A Real Estate Correction Without a Recession?

With so much focus on monitoring for the launch of another economic recession, an emerging home price correction could be taking flight under the radar.

One in four local real estate markets is expected to experience a home price decline in 2020, according to the Realtor.com 2020 Housing Forecast released in December. The report calls for national home price growth to essentially plateau next year, increasing a meager 0.8 percent even while many major markets including Chicago, Dallas, Las Vegas, Miami, St. Louis, Detroit and San Francisco post home price declines.

According to Realtor.com, these local market declines won’t be driven by an economic recession or by destined-to-fail mortgage products, but by migration patterns triggered in large part by buyers chasing affordability — a trend that was already evident in 2019.

“As housing prices outpaced incomes by a wide margin, home buyers made a noticeable move toward affordability during the year. Large, expensive coastal markets—New York, Los Angeles, San Francisco—began experiencing net migration outflows, as buyers flocked to mid-sized cities, in search of quality of life and amenities at a more affordable price point,” writes Realtor.com senior economist George Ratiu.

This nascent affordability-chasing migration pattern has already begun to hurt home prices in some of the highest-priced coastal markets, according to an Auction.com analysis of public record data from ATTOM Data Solutions.

The analysis found that 41 of 314 local markets analyzed (13 percent) posted a year-over-year decline in median home prices in Q3 2019, including Washington, D.C. (down 2.0 percent); San Francisco (down 1.1 percent), San Jose (down 3.2 percent), Bridgeport, Connecticut (down 4.8 percent), and Naples, Florida (down 0.7 percent). Six of the 10 highest priced markets — all of which are in California except Honolulu — posted year-over-year declines in home prices.

Hole in the Home Equity Safety Net

Slowing home price appreciation in most local markets means less air is being pumped into the home equity cushion that homeowners often fall back on in the event of a loan default.

A report from Black Knight released in early December shows that so-called “tappable equity” — the amount of home equity below an 80 percent combined loan-to-value ratio that is available to homeowners with a mortgage — decreased 1 percent in Q3 2019 compared to the previous quarter. Total tappable equity of $6.2 trillion was still up 5 percent from a year ago, but the annual rate of increase has slowed substantially since 2016, 2017 and early 2018, when it hovered close to 15 percent each quarter, according to the Black Knight report.

And while the average homeowner with a mortgage holds $119,000 in tappable equity, homeowners who have purchased in recent years using low down payment loans backed by the Federal Housing Administration (FHA) likely have little to no tappable equity. FHA’s annual report to Congress for fiscal year 2019 shows that FHA-backed purchase loans originated in 2019 had an average loan-to-value ratio of 95.58 percent, on par with the average LTV for all post-recession loan vintages.

FHA backs more than 8 million active loans, about 15 percent of the 53 million total active U.S. mortgages. In dollars, those 8 million active loans represent nearly $1.3 trillion in insurance-in-force on the FHA books. That’s a significant slice of the mortgage market without a comfortable equity cushion protect against foreclosure — particularly in the case of declining home prices.

Non-Performing Loan Shell Game

Another trend that could eventually result in an uptick in defaults without a recession is the continued selloff of non-performing loans on the part of Fannie Mae and Freddie Mac.  

A report published by the Government Sponsored Enterprises in early Decembers shows that the GSEs combined have sold more than 117,000 non-performing loans since 2014, not including more than 12,000 additional sales in 2019 that have been announced by Fannie Mae and Freddie Mac.

NPL sales have helped the GSEs accelerate the reduction in their inventories of legacy delinquent loans left over from the last housing crash. The report shows that GSE portfolio of loans that are delinquent by 365 days or more decreased 71 percent from December 2015 to June 2019.

Fannie and Freddie — and by implication the U.S. government — have used NPL sales to wash their hands of many delinquent loans, but the entities that purchase those NPLs are still in the midst of the messiness. The GSE report shows that 42 percent of these NPLs have since been foreclosed on and 30 percent have avoided foreclosure — but 24 percent have not yet reached any permanent resolution.