounts in a declining market. Eventually these properties will foreclose and add to bloated inventories at the high end. Under current credit conditions, most buyers cannot afford these homes at current prices and without exotic mortgages (which we know now are unsustainable) the prices of these properties must deflate to the point that they are affordable for financing under current conditions.

The bank solution to this problem has been to withold foreclosed properties from the market in an effort to control the supply and keeps prices as high as possible for as long as possible and hope for a miracle in the overall economy that would support continued high bubble prices.  This approach will not work and if you look at the future resets of adjustable mortgages, you will quickly see that there will be large numbers of Prime borrowers and Alt-A (not quite Prime) borrowers whose loan rates will reset through 2011.  Many of these buyers are sophisticated financially and many will make the decision not to pay out their mortgages and either do a short sale or simply walk away.  Some in this group are buying smaller houses at much better values, supposedly as investments, while actually planning to walk away from the larger property and move into the smaller, more affordable home with current or below current market pricing.

Here is the Suisse Bank chart showing resets of A (Prime) and Alt-A loans, starting now and continuing through 2013.

 

Facing the Real Problem

The real mortgage problem of Prime and Alt A mortgages is still in the early stages of showing itself in the marketplace. One reason is that the borrowers on these loans generally have higher incomes, with more discretionary income and many have chosen to maintain their payments on current loan amounts even as values have declined.

The real question is, will they continue to make payments on current loan balances if there is a credit driven deflation in values (no exotic loans to refinance existing loans) and available terms under current credit conditions make ownership unsustainable. As we have seen, the effect of Loan Modifications in bubble areas has been very minimal at best.  In spite of continued political rhetoric and announced "enhancements" to the Home Affordable program, 90% of homeowners who get a Notice of Default (NOD) end up losing their property to foreclosure. 20% of "Modified" loans have payments higher than the original payments.

Take a look at the scope of the "Real Mortgage Problem" of Prime Paper. There are more than $4 Trillion Dollars of Prime Mortgages out there, dwarfing the "Subprime" problem and if you add Prime and Alt A paper outstanding, the totals are more like $7 Trillion Dollars.






Add to this the current trends in unemployment and I think you will see that it is fair to say that the next round of price deflation in Residential Real Estate will be in higher priced properties in all except the very best, most exclusive real estate enclaves, which may not be immune if the downturn continues, because of the ripple effect in pricing.