Investors Are Controlling the Housing Market

Dave:
You may be hearing that investors are swinging the entire real estate market and not for the better, but the data is actually a lot more nuanced. Investors play a significant role in the market, but a new report indicates that it’s far more complex than these headlines about hedge funds buying up would be affordable homes led on. Let’s dig into what’s really going on. Hey everyone, I’m Dave Meyer and this is On the Market. Our guest today is Rick Sharga. Rick is the founder and CCE O of CJ Patrick Company, a market intelligence firm for companies in the real estate industry. Rick is a super sharp observer of everything that’s happening in the housing market, so I’m going to ask his opinions on what role investors play in the market, what’s happening with inventory and mortgage rates, and how these trends might develop moving into next year, let’s welcome Rick back to the show. Hey Rick, welcome back to On the Market. It’s great to see you again.

Rick:
Always a pleasure to be with you.

Dave:
I think you might be our most frequented guest of all time on the market, so thank you for always being here. It’s always a pleasure to have you. Well, the reason we always have you is have a great perspective on the housing market. So let’s just start big picture. We’re sitting here in August 20, 25. Feels like the market’s transitioning. There’s all sorts of strange stuff. What’s your big picture view?

Rick:
Well, Dave, we’ve had this conversation over the last couple of years and when mortgage rates doubled back in 2022, a lot of people were predicting that we’d see home prices crash 20, 30% declines. And we talked back then about the more likely scenario being that we’d see a market take three to five years to kind of transition into a market that could handle these higher mortgage rates and higher home prices. And it really feels to me like we’re in year three of a five-year transition period, slow home sales, price appreciation has slowed down to a crawl actually gone negative in some markets and I really feel like we’re going to be seeing another probably 12, 18, maybe 24 months of this kind of just slow lackluster on exciting home sales. I

Dave:
Couldn’t agree more. It’s just that you’re describing everything that we’re seeing on the ground. So you said a transition period, Rick. So what are we transitioning from? What would you call the previous market and what are we transitioning to

Rick:
Right now? We’re experiencing a couple things. The big shock was a payment shock When those mortgage rates doubled, we’d never had mortgage rates double in a calendar year in history according to the researchers at Freddie Mac that happened in a few months back in 2022. So they we’re transitioning into that kind of payment shock and we had probably 75 to 80% of people with a mortgage who had mortgage interest rates below 5% we’re see 4 million or so homes, trade hands every year. And as that happens over three, four or five years, the percentage of people with those low mortgage rates gradually get smaller and smaller. So by the time we come out of this transitional period, we’re going to have more homeowners who are actually at current market rates. And so that shock of going from a 3% mortgage to a 6% mortgage, 7% mortgage won’t be as severe. But the other thing that we’re suffering from right now candidly, and nobody talks about this really is when mortgage rates historically low, two and a half, 3%, we had a lot of sales pull forward back in 2021, we had about 6.2 million existing home sales
That was at least a million more than we probably would’ve had normally, and some of those sales would’ve happened in 23 and 24 and maybe even 25. But people jumped into the market early and I think we’re still seeing a little bit of a hangover from that kind of buying exuberance we saw back in 2021 and early 2022.

Dave:
I do think that’s an important point. A lot of people have said, oh, we hit a bubble, the housing market pricewise. Clearly that hasn’t happened. We haven’t had a pop, but there is almost a bubble, right? The volume, just the total amount of home sales went up and that has sort of popped the pendulum has swung back in the other direction essentially. And we’re sort of at the low end of the spectrum.

Rick:
And so economists talk about a reversion to the mean,
Which basically just means that pendulum swinging back and forth as you just described it. But demographically speaking and from a population standpoint, the market does continue to underperform. We have millions of people coming of age to either form a household or buy a house every year, and right now they simply can’t find anything they can afford. So a couple of the trends in the market will ultimately reverse that. We’re seeing inventory of homes for sale up 27, 20 8% year over year. By the end of this year we’ll probably be back to pre pandemic levels. As more inventory comes to market, you have more competition among sellers, which means that there’s negotiation and pricing, which means that home prices will either flatten or maybe come down a little bit depending on which market you’re in, and that’ll improve affordability for those prospective buyers. So demographics really should be a tailwind for the housing market that eventually will pay off in higher sales.

Dave:
When you said that we’re transitioning, which I agree we are, you said you think we’re in year three of five, so we’re going to be stuck here for two more years of that kind of your read.

Rick:
Unfortunately, yes. I think we’re going to be stuck here for two more years. I’ve been trying to be optimistic forecasting sales the last couple of years and it’s come back to bite me. I was hopeful that 2024 was the bottom and that we would see a modest increase in home sales. This year as we record this, the National Association of Realtors has just released its July report on home sales and they were up about 0.8% month over month and a little bit up year over year from what was a really weak July a year ago. But we’re still looking like we’re going to close the year right around 4 million homes being sold existing homes which would be flat from last year or maybe even a little bit below last year.

Dave:
But in a historical context, super low in normal year is like five and a quarter, just so everyone knows,

Rick:
Right? Well, what we should be seeing for our population right now is probably a little bit north of five, but again, there’s an affordability gap. The Atlanta Federal Reserve believes there’s in almost a $50,000 gap between the median salary and what the median salary should be for somebody to be able to buy a median price home. So it’s the worst affordability we’ve really seen in the past 40 years since the 1980s when mortgage rates were at 18 and 20%. So it just takes time to narrow that gap.

Dave:
Yeah, I was looking at some affordability study. It was based on CBRE, actually commercial real estate company and they looked at it all these different ways like household income to median home price. When you look at affordability and factor in mortgage rates, when you look at how big of a raise you would need to be able to afford and everything just bad, it’s just affordability is just brutal across the board. And I guess that is sort of the thing that has a lot of people pointing to a crash. They see low affordability. The only way to fix this is if prices come down quickly.

Rick:
Well, that’s the knee jerk reaction and most people that are espousing that idea are still suffering PTSD from 2008 when we saw home prices go up as rapidly as they did and then crash. But the big difference between then and now is what I would refer to as forced selling. Back in 2008, you were an unqualified borrower, never should have gotten a loan. You got an adjustable rate mortgage at 0% interest, 2% interest, and then it adjusted to six or 7%. You couldn’t make a payment so you had to sell the house and you sold it at a time when the market was oversupplied, you were going into foreclosure. There were 10 million people that got a foreclosure notice in a few years and it became a race to the bottom. In this market you’re dealing with homeowners who’ve amassed $36 trillion in equity are sitting on a mortgage rate lower than when they bought their house probably, which means their monthly payments likely went down when they refinanced, they don’t have to sell. And if they don’t have to sell, what’s their motivation to give you a 20 or 30% haircut?

Dave:
I agree

Rick:
There’s none. I always tell people who are predicting home prices are going to come down 20%. I always say, you go first.

Dave:
Yeah, exactly. You sell your house for 20% loss.

Rick:
So you’ll see boomers aging out of their properties gradually, you’ll see some of those properties coming to market and a boomer might be able to get less than full value on the house because they’ve amassed tens or hundreds of thousands of dollars of equity and they’re probably not buying another house. But by and large, the people that are selling right now are people that are either leveraging the equity they build up to buy their next house or they’re people that have to sell and it’s a death in the family, a birth in the family, a wedding, a divorce, a job loss, a job transfer, and that works out to about 4 million sales a year. And I think gradually again, over time what happens is instead of a price crash, you have home price appreciation slow down or in some markets go negative slightly and you see wages go up. And wage growth right now is outpacing home price appreciation and it’s outpacing inflation. So if wages are going up four to 5% a year, inflation’s a 2.7%, home prices are going up 2%. Gradually that wage improvement narrows the gap a little and mortgage rates ultimately will come down at least a little bit, not back to where we were, but that combination of home prices, not even keeping pace with inflation of wages going up and of mortgage rates coming down does start to at least narrow that affordability gap a little bit.

Dave:
I think this is the most important concept in prediction in the housing market right now because I think people generally understand that the affordability, the current levels of affordability are unsustainable, can’t go on forever this way. And so people who don’t have your knowledge of the housing market say there’s going to be a crash, but as you said, without for selling a crash is extremely unlikely. We talk about this on the show very often. You can’t just have a crash just because prices are going down modestly. That’s a normal correction that happens in housing cycles.
You need the element of forced selling to be the catalyst to go from a correction to a crash. Of course it could happen, but there’s no data evidence that that’s happening right now, and so it just seems unlikely. But what Rick is saying is sort of what I’ve started calling the great stall here. I’m trying to come up with a name that helps people understand what is going on, and it’s really important idea that home price affordability can get better without a crash, it can also get better without a significant drop in mortgage rates. It can also get better without real wage growth going to the moon. It’s a combination of those three things that from everyone frankly I respect in this industry, everyone seems to think that’s what’s going to happen. Of course, sometimes wisdom of the crowd, sometimes people are wrong, but people really understand the data.
Here all are saying that the most likely scenario is that affordability will get better over time, but it’s going to be a little more boring. It’s not going to be as dramatic as people think it’s going to be with a crash or anything like that. It’s just a gradual improvement of wage growth. It’s a gradual decline of mortgage rates and it is home prices in real inflation adjusted terms going down modestly probably for what Rick thinks is another two years or so. So I think people just really need to wrap their head around this that it doesn’t have to be dramatic. It can be kind of boring

Rick:
And there are other things going on. Right now we have an unusually large number of properties that are undergoing a list price reduction. About 42% of properties on the market have had a reduced price, which is almost 10 percentage points higher than normal and very unusual for this time of year. Usually spring and summer months. You see very little in the way of list price reductions. So sellers are kind of getting some religion and again, as we get more inventory, there’s more negotiating power for the buyers. But the other aspect of that is that everybody would get excited. Oh, four out of 10 properties are having a list price reduction, but the median reduction is less than 5%.
And you have to assume the seller is listing the property for more than they bought it for. So it’s not like this is a huge drop in price. It’s a 5% or less a drop in price in order to close a sale. So to your point, we don’t always see home prices go up in a straight line. Very often they kind of go up in a saw tooth manner up a little bit down a little bit. And I do think we’re in the down a little bit phase in probably about half the country, but this is one of the biggest dichotomies I’ve seen in terms of pricing really in the last 25 years that I’ve been watching this industry. It’s not necessarily the range of price differences, it’s that in about half the country we see prices going up and in about half the country we see prices going down and there’s a very strong correlation to how much inventory is available in those two disparate trends. So if you’re in the northeast or Midwest, odds are you’re seeing prices continue to go up if you’re in the southeast, if you’re in the southwest parts of the Pacific Northwest, you’re probably seeing property values go down a little bit. So it really just depends on where you are.

Dave:
I’m definitely seeing that. I operate in Denver and in the Midwest, and I live in Seattle, so I’m actually starting to operate in Seattle too. And Denver’s seeing one of the bigger corrections in the country consistently. It’s not huge numbers, but it’s just been consistently soft for years and we are seeing a lot of the metro area down there. Seattle is starting to see a lot more inventory come on the line places I invest in Michigan, they’re just humming along. But I guess my R of situation, Rick, is just with so much going on, I feel like everything’s softening. So not necessarily everything’s going to turn negative, but the places that have places like Milwaukee that have surprisingly amazing appreciation, like six, 7% year over year this year, they might still be positive real growth, but it’s going to soften still. And my advice to the audience, feel free to disagree, but my read on the situation is that everything’s going to slide a couple percentage points down. So if it’s doing great, still might be positive, but it’s going to be a little bit slower. And if you’re sort of teetering on the edge, it might go into a correction.

Rick:
Yeah, I don’t disagree with anything you just said. I think that is the general trend. I know people question how accurate a lot of Zillow forecasts are, but their home price heat index, if you will, has seen the overall numbers go from a strong sellers market a couple of years ago to a neutral market today. And it looks like it’s trending pretty much toward a buyer’s market nationally as we move into the coming months and maybe the next year or two. And I think you have a buyer’s market that tends to be characterized by home prices that are flat or falling more inventory than there is demand in longer days on market.

Speaker 3:
And

Rick:
I probably just described the Denver market to you and maybe Seattle as well. So certainly seeing that in Texas and Florida right now, and those markets have other exacerbating conditions in Florida, not unusual to see somebody paying more annually for their home insurance than they’re paying on their mortgage. Texas, we’ve seen property taxes skyrocket, so there are other factors that are making it difficult for home sales and home prices to accelerate.

Dave:
Absolutely. Well, I think this is good advice for our audience to heed here is just expect things to cool off generally around moving from a seller’s market to a buyer’s market. Agreed. A lot of people are skeptical about Zillow. They’ve actually been fairly accurate the last year or two, just calling that out. But I do think look at a lot of different sources of data and all of them are showing the same trend. Some of them might be showing year over year remaining positive, negative, flat, but all of them are showing a softening. So everything is just getting weaker might not be the right word, and maybe even more balanced is potentially a better word, and it might go past balance to a buyer’s market, but we’re sort of in this shift right now and I don’t know if I can name a single data source that’s showing a different trend. Do you know of any?

Speaker 3:
Yeah,

Dave:
Yeah. So it’s kind of everyone. Alright, well that’s a great summary of the housing market. I want to turn to some of the work you’re doing, Rick at your company, CJ Patrick talking about the role investors are playing in the housing market right now, but we got to take a quick break. We’ll be right back. Welcome back to On the Market. I’m here with Rick from CJ Patrick, and we are shifting our conversation from a discussion of just what is going on in the Hollywood market to talking about the role investors are playing in the single family market today. Rick, tell us a little bit about your research.

Rick:
Yeah, I recently did some research with a company called Batch Data where we took a look at investor activity in the residential market and a couple interesting, at least from my perspective notes that came out of that first investors collectively own about 20% of the single family properties across the country. And that’s basically anything that on the deed is recorded as a single family house. So it’s probably a little bit limiting in terms of the scope, but 20%, and if you look at purchase activity in the first quarter, about 26% of all home purchases were made by investors. So it’s a huge and very significant part of the overall market. And to a certain extent, it’s probably providing a lot of necessary liquidity to the housing market because one of the things that’s just underneath the surface of that data is that it’s not a question of investor activity of skyrocketing over the last couple of years. The percentage increase is really driven by a subsequent drop in the number of consumers that are buying houses.

Dave:
So

Rick:
The absolute

Dave:
Number is not moving that right?

Rick:
Yeah, it’s up about 9% year over year. So

Dave:
Oh, total volume is up,

Rick:
But still it’s the number is sort of inflated a little bit by the lack of traditional homeowners coming into the market. And by the way, before anybody jumps on that, it’s not that investors are pricing out or competing with potential home buyers, there’s just not the demand that we would normally see because of the affordability issues we talked about earlier. And the other thing that was very telling and actually kind of confirmed, some of the things I believed and things you and I have talked about over the years is for all the press and all the government attention that the institutional investors are getting, the overwhelming majority of investor purchases and investor owned properties are by small investors.

Speaker 3:
90%

Rick:
Of the single family homes that are owned by investors are held by investors who own fewer than 10 properties.

Dave:
It’s wild.

Rick:
The institutions collectively in our study own about 2.2% of all the homes in that category of investor owned homes and they’ve been net sellers for the last five quarters consecutively. So the biggest institutions have actually sold off about twice as many homes as they’ve purchased over the last five quarters. So all the kerfuffle about Wall Street gobbling up Main Street, the numbers just don’t support it at all.

Dave:
Yeah, that’s super interesting. I have a lot to dig in there, but I just wanted, do you know John Burns and his company? Yeah, so he was on the show, it was a year or two ago, but he said that the 600 pound gorilla in the room of the single family homes is not institutional investors. It’s the BiggerPockets audience, which I
Honestly had never really thought about, but it’s true. There’s this stat, what 90% of all rental properties are owned by people with 10 units or fewer. According to Rick’s study, that’s only expanding, right? The share of investors who own rental properties is going more towards mom and pop smaller investors than it is to institutional investors. That is not what the media shows, but that’s just the case. And honestly, I believe personally that having rental properties are an important part of society and our housing mix that we have in the United States. And I think it’s a good thing that small local investors are the ones who are buying it over institutional investors because personally I know that I care a lot about my tenants and the way I run my business, and I’d like to think that, I’m sure there are still bad landlords out there, but that I’d like to think that small businesses are going to be taking care of their tenants and thinking more holistically about it than these large institutions that have 20 different businesses that they’re running and adding it to some massive portfolio. But that’s just my take.

Rick:
No, I think you’re right. I think for a small investor you’re dealing with an actual tenant, whereas if you’re an institution, you’re probably looking at a line item on your spreadsheet and you do have to maintain profitability and positive cashflow over time, but it is a different kind of relationship between landlord and tenant in that case. The other thing by the way that we’re seeing, and I think this actually is one of the reasons we’re seeing net sell-offs by the larger institutions, is a lot of the money that they would’ve been spending on buying individual properties, they’ve now diverted into bill to rent projects. So they’re working with builders and building entire communities of single family properties to rent out, and that’s actually adding inventory to the market and certainly not competing with traditional home buyers. So you made a really, really important point, Dave, in that rental properties are a critical part of our housing ecosystem right now. One of the realities is as affordability has become worse over the last few years, people still need somewhere to live. So if they can’t afford to buy a house stands to reason they’re going to want to rent something. And a lot of these folks have growing families would probably prefer to rent a house rather than an apartment. I think in many cases, investors, small investors who have these homes available for rent are filling a critical market need.

Dave:
I agree with you, and of course I’m biased. I am a real estate investor, but I just look at this situation. I do understand that people get frustrated when they can’t afford a home, and often they look at investors who own multiple homes and they place blame there. I get the sentiment people want to own a home, but I think often the piece that they’re missing is one, they’re not necessarily competing for the same types of properties, like you said, correct. Two, the home ownership rate in the United States has actually really not moved all that much for the last, what, 60 years? It’s like between 64 and 69% going back to 1960, and we’re actually at 67% right now. So we’re right at the average home ownership. So this idea that we’ve become a renter nation is just not supported by data at all. And then I do think the thing that you said about investors providing liquidity is super important because yeah, a lot of stuff went wrong in 2008, but one of the things I think to be fair to investors is investors sort of set the bottom in 2011, 12 and 13 and help the housing market recover.
And to your point, although I’m not trying to make investors out to be superheroes coming into save society, but I do think like you said, they are serving an important role in the housing market right now where they are providing liquidity and setting a bottom so that the demand just doesn’t evaporate altogether because these small investors are still buying and providing that important role in the housing ecosystem.

Rick:
Yeah, I think where people get riled up is that we have had a structural shortage of housing available for a number of years now, really since 2010. The builders underbuilt every year up until recently. And so there’s this kind of notion that investors are making that scarcity issue even worse and driving up prices. Again, the numbers don’t support that. If you look at the prices, investors pay for properties significantly lower than what consumers are paying. So to your point, Dave, investors are buying different properties. They typically are buying properties that require a lot of TLC before they’re available for people to live in.
And so investors are buying low, they’re fixing the properties up. If they’re fixing flippers, they’re then selling it at closer to market value. But most of these properties today are being bought by folks who want to rent them out. They have to fix ’em up too. So that’s actually net positive contribution to the economy because they’re not just buying the properties, but they’re spending money on materials and products and services they need to fix up the properties. So that’s contributing to the local economy. And to your point, if these homes were sitting there vacant for months and months and months because there’s no investor activity, it’s going to drive home prices down in the surrounding neighborhoods.

Speaker 3:
That’s right.

Rick:
Which isn’t really good for anybody. So there’s a lot of benefits to this. And again, we’re not trying to create an image of investors as superheroes, but they’re certainly not super villains either. That’s a good way to put

Dave:
It. Well, I want to talk to you more. You sort of went into this talking a little bit about the types of properties that investors are buying. I want to dig into that a little bit more, but we got to take a quick break. We’ll be right back. Welcome back to On the Market. I’m here with Rick Sharga talking about some of his research into I investor buying behavior. We looked at the top line, but you mentioned that investors are often buying things that are either distressed or need a little TLC before they can realistically be renovated. Are there any other trends that you’re seeing in terms of the type of assets, the geographies, or anything that where investors are buying?

Rick:
There’s some surprises in the data. Oh,

Dave:
Okay, I like this.

Rick:
When you think about a little bit more, you get one of those aha moments. For example, two of the states that had the highest percentage of investor owned properties were not California or Florida or New York or Texas. They were Hawaii and Alaska. Both over 30% of the residential homes were owned by investors.

Dave:
Alaska, I’m not surprised by who I guess, but Alaska, I wouldn’t have guessed.

Rick:
Same reasons, very, very dependent on tourist economy. And so you have a lot of people buying a property up there for the sole purpose of renting it out. These are not long-term rentals, they’re short-term rentals. So that was a little bit of a surprise in the data, but you continue to see the most investor properties purchased in states like California and Texas and Florida, where you have the highest populations. And again, in the cases, particularly with California and Florida, you have a lot of vacation kind of traffic where people can rent these properties out in that manner. The other trend that we haven’t seen in the last few years, and this has slowed down investor activity, is foreclosure activity has been historically low really since the COVID pandemic and programs the government put in place to try and prevent people from losing their home due to COVID issues. But foreclosure activity really isn’t even back to where we were prior to the pandemic, yet we are finally starting to see a return to more normal levels gradually as that happens, investors play a really critical role in buying and rehabilitating these properties. Typically because a homeowner couldn’t really afford to live there anymore, have fallen into various states of disrepair. So I think you’ll start to see a little more of that in the next couple of years,
And that’ll add to the inventory of properties that are available not just to be rented, but available for resale to consumers who are looking for an affordable property.

Dave:
Awesome. Well, let’s dig into a couple of things here. I want to talk about foreclosures, but I’m surprised by the California thing too. I know that that has the biggest population, but the cashflow there is just non-existent. So I mean, do you have any sense of what are people just buying on hopes of appreciation? Same thing with Florida and Texas. Are people sort of buying the, that’s kind of been the investor philosophy across asset classes for the last year or two, at least the retail investor philosophy where you see people buying stocks when they go down, they’re buying crypto when it goes down. Is that what’s happening? These markets have seen corrections.

Rick:
Yeah, really, really good questions. Wish I had definitive answers for you, Dave. In California, a little bit of it is market selection. You’re probably seeing more rental properties being purchased in the Central Valley. You go kind of from Modesto down to San Bernardino and Riverside. So the property prices aren’t quite as eye watering in those areas as they are in the coast. And a lot of the other investment properties that are purchased tend to be properties purchased to flip.
And so even at the high price points, flippers who know what they’re doing and are very careful with their calculations, they may turn a lower percentage profit on a flip, but the raw number is a pretty nice number when they factor that. In terms of Florida and Texas, I think we’re seeing the volume of purchase activity go down. A couple of years ago, Florida had the highest number of out-of-state investors of any state in the country, and the market was booming. Right now, I don’t think that’s the case. The state is still seeing a net increase in population year over year. So I think there are probably some investors that are selectively looking for parts of the state where, to your point, they can either buy on the dip, assuming that the state will come back as it usually does, or they’re buying in lower price parts of the state where they’re still seeing population growth and job growth. And you and I have talked about this till people are probably sick of hearing about it, but if you’re really looking for underlying conditions that are good predictors of a housing market, you want to look at population growth, job growth, and wage growth. And where those three things are positive, you’re probably going to have a good housing market, both for owner occupied sales and for rental properties.

Dave:
It’s sort of just this necessary evil that we talk about housing markets at a state level. But it really, to your point here, what’s going on in central California can be totally different than what’s going on from coastal California. Florida and Texas are obviously massive states population and land wise as well. There’s tons of big metros in all these areas. So you really do need to look at it at a metro by metro area and look for some of these underlying fundamentals that Rick’s talked about. The last thing I want to get to here, Rick, is you mentioned foreclosures before because all the media, you read these headlines that drive me insane. It’s like foreclosures went up 30% year over year, which is technically true, but totally misses the point that foreclosures are still below historical norms. They’re below pre pandemic levels. And so using that as your headline is just deliberately trying to rile people up and not explaining context. Why do think foreclosures are so low? And you said that you thought that they might pick up. Why do you think that might change in the future?

Rick:
So conspiracy theories aside, I think the reason foreclosures,

Dave:
I like the caveat,

Rick:
I think foreclosures are as low as they are for a couple reasons. And one is basic economics. We’ve had a very strong economy for a number of years now. We’ve had very low rates of unemployment. There’s usually a really strong correlation between unemployment rates, mortgage delinquencies, and foreclosures. So as long as we have low unemployment numbers, we will continue to have relatively low foreclosures. The government did put some programs in place that basically shut down any foreclosure on loans that the government had a hand in, and that’s 70, 75% of the mortgages that are out there. And candidly, private lenders were reluctant to foreclose on anything for fear of running afoul of what the government wanted to do. So for a couple of years, the only foreclosures we saw were on commercial properties or vacant and abandoned properties, and we’re only slowly working our way out of that. But mortgage RS have been over backwards to accommodate distressed borrowers. And this is something most people don’t realize. Distressed borrowers, even those in foreclosure most of the time have enough equity in their property to be able to sell the home at a profit.
And so what we’ve been seeing an unusually large number of these homeowners do over the last couple of years is they get their delinquency notices, they get their early foreclosure notice, and they sell the property rather than risk losing all of their equity to a foreclosure auction. And that’s been happening in about 55 to 65% of distressed property sales for about three years now. So there are fewer properties getting from that first foreclosure notice to the actual foreclosure sale because there’s less inventory getting to the auction. The buyers are bidding more on the properties that are going to the auction. So there’s even fewer properties going back to the lenders as bank owned properties. And that’s where a lot of investors typically focus their efforts were on these bank owned homes, so we’re gradually seeing an increase in the number of foreclosure starts. Those first notices
We’re at a two year high now in terms of foreclosure sales, but it’s still only about 50% of where it was prior to the pandemic, and we’re still about 70% below where we were in terms of repossessions. A big part of the reason we’re seeing fewer foreclosures is homeowner equity. The reason I think we’re going to start to see more foreclosure activity really has a lot to do with VA and FHA borrowers, people that have FHA loans and VA loans. The VA had a moratorium that was in place until a couple months ago. We saw a 60% increase in VA properties entering foreclosure when that moratorium ended. That’ll settle down a bit, but that’s a group to watch. The real group to watch is the F-H-A-F-H-A loans account for 50% of seriously delinquent loans, even though they only account for about 13% of mortgages.
And up until now, if you were an FHA borrower, you would get multiple bytes at the lost mitigation apple. So you got delinquent, your servicer puts you into a loan modification program, you might make a payment or two, then go delinquent again, they’d put you in another program. And some of these borrowers were going into lost mitigation three, four or five times a year and just never making payments. The FHA announced a new program, which starts officially in October, but unofficially as already started, where if you’re a borrower, you get one lost mitigation try every 24 months. So now we’re going to start to see a lot of these seriously delinquent. FHA loans go from delinquency into foreclosure, and they’re going to go through the foreclosure process at much higher rates because your typical FHA borrower got a low down payment loan, so they don’t have a huge amount of equity,

Dave:
Less equity.

Rick:
And if they happen to be in a market like some of these Florida or Texas markets we’re talking about where home prices have gone down, they may be underwater on their loan. So we’re likely to see more short sales. We’re likely to see more of these properties getting to foreclosure. What I’ve been telling people is I think by the end of this year, we’ll see foreclosures starts back to pre pandemic levels. By the end of next year, we’ll probably be close to pre pandemic levels of foreclosure sales. I don’t expect REO inventory to come back for at least another two years. And

Dave:
This is all assuming sort of like standard status quo in the labor market. Could this get even worse if there’s a break in the labor market?

Rick:
Yeah, if we have an unexpected downturn, we have a recession, we have an economic slowdown that’s more severe than most economists are projecting right now. And unemployment rates go up than the numbers I talk about would go up too and probably go up more quickly. The other thing you have to keep in mind is consumers are carrying a record amount of debt right now, $18.4 trillion in consumer debt, student loan payments are now due again, October could be a real mess, by the way. And it’s not just because the FHA lost mitigation program starts officially in October, but there’s a clause in student loans through the government that the government can start garnishing wages. If you’re 270 days past due, guess when 270 days past due hits for a lot of student loan recipients.

Dave:
October,

Rick:
October and October is also when the severance package for the thousands of government workers who took the buyout expire. And with all due respect, I’m a little concerned about how well the skillset of government employees is going to translate when they start looking for work in what we will call the real world. And so you have those three things hitting all at once. Government severance packages expiring, student loan garnishment, potentially starting in FHA loss mitigation, tightening up all in the same month, so we could have a rough October if all those three things hit in a meaningful way.

Dave:
Well, not just October, that could just be the start of a rough couple of months or a period here, right?

Rick:
Well, it could be except that Fannie Mae, Freddie Mac and the FHA and the VA all put foreclosure moratoriums in place really from Thanksgiving through New Year’s. So October we could see a blip. It could artificially slow down for the holidays and then hit with a vengeance in January and February.

Dave:
All right. Well, that is something we’ll have to keep an eye out for. That was a great explanation of what’s going on, Rick. I have not heard that before. Really appreciate your insights on that. Thank you so much for being here, Rick. We always appreciate you sharing your research, your thoughts on the housing market. This was a great conversation. I learned a lot, and I believe our audience must have learned a lot too. Thanks again.

Rick:
My pleasure.

Dave:
And thank you all so much for listening to this episode of On The Market. I’m Dave Meyer for BiggerPockets. We’ll see you next time.