If you’ve had a hand in real estate over the last few years, you’ve lived in interesting times.
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Never before have home prices peaked and plummeted so dramatically, have homeowners embraced the American Dream in such droves, or have regulators stepped in with such urgency to rescue lenders and cash-strapped borrowers.
Indeed, the residential real estate market of 2009 bears little resemblance to the one our grandparents helped create.
“The real estate market looks a lot different than it did even three years ago,” says Rachel Drew, a research analyst for the Joint Center for Housing Studies at Harvard University. “From people’s incomes to home prices to construction levels, the entire landscape has changed very dramatically in a very short amount of time and nobody really knows what it will look like going forward.”
Some of the most significant changes, of course, have occurred over the last few weeks as the new administration earmarks billions of dollars to stabilize the troubled housing sector.
Others include long-term market forces that continue to evolve amid the recession, including housing affordability, exotic loan products and rates of homeownership.
All, however, are likely to reshape the housing market for generations to come.
Affordability
Speculators were largely blamed for the unsustainable run up of real estate prices during the first half of the decade, pricing millions of would-be buyers out of the market.
But higher home prices are just one of several factors contributing to the challenge of rising housing expenses today.
The Center for Housing Policy reports that between 1996 and 2006 all major categories of homeowner expenses increased faster than incomes.
Mortgage payments increased 46 percent, utilities 43 percent, property taxes 66 percent and property insurance 83 percent. By contrast, homeowner incomes increased by 36.3 percent.
And since 2006, the cost of heating oil, natural gas and gasoline have further stretched families’ budgets.
“By documenting the substantial increases in a wide variety of housing expenses, this study shows that the nation’s housing concerns extend beyond higher mortgage payments,” said Center for Housing Policy Chairman John McIlwain. “To get the American economy back on its feet, we will need to look comprehensively at helping Americans afford the full ‘costs of place,’ which include the costs of shelter, utilities and transportation.”
Already, however, data suggest the market is starting to give homebuyers a much-needed break.
The National Association of Realtors reports the housing affordability index rose 13.6 percent in January to 166.8, the highest since tracking began in 1970.
The January index, the most recent month for which data are available, indicates a median-income family, earning $59,800 could afford a home costing $283,400 in January with a 20 percent down payment, assuming 25 percent of gross income is devoted to principal-and-interest costs. A year ago, the same family could afford a home costing $263,300.
New Lender Restrictions
The proliferation of “exotic” loan products that targeted nonprime borrowers during the housing bubble, and the subsequent retrenching by lenders following the mortgage market meltdown, is another notable trend.
To lure buyers during the real estate run up, banks eased underwriting restrictions and created a slew of higher-risk products including interest-only loans and zero-down mortgages, which put borrowers without much equity in a tight spot when the housing market collapsed.
The widely popular adjustable rate mortgages, some of which included exploding terms, also left millions unable to afford their monthly payments when their rates reset.
The Joint Center for Housing Studies reports the number of homeowners paying more than half their income on housing surged from 6.5 million in 2001 to 8.8 million in 2006, the most recent year for which data are available.
“This reflects looser lender enforcement of debt-to-income caps and the widespread use of mortgages that have been resetting to higher payments,” it writes in its “2008 State of the Nation’s Housing” report. “With so many stretched thin and home prices falling in many areas, foreclosures are skyrocketing.”
As a result, lenders have scaled back the availability of non-traditional loans dramatically; going back to basics by requiring larger down payments, higher credit scores and written documentation of solid income histories.
“Over the last five years we saw a dramatic increase in the amount of leverage homeowners could get,” says Joe Gyourko, professor of real estate and finance at the Wharton School of Business. “We now know housing prices are volatile enough that if you don’t have a percent down you can easily lose all your equity [in a down market.] I don’t view [the return to fundamental lending practices] as a return to the dark ages. I view this as a prudent thing.”
Making Home Affordable
Since the housing recession began, millions of US families have seen their property values plunge, leaving them unable to refinance to lower mortgage rates. Millions more have lost their jobs and are struggling to stay current on their monthly mortgage payments.
It’s those homeowners, up to 9 million all told, that the Obama administration is hoping to assist with the new “Making Home Affordable” plan, passed earlier this year.
The plan includes two distinct programs:
The Home Affordable Refinance program, which ends June 2010, will be available to homeowners with a solid payment history on an existing mortgage owned by Fannie Mae or Freddie Mac, who are unable to refinance because their homes have lost value.
Up to 5 million homeowners will be eligible to refinance their loan to take advantage of today’s lower mortgage rates or refi an adjustable rate mortgage into a more stable 30-year fixed rate loan.
The Home Affordable Modification program will help homeowners at risk of default and foreclosure by working with lenders to reduce their monthly mortgage payments. It is expected to become standard industry practice.
For many families, the Treasury Department reports a low-cost refinancing could reduce their mortgage payments by thousands of dollars per year.
Tax Changes
You’re Forgiven
Another change to the US tax code gives the nearly 4 million homeowners who have already entered foreclosure some added relief.
“If your home is foreclosed upon and if your mortgage is higher than the proceeds realized on your property, that debt would have been considered taxable income to the seller prior to 2007,” says Mark Luscombe, a principal tax analyst with CCH, a tax and accounting firm in Riverwoods, Ill. “Now, they’ve created an exclusion for principal residences so that debt is not considered taxable income. That’s fairly unique in recent times and it’s clearly in response to the housing crisis.”
First-time Homebuyer Tax Credit
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To jump start the housing sector and decrease the over-supply of homes for sale, President Obama also signed into law the American Recovery and Reinvestment Act in February 2009.
Among the provisions was a bill that increased the existing first-time homebuyer tax credit to $8,000 (from $7,500) for the purchase of a principal residence between January 1, 2009 and December 1, 2009.
The credit, which does not require repayment, will be claimed on a homebuyer’s tax return to reduce their income tax liability. Unlike a deduction, each dollar of a tax credit reduces one’s income taxes by a full dollar.
Though the program is designed to jumpstart the entry-level housing market, which fuels real estate liquidity, it’s still unclear how many first-time buyers will take the plunge.
“Many of these programs are so new that that they haven’t even had a chance to impact the environment for residential real estate yet,” says Drew.
Record Homeownership
One of the biggest trends in the modern day housing market, however, and the one most likely to restore stability in the years to come has nothing to do with government intervention at all.
Fueled by underlying strength in the US economy, record low interest rates and the expansion of mortgage credit, the rate of homeownership—a major contributor to economic growth—has been on the rise since 2000.
After averaging 1.15 million per year between 1995-2000, the Joint Center for Housing Studies reports household growth notched up to 1.37 million annually between 2000-2006.
“While some of this increase may be due to the unusually favorable home-buying conditions in the first half of the decade, much of it was expected as the echo boomers began to form independent households and immigration continued to climb,” the Center notes in its “2008 State of the Nation’s Housing” report.
The Center projects household growth will climb from 12.6 million between 1995-2005 to 14.4 million between 2010 and 2020.
Minorities overall are expected to account for more than two-thirds of the net increase in households over the next decade, while the foreign born will contribute at least one-third of that gain.
Although lower average incomes among the minority population “may force them to spend less on non-housing items as housing costs rise, minority households will nevertheless provide broad demand support to housing markets in the years ahead,” the Center reports.
A New Tomorrow
Given recent volatility in the housing sector and the litany of new federal assistance programs aimed at borrowers, it’s anyone’s guess what shape the real estate market of tomorrow will take.
One thing, however, is clear: As the industry responds to current challenges, the groundwork is already being laid for a new reality in residential real estate—one in which lenders are more accountable, investors are more cautious and homeowners are better positioned to manage their monthly payments.