Existing Home Sales: Too Much Friction in the System

Published by clickbroker.blogspot.com.

The National Association of Realtors’ (NAR) August 24 press release, “July Existing-Home Sales Fall as Expected but Prices Rise”, along with The Wall Street Journal’s inside look at the August 10 Federal Reserve’s “contentious meeting”, “Fed Split on Move to Bolster Sluggish Economy” left the market uneasy Tuesday morning. Headlining the NAR release; “completed transactions … dropped 27.2 percent to a seasonally adjusted annual rate of 3.83 million units in July from a downwardly revised 5.26 million in June, and are 25.5 percent below the 5.14 million-unit level in July 2009.”

Miraculously, Bernanke seems to build consensus each meeting to push mortgage rates lower and lower with little impact on transaction growth. Traders became concerned that the Journal’s inside look showed that Bernanke might not be able to maintain a united front. Publishing this level of detail prior to the Fed minutes is unprecedented. My intrigue is the objectives of those in the FOMC meeting that spoke so openly to the reporter.

Low mortgage rates might stimulate the economy through refinancing, but why is a sub-5% mortgage rate having so little impact on home sales? And given the reality of the numbers, why doesn’t the Fed recognize the limits of its power? First, home sales are not being restricted by interest rates and second, the Fed feels the need to act when Congress is tied in knots. The Fed believes that Congress will never get fiscal policy right and there is no time to wait.

Forget about the end of home buyer’s tax credit and its overhang. The credit was a boondoggle to the new home builders and “first-time” buyers. The real issue in the housing debacle is there is so much friction in the system that is it surprising any transactions take place. The friction in the existing home market is the only thing that has kept any of the new home builders out of bankruptcy.

Everyone recognizes that most sellers are underwater, many with multiple mortgages on their properties. Short sales can take 6 to 9 months to complete. Even bank preapproved short sales can take as long as 3 months or more. Foreclosed properties, bank real estate owned (REO), involve a complex and often lengthy negotiating process. The time required and uncertainty of conclusion makes this process impractical for most buyers, except investors and second home buyers. Throw on top of that sellers with equity are often strong enough to wait for their price.

From the press release: “A parallel NAR practitioner survey shows first-time buyers purchased 38 percent of homes in July, down from 43 percent in June. Investors accounted for 19 percent of sales in July, up from 13 percent in June; the balance were to repeat buyers. All-cash sales rose to 30 percent in July from 24 percent in June.” The price increase was due only to mix.

Hence, we’re left with an almost frozen market. And the Fed has no control over the mechanics of the housing market. The levers that worked in previous recessions are not working now because sellers won’t or can’t let go.

First the realtor sets the market price for the short sale property, and then the seller starts the negotiating process with the mortgage servicer for how much, if any, money the seller must bring to the closing table. The bank or mortgage investor might also require the seller to sign a promissory note to cover any deficiencies not forgiven. Any secondary mortgages or other liens make the process even more difficult. With each offer a buyer submits, the process goes through another round, requiring approvals from the servicer and the mortgage investor.

Often a low ball asking price leads to unrealistic buyer expectations while an asking price that seems sure to be approved would scare away buyers. Again, only investors and second home buyers have the patience to work through the process.

Foreclosures and REO properties are often sold through a modified auction process. Realtors advertise a low ball price to attract interest. Banks set a period of a week or more for buyers to submit offers; afterward banks hold additional rounds for rebidding until they are satisfied. Cash buyers are often given preference for their ability to close.

When the buyers have deposits tied up in the process, it is difficult for them to start negotiations on alternative properties. There is nothing the Fed can do to bring back the efficiencies of selling that existed in the pre-crash, equity positive market.

I am not a real estate professional and don’t know all the intricacies of the process. But I can still conclude that unless the shackles are removed from the system, few transactions to owner occupants will be completed. Investor owners are just another form of shadow inventory. There is no reason why banks and securitization trusts cannot establish a more standardized process. Quick decision making will move the merchandize.

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