Negative Equity, Foreclosures Will Likely Delay Broader Recovery

Various reports are cuing in support for what is expected by many: negative equity and foreclosures will likely delay broader recovery despite budding improvements.

Seattle-based Zillow Real Estate Market Reports showed mixed market results in the first quarter as home values in 106 of the 135 markets tracked by Zillow continued to decline on a year-over-year basis, also several metro areas in California that started reaching bottom in 2009 showed signs of improvement.

"It's a very positive sign that several large markets have hit what appears to be a tentative bottom in home values," said Zillow chief economist Stan Humphries, who nonetheless warned it is "no guarantee that home values there will not fall again" but probably remain at last year's lowest point. For example, home values in Los Angeles, San Diego, San Francisco, Santa Barbara and Ventura stabilized significantly in April or May 2009 and "have risen significantly for at least the past 10 months," after values in all five markets reached a low point in 2009.

Now the general concern is about other factors playing out in markets across the country.

The Zillow Home Value Index fell 3.8% year-over-year, and 1% quarter-over-quarter, to $183,700. At the same time, negative equity across the country increased to 23.3% of single-family homes with mortgages underwater, up from 21.4% in the fourth quarter of 2009, while foreclosures reached a new peak in March, with more than one out of every 1,000, or 0.11%, of U.S. homes going into foreclosure during the month.

Even with the tax credits in place during the first quarter, inventory levels were rising, and home values continued to decline rather than steady, Zillow said, so national home values are more likely to reach bottom in the third quarter of 2010, rather than in the second quarter, as previously hoped.

"When we do get there," Humphries says, high rates of negative equity and foreclosures are expected to keep national home value appreciation near zero for some time, "possibly as long as five years."

Zillow data also show that one-third, or 32.4%, of home sales nationwide sold for less than what the seller had paid originally. While in March foreclosure resales nationally made up over one-fifth, or 22.2%, of all U.S. home sales. Foreclosure resales also made up the majority of sales in several MSAs especially in California where they represented over 60% of total sales.

According to Fitch, what makes California stand out and worth observing is the fact that it represents approximately 40% of the overall nonconforming mortgages originated in the country. Therefore, Fitch analysts say trends in the state are "important for both new and existing securities."

And recent findings in California indicate there is a close correlation between the state's negative equity levels and delinquency rates.

A Fitch Ratings study of all securitized nonagency mortgage loans in California shows the "dramatic differences" in local-level loan performance that result in high delinquency rates are triggered by the level of negative equity.

Along with unemployment Fitch managing director Roelof Slump says property declines in California are having "a dramatic effect on a borrower's willingness to pay." Meanwhile, 39% of underwater borrowers and 58% of the borrowers that are over 50% underwater are 60 days or more delinquent, compared to 18% for mortgages that are not underwater.

What seems unusual is that some areas in California have seen the lowest level of home appreciation from 2000-2006 as well as the lowest level of delinquency rates. Fitch reports that a "closer look" shows that while mortgage performance in the state "is not substantially different" from the rest of the country, regions with the largest home price increases have also seen "the most precipitous declines."

In other words there still is some consistency in equity performance.

For example, according to CoreLogic the ranking of the top five states with the highest concentration of underwater homes has not changed. Nevada leads with 70%, followed by Arizona with 51%, Florida with 48%, Michigan with 39% and California with 34%. Similarly, Las Vegas continues to top the chart of metro areas with 75% of properties underwater.

A "slight improvement" compared to the fourth quarter of 2009 is that in the first quarter of 2010 11.2 million or up to 24% of all residential properties with mortgages remained in negative equity status at the end of the first quarter 2010, down from 11.3 million. By the end of the first quarter an additional 2.3 million properties have less than 5% equity, negative and near-negative equity mortgages, or 28% of all residential mortgages nationwide.

CoreLogic chief economist Mark Fleming expects "the typical underwater borrower" to likely regain their lost equity over the next five to seven years.

"The two most important triggers of default, negative equity and unemployment, have stabilized over the last six months. As house prices grow again and borrowers pay down their mortgage debt negative equity levels will begin to diminish."