Inventory to Delay Not Stop Improvements

Experts predicting a better year for the mortgage market foresee more of a status quo situation when reviewing the foreclosure inventory, especially in states like Florida and Nevada, which are not expected to see their real estate owned property books shrink any time soon—at least not in the next couple of years.

Veros’ vice president of statistical and economic modeling, Eric Fox, told this publication that Nevada and Florida will continue to be at the bottom of the market ratings. The high amount of the REO foreclosure inventory is leading to the high supply in those markets “and is one of the key variables” that is causing depreciation in these markets.

For example, Fox says, Miami features “double-digit month supply of inventory,” which is very high.

Consequently, even if all economic conditions improved, worst-performing markets such as Miami will need to clear out their REO inventory before they can return to normal conditions.
He argues that while inventory is driving the country’s worst performing markets, “markets that have eight or nine months of inventory will get there a lot more quickly.”

The December 2010 through December 2011 forecast compiled by Veros Real Estate Solutions finds that key markets in Florida and Nevada—two of the country’s top foreclosure states—will depreciate an average of 6% to 7%.

Comparatively, this expectation becomes even more significant considering that the Santa Ana,

Calif.-based enterprise risk management and collateral valuation service provider also expects property appreciation in 40% of the major metro areas over the next 12 months, and nearly 60% within a 12 to 24 month timeframe.

(Major metro areas typically have greater than 500,000 residents living in single-family homes in the median price tier.)

Even though expected improvements will be mild and are not happening rapidly, Fox says, the overall market performance is “getting better” unless one looks at the states with the highest REO inventory in the nation.

Veros projects as the five weakest markets: Reno/Sparks, Nev., -7.2%; Orlando/Kissimmee, Fla., -6.5%; Boise City/Nampa, Idaho, -6.4%; Deltona/Daytona Beach/Ormond Beach, Fla., -6.3%; and Port St. Lucie/Fort Pierce, Fla., -6.3%.

Weak outlooks were cast for Florida because it contains six of the 10 U.S. markets expecting the greatest depreciation. Other “especially weak forecasts” include Reno/Sparks, California’s interior, many areas in Idaho, and western portions of Washington and Oregon. 

What should qualify as good news despite market specifics is the fact that the REO foreclosure inventory is not increasing as rapidly as it used to in the past few years. Fox says some markets reached their peak, and other markets may have seen small increases but have started to balance out.

“It appears that the influence of REOs and foreclosures has stopped increasing and started to diminish as a key factor that pressures the markets to go down. Also, even in the worst markets, we no longer see predictions of -10% or -15%, but -6% or -7%, and with each quarter we move ahead with those numbers getting better and better.”

The Veros forecast report that draws from micro-market data analytics shows Florida, Reno and Boise will experience the nation’s greatest depreciation rates in the coming 12 months, “a trend which continues from prior periods.”

California is one of the top foreclosure states and, as shown by various industry reports, is the only such market that is consistently improving. Veros lists California’s San Diego as one of the strengthening markets that are seeing home value gains. 

And the reason is mainly market size. Fox credits affordability factors as the driver for improvements in smaller metro markets with populations less than 250,000—which make up “the majority of the better-appreciating markets.”

What remains unclear is the short-term effect of the so-called shadow inventory.

Estimates of the total number of foreclosures that are not closed but rather are stalled in the pipelines of both judiciary and non-judiciary states or delayed by moratoriums may vary, but most analysts agree that at least a share of these properties will add to the existing inventory and eventually put downward pressure on home prices.

There is a risk, agrees Fox, “But I don’t think there’s going to be the big jump that everybody is forecasting.”

In the past, he noted, when there was a big wave of foreclosures and prices plummeted, “it was a very different situation” compared to where the market is now.

Prices were much higher than today’s prices.

“That depreciation allowed prices to fall more into equilibrium. Now we’re at a state—maybe not at [complete] equilibrium yet because some are still keeping prices artificially high, but once some of that shadow inventory potentially hits the markets in some areas, there’s not so much room for prices to fall.”

Examples from various markets, he said, show that once the prices fall below a certain value, the price-to-rent ratios are at historic lows in some markets that at the same time are very attractive for investors, “who can get a 10% return on their money.“

Even if unemployment and interest rates increase, investors will continue to buy.

“That’s why even if more shadow inventory comes into the market, especially in the areas that are hardest hit but have really strong rental markets, the downward pressure will be there—but not at the -20% or -30% level that we saw happen a couple of years ago.”

According to Fox the effect of the moratoriums, federal programs, tax credits and judiciary requirements are only delaying the time when the markets will come into equilibrium. “Had this never occurred we would have been in equilibrium maybe a year ago.

Currently the economic variables are certainly moving into positive directions.” In his view the federal effort to solve the crisis was an unnatural intrusion to market developments that delivered unintended consequences.

Investor interest in purchasing REOs following a rent-to-sell strategy that will bring back returns years into the future is making a difference in the current market.

Fox argues that these long-term investors who start renting these affordable properties shortly after purchase are not interested in selling right now.

Market improvements however, are not expected to ease up the crisis in Las Vegas and other areas in Nevada, the state that is expected to remain the country’s worst performing market in the near future.