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» VISIT US ONLINE @ DSNEWS.COM JUDICIAL REVIEW POINT-COUNTERPOINT According to Michael Feder According to Dr. Stan Humphries The housing market recovery we've been experiencing over the past year is real and sustainable. Since hitting bottom in October 2011, we watched as home values appreciated by 5.9 percent last year—rates not seen since 2006. These rising home values helped contribute to declines in overall negative equity—the percentage of homeowners with a mortgage who owe more on their home than it is currently worth—and will continue to do so as the market moves forward. After rising throughout 2011, negative equity levels fell to 28.2 percent of all U.S. homeowners with a mortgage by the third quarter of last year. POINT— COUNTERPOINT we expect the gains in non-motivated prices to be meaningfully weaker than the figures we can see now, with data ending in November. Investors appear to be purchasing properties mostly from two sources: financial institutions selling REOs and investors trading distressed properties purchased earlier in the housing crisis. They have not purchased significant volumes of homes from builders and households. It is hard to see a direct connection between the current increase in institutional demand and future gains in household demand, especially at a time when traditional buyers are faced with high down payment requirements and tight standards for mortgages. We fear that an alternative scenario may be more likely in the near term, one in which housing price metrics rise and fall periodically but the secular price trend remains flat. After a period of frenetic purchasing activity on the part of institutional investors, prices for foreclosed homes and investment properties are bid up to the point where the economics of buy-to-rent strategies no longer work. As there is still an abundance of delinquent mortgages and properties in foreclosure, REO inventories swell, and banks and their agents respond by lowering prices for such properties. Lower REO prices make the economics of buy-to-rent strategies attractive again, and institutional purchases of (once again) low-priced distressed homes increase. This causes another shift in the mix of sales toward low-priced homes, which pushes down broad-based housing price metrics. Until consumer demand recovers and drives a real recovery in housing values, we expect the cycle to continue, and do not expect a real recovery to occur. INDUSTRY INSIGHT Last year was a year of broad and dynamic changes in the housing market. Broad indices are up, builder sentiment is up, and Realtors are saying the market is back. Private investment funds have revved up their single-family rental (SFR) strategies and there are many stories of bidding wars in what were recently extremely depressed markets. Does this mean, or prove, that we are in a recovery in housing? Maybe, but we think a closer look at the facts suggests not. Our view is that a lasting recovery in housing will be driven by a widespread return in demand from households, and this did not occur in 2012. Both the activity and prices were driven by a combination of new players, shifting segments, volatile values, and specifically not a broad increase in buying by households at consistent or higher prices. While the Radar Logic Composite increased in the 12 months ending in November 2012, this increase reflects a significant shift in the composition of home sales and overstates the appreciation in individual properties. REO sales and foreclosure auction sales (i.e., motivated sales) declined from 24 percent of transactions to 12 percent, while the composite price for motivated sales was as much as 39 percent lower than the composite price for all other sales. When we control for the shift in the mix of sales by looking solely at the composite price for non-motivated sales, we find that home prices increased at slightly over half the rate of the RPX Composite price. Moreover, the year-on-year gain in nonmotivated prices likely overstates their strength and momentum. Typically, prices in nonmotivated sales stabilize temporarily in October and November, before declining rapidly again in December. This pattern occurred in 2009, 2010, and 2012. In 2011, prices did not stabilize in October, but declined continuously through the end of the year. We expect the non-motivated composite declined rapidly in December 2012, according to the more typical pattern. As a result, we expect the year-on-year change in December to drop back down toward the gains we saw in September 2012, when the composite nonmotivated price was just 1.5 percent higher than it was a year earlier. In other words, when we have the data to look at the calendar year 2012, This was the first time negative equity fell below 30 percent since Zillow revised its methodology for determining negative equity in early 2011. The importance of negative equity to the overall health and continued rebound of the housing market is difficult to overstate. We experienced a robust and often rapid recovery in overall home values in 2012, and a large portion of this phenomenon can be attributed to falling, but still uncomfortably high, negative equity rates. The same markets that experienced the most robust gains in home value in 2012—places like Phoenix, Las Vegas, and Sacramento—also, not coincidentally, were among those hardest hit by the housing bust and featured the highest levels of negative equity. Because home values fell so far and so fast in these places, investors and opportunistic buyers alike swooped in looking for deals. But because so many homeowners in these places remain trapped underwater, only a relative handful had the option of listing their home. As a result, intense demand ran headlong into tight inventory, boosting values along the way. As more homeowners are freed from negative equity as a result of rising values, and are given the option of listing their homes and shopping for new ones, current inventory shortages should ease. This will have the effect of dampening rapid value appreciation in some areas, as supply begins to meet demand and inventory levels rise to more typical norms. That moderation in home value increases will actually end up being a positive for the market, and a contributor to its sustained healthy recovery. A deeper pool of available homes for sale will entice more overall buyers into the market, and a wider breadth of home styles and price levels available for sale will help bring in other buying demographics besides bargain-hunters and investors. Which is not to say home value increases will stop. Zillow is currently predicting 3.3 percent annual home value appreciation for 2013, a level far below last year's appreciation rate, but still very much in line with historic annual appreciation norms of roughly 3 percent. Appreciation rates like we saw in 2012 are unsustainable, and a return to more healthy levels is a good sign for a market that is finding its own level. Just as rapid home value depreciation can wreak havoc with the market, too-rapid appreciation has the potential to cause volatility and instability of its own. Continued improvement in negative equity rates, coupled with more moderate home value appreciation, will ensure the housing recovery that began in 2012 will continue in 2013—and beyond. BEST PRACTICES T he country is primed and ready for a real and sustainable recovery, but has suffered a few false starts in the past few years. Now, certain indices are telling a different tale, one that suggests the recovery may be real and lasting. But, are they overstating the growth that's occurring? DSNews asked officers of two firms that regularly conduct extensive marketplace studies to weigh in on the recovery: Is it real or an exaggeration? 71

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