Rising markets may bring in tide for those who were needing to short sale

Relief to Millions of underwater homeowners that may no longer have to Short Sale

During the market crash of 2008-2010, people were stuck with their homes. Home values nosedived, leaving many homeowners owing more on their mortgages than what their home was worth. Selling at that time would have been financial suicide because homeowners would be unable to sell the home for more than what they owed. Sadly, these underwater homeowners had few options other than to wait and hope for the best.

Fortunately, the best has come sooner than most experts ever expected. Maggie Medved, a Phoenix homeowner, experienced just this – she lost all equity in her home, a quaint retro-style house, after the market crash and was forced to keep living in the home until things turned around. Instead of capitulating and going through the short sale process in Arizona, two years later, Medved and her husband were able to take advantage of the rising home prices in Phoenix by selling their home and moving into a larger one.

Twelve million homeowners in the U.S. were considered underwater at the time. Not only were they unable to sell their home or purge their debt without foreclosing, but they were also unable to take advantage of record low refinancing costs that helped millions of other homeowners save money and get a bargain on a new home.

Rise in Prices starting to Float some Homeowners

With the market now in recovery, underwater borrowers are finally coming up for air. JPMorgan Chase & Co. reports an estimated 7 million homeowners still underwater as of last year, down nearly five million from the peak of the housing crisis. Furthermore, that number could drop to as low as 4 million by 2015.

Luckily for these homeowners, now is still a great time to buy and an even better time to sell. The Federal Reserve has still managed to keep mortgage rates low, investors are continuing to acquire the decreasing number of foreclosed properties on the market, and housing construction is adding new homes to the market faster than it has in years.

Home Price Appreciation

Rising prices are adding tremendously to the growth of the market. Price appreciation, or the increase in value of an asset, is putting confidence back in homeowners. Just knowing that the value of their house is appreciating can change the entire way they budget, spend, and credit, which is great not just for the housing market but for the economy altogether.

Medved’s house sold for $85,000 after just two days of being on the Phoenix market. That price was just a tad lower than what she paid for the home back in 1998, and probably more than what she would get if she did a short sale. She has been planning to move for a while, but the crash set her back longer than she would have liked. Her financial situation – debt reaching $30,000 and a house that was worth less at a time when no one was buying – forced her to stay and wait patiently. Two years later it paid off. Now she and her husband live in a much larger home in a beautiful neighborhood in Glendale.

One thing in Medved’s favor was the fact that Phoenix was the top market in the entire country for home price appreciation. Home values shot up 22 percent between October 2011 and October 2012, which was the biggest increase anywhere since May 2010. Eighteen other major U.S. cities also showed year-to-year increases.

While this is certainly good news, let’s put it into perspective: current home prices in Phoenix are still down 45 percent from their peak in 2006 – nearly half in just a span of six years. The national market fares better, however, with the average home price now down 19 percent from its peak in May 2007.

A Drop in Supply

In Phoenix, the supply of available houses for sale dropped substantially. About 14,700 homes are currently on the market or ready to be made available, which is half of the normal amount. The reason for this: investors acting more quickly than buyers, taking advantage of the diminishing number of foreclosed homes on the market. As well, homeowners are tightly holding their rapidly appreciating asset.

This drop in supply is responsible for pushing prices upward (as the law of supply and demand would agree, a drop in supply means an increase in demand, which results in an increase in price). However, buyers are hooked. Last year, increasing prices led to 4 million homeowners getting back above water, so even those that might be considering a short sale are trying to hang tight.

Restrained Inventory

What’s interesting to note is that although a 5 percent increase in the average house price would result in a decrease of 2-3 million underwater homeowners, a 5 percent decrease would put that same number back underwater.

This has led to a critical tactic by stalwart investors, such as Colony Capital and Blackstone, who are restraining the tapering supply of homes by pushing traditional homeowners who are also looking to buy these properties out of the market.

How are they doing this exactly? We can specifically look at Blackstone, the biggest private real estate owner in the United States. The sudden jump in prices in the Phoenix market caught them off guard, but they acted quickly by purchasing over 16,000 homes at a total cost of $2.5 billion in November. In October, they only spent $1 billion on homes, and even that was up from their average spending. They will handle these homes as rental properties. What might happen if they all unload in 3-5 years is still up for debate and I'm sure will be closely watched.

Decline of Foreclosures

Meanwhile, foreclosures elevated in part because of underwater borrowers who did not want to wait to get rid of their home until the market recovered. Known as strategic default, the idea that their home would never again be worth more than what they owed on it led them to hand in the keys, move out, and count their losses, leading to an increased number of abandoned homes that made many neighborhoods less appealing to potential buyers. The others that couldn't do a strategic default just opted to do a short sale and leave.

At the moment, however, foreclosures have slowed tremendously. From a year earlier, foreclosures were down 28 percent, as reported by Lender Processing Services in November.

Underwater homeowners who waited can now get back in the market. As prices continue to rise, home equity will go back up, causing many of these homeowners to sell now while buyers are interested and rates are still low.

While a lot of attention is being placed on the “sudden” increase in home prices, this has been sensationalized into something that is largely false. As predicted, the increases will affect the market gradually, but with all the pieces of the puzzle connecting, it’s certain they will continue rising.

Future Estimates for the Housing Market

In the last year, the combined home values went up by about $1.3 trillion, or 4.5 percent, to $23.7 trillion. This coming year, values are expected to rise an additional 3.3 percent, while the number of existing home sales is predicted to increase by a substantial 7.2 percent to nearly 5 million.

On the other hand, bond investors could run into trouble with the widening diversity of borrowers who are eligible to refinance, due to the increasing prices and continually low mortgage rates. Investments without government support, including adjustable rate mortgages, subprime bonds, and others that were made at the height of the housing boom in the mid-2000s and that trade at discounts to break even, will be affected by the high levels of financing.

Government supported mortgage bonds – with prices averaging about 108 cents on the dollar – will also be affected, mainly by faster prepayments.

Lastly, the economy has benefited and will continue to benefit from an improving housing market. The crash was essentially responsible for the recession our economy suffered at the end of last decade, often considered the worst since the Great Depression. While our economy is still not at the strength it was before the crash, it’s improving right alongside the housing market – unemployment has already dropped to 7.8 percent, one of the lowest rates in many years, and overall economic growth of 2 to 3 percent is expected this year.

The connection between the housing market and economy is easy to figure out. For most families and households, the home is the biggest asset. Once equity is lost, finances are sent on a downward spiral. But when prices begin to rise again, so does consumer spending, which is the main driver of economic growth.