Forces Influencing the Market Recovery

Is the single-family housing THE SINGLE-FAMILY housing boom of the mid-2000s was driven by market recovering, or are we low interest rates and speculative invest- ing, resulting in overbuilding, low in for another leg-down? affordability and eventually a wave of . Four years of price declines and millions of foreclosures later, the for-sale housing market is beginning to show signs of recovery in most parts of the country. Mortgage rates are currently low, affordability has improved markedly, and several govern- ment-sponsored programs are fueling demand for single-family housing. Renewed housing demand, particularly

KENNETH T. ROSEN at the low and middle ends of the mar-

THE WHARTON REVIEW, VOL. XIV, NO. 1, SPRING 2010 ket, is depleting inventory levels and GOVERNMENT helping to stabilize single-family home INTERVENTION prices, despite the large numbers of cur- rent and potential foreclosures in some Massive government intervention in the markets. housing and residential mortgage markets We believe that improved affordabil- has been a major force driving the housing ity levels, low mortgage interest rates, recovery up to this point. Federal govern- and government programs are driving ment intervention has taken four major the current housing recovery. Although routes: the purchase and holding of mort- some of these programs are scheduled to gage-backed securities by the Federal end in the first half of the year, Reserve in order to keep mortgage interest improved employment conditions dur- rates low relative to other borrowing costs; ing the second half of the year could the enactment, expansion and extension sustain the recovery. Additionally, of a home purchase tax credit through because demand is seasonal, with more April 2010 (including home sales closed sales occurring during the spring and by June 2010) to nearly all homebuyers; summer months, the dip in sales follow- an aggressive mortgage guaranty program ing the expiration of the tax credit will through the Federal Housing be less pronounced, helping to maintain Administration (FHA) designed to sup- momentum for the housing market port home purchases by low- to moder- recovery. A number of headwinds may ate-income households; and a commit- abort the recovery, including foreclo- ment of $75 billion for a loan modifica- sures, stricter mortgage qualification tion program to ease the requirements, increasing mortgage tsunami, as well as more than $2 billion in interest rates, and sustained high unem- funding for innovative mortgage modifi- ployment. Despite these headwinds, we cation measures in the hardest hit housing believe that the recovery we have seen is and employment markets. real and sustainable, though at a moder- In late 2008 and 2009, the Federal ate pace, and is not a temporary recov- Reserve committed to the purchase of ery that will lead to another leg down in $1.25 trillion worth of mortgage-backed the housing market and home prices. To securities to keep mortgage interest rates back up this conclusion, we now turn to low in the near term and help stabilize the an analysis of the various forces influ- housing market. The plan worked, as the encing the single-family housing market spread between the 30-year fixed agency in the next year. mortgage rate and the 10-year Treasury

THE WHARTON REAL ESTATE REVIEW, VOL. XIV, NO. 1, SPRING 2010 Figure 1: 30-Year Fixed Agency Mortgage vs. 10-Year Treasury

300

280

260

240

220

200

180 Basis Points

160

140

120

100 90 92 94 96 98 00 02 04 06 08 10

bond fell from a peak of 311 basis points in the second half of 2010, up from 5.0 in December 2008 to 119 basis points by percent during the fourth quarter of 2009. April 1, 2010, even as Treasury bond rates Even so, affordability will remain higher declined to historical lows. This drop than during the boom years of the housing made home purchases more attractive and market, stimulating sales activity among contributed to rising affordability levels, buyers with stable incomes and keeping which, along with other government pro- home prices from dropping further. grams, spurred demand for housing. Although the Federal Reserve is set to The Federal Reserve ceased purchases stop purchasing mortgage-backed securi- of mortgage-backed securities at the end of ties, talks are already under way about March 2010 but will continue to hold the extending efforts to keep mortgage rates securities on its balance sheet. As the low if the housing market exhibits addi- Federal Reserve stops purchasing mort- tional weakness. Given the aggressive gage-backed securities and the market stance the government has taken in bol- returns to more normal levels, mortgage stering the housing market thus far, we do rates could increase. Rising Treasury rates not expect policy efforts to disappear if the and an increase in the mortgage interest market is still in need of stabilization dur- Treasury spread to a more normal 150 ing the coming year. Accordingly, we basis point level could push the rate on a expect mortgage rates to be contained at a conventional 30-year loan to 6.3 percent level that the market can handle, with

THE WHARTON REAL ESTATE REVIEW, VOL. XIV, NO. 1, SPRING 2010 Figure 2: Residential Mortgage Rates

14%

12%

10%

8%

6%

4%

2%

0% 85 87 89 91 93 95 97 99 01 03 05 07 09 FRM ARM increased affordability from lower prices ket. In 2009, existing home sales (includ- helping to offset the negative demand ing condos and co-ops) rose to 5.2 million effects of an increase in interest rates from 4.9 million in 2008. through the short term. In November 2009, the tax credit was In addition to keeping interest rates extended through April 2010 for contracts low, the government introduced a tax cred- and June 2010 for closings, and expanded it to stimulate home sales. The first-time to include higher income and repeat buy- homebuyer tax credit was introduced in ers. Through April, households that earn February 2009 as part of the American up to $125,000 for a single taxpayer and Recovery and Reinvestment Act. The $225,000 for a married couple can qualify $8,000 tax credit originally applied only to for the $8,000 credit if they are first-time first-time homebuyers who met income homebuyers. Furthermore, qualified limits of $75,000 for a single taxpayer or repeat buyers are eligible for a $6,500 cred- $150,000 for married taxpayers filing joint it, subject to the same income constraints. returns. According to the latest data from The extension allows households that the Internal Revenue Service, the tax cred- required more time to accumulate the nec- it helped 1.4 million families year-to-date essary down payment to take advantage of as of September 2009. As a result, home the tax credit and enter the market. The sales increased, particularly those of entry- raised income limits also increase the pool level at the low end of the mar- of potential homebuyers, fueling demand

THE WHARTON REAL ESTATE REVIEW, VOL. XIV, NO. 1, SPRING 2010 Figure 3: Existing Single Family Home Sales

8 7.1 6.7 7 6.5 6.2 6 5.7 5.7 5.2 5.2 5.3 5.2 5.0 4.9 5 4.2 4.0 4.1 3.8 3.8 4.0 3.8 4 3.7 3.5 3.5 Millions 3.5 3.4 3.4 3.1 3.2 3.2 3.2 3.0 2.9 3 2.7 2.5 2.3 2.3 2.3 2.4 2.0 2.0 2

1

0 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 for homes in the mid-range. Finally, the 7.0 million annualized units in April and inclusion of repeat buyers contributes to May and then fall back to 5.0 million an increase in trade-up activity. annualized in the second half of the year. In addition to the federal credit, sever- We expect 6.2 million existing home sales al states have offered incentives toward in 2010. home purchases. In California, for exam- The probable expiration of the tax ple, Assembly Bill 183 was signed by credit by June 2010 will not only cause a Governor Schwarzenegger in late March surge in sales during the first half of the providing a tax credit of up to $10,000 year, but also could put some upward sup- toward the purchase of a new home for all port to home prices, as demand is pulled buyers, or a new or existing home for first- forward from the second half of 2010. time buyers, for purchases made through These trends will cause some potential December 31, 2010. The credit is available buyers to purchase a home sooner than on a first-come, first-served basis, with the they otherwise would, in order to take credit applied to owed taxes in equal advantage of the tax credit. amounts over three consecutive taxable Actions taken by the Federal Reserve years. The effects of the federal credit and and tax credits are not the only federal the various state credits should cause an government measures taken to support increase in home sales activity in the spring the housing market. The government has of 2010. We expect home sales might top also provided support for homeowner-

THE WHARTON REAL ESTATE REVIEW, VOL. XIV, NO. 1, SPRING 2010 ship through a number of dedicated ing the housing bust. According to the lat- housing agencies. The Federal Housing est available data, the FHA market share of Administration (FHA) provides mortgage all homes purchased was 21.5 percent at a insurance for low- and moderate-income seasonally adjusted annual rate in borrowers who cannot amass the resources November 2009, up from 6.4 percent in for a 20 percent down payment. FHA- October 2007. During the same period, insured mortgages have a minimum down the number of households purchasing payment requirement of 3.5 percent. FHA-insured homes increased to more Private, FHA-approved lenders make the than 1.5 million from approximately loan, and through FHA insurance, the fed- 376,000 in October 2007. According to eral government takes on the additional the FHA website as of March 2010, the default risk. During the current crisis, the agency currently insures 4.8 million single- federal government announced support family mortgages. By increasing the for an increase in the FHA’s mortgage amount of loans the FHA can insure, the portfolio, thereby opening up homeown- federal government provided support for ership to a much larger number of house- low- and moderate-income homebuyers, holds. This government support for the further augmenting home sales. mortgage market was particularly impor- Additionally, the Hope for tant as many private lenders had tightened Homeowners program, administered by their mortgage lending standards follow- the Department of Housing and Urban

Figure 4: Increased FHA Mortgage Activity

1,600 25%

1,400 20% 1,200

1,000 15% 800 10% 600 Thousands Market Share

400 5% 200

0 0% Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Households Buying FHA Homes FHA Market Share of Homes Purchased

THE WHARTON REAL ESTATE REVIEW, VOL. XIV, NO. 1, SPRING 2010 Development, provides another avenue for able to reduce their monthly payments borrowers who are having difficulty mak- through the HAMP program. Although ing their mortgage payments to refinance these figures are still small in comparison to an FHA-insured home loan. Borrowers to the number of homeowners facing fore- who refinance through the Hope for closure, the efficacy of the program has Homeowners program will have their loan been increasing rapidly, with the rate of written down to 90 percent of the home’s loan modification doubling in December current appraised value, helping both the and January. These efforts resulted in a borrower and the lender avoid the costly drop in the roll rate to foreclosure during foreclosure process. This program is sched- 2009. As of December 2009, the percent- uled to last through September 2011. age of loans that were 90 days delinquent The federal government has also been that went into foreclosure was approxi- actively trying to stem the tide of foreclo- mately 12 percent, down from a peak of sures. The most recent legislation aiming nearly 30 percent in September 2007. to increase the practice of loan modifica- Loans that were more than 120 days delin- tion by banks was enacted in March 2009. quent had a roll rate into foreclosure of The Making Home Affordable Program approximately 8 percent in December provides homeowners with the opportuni- 2009, down from a peak of nearly 30 per- ty to refinance through Fannie Mae or cent in September 2007. Loans that were Freddie Mac, provided they originally took more than 150 days delinquent posted a out their loans through the GSEs. roll rate of approximately 5 percent in Additionally, the program provides $75 December 2009, down from peaks of billion for a loan modification program more than 20 percent. that could affect up to four million at-risk In order to augment HAMP efforts, households under the Home Affordable the Second-Lien Modification Program Modification Program (HAMP). (2MP) was formed to tackle the problem According to the latest data, the number of of second lien holders, who have been monthly permanent modifications was impeding some willing borrowers from only 116,000 in January 2010, but anoth- receiving modified terms or selling their er 1.0 million mortgages are in the early homes to avoid foreclosure. The program stages of modification. In total, 1.3 million requires second lien holders, if they have trial modifications have been offered to signed up for the program, of HAMP- distressed borrowers, more than one mil- modified loans to either modify the loan lion borrowers have started trial modifica- according to defined protocol or accept a tions and 940,000 borrowers have been lump sum payment from the Treasury

THE WHARTON REAL ESTATE REVIEW, VOL. XIV, NO. 1, SPRING 2010 Department for extinguishment of the rowers, including those with FHA loans, loan. Additionally, both the borrower and borrowers in the bankruptcy process and the holder of the second lien receive addi- underwater homeowners who are not nec- tional incentive fees for on-time pay- essarily in distress. Using $50 billion of ments of loans modified through the pro- housing-designated funds from the gram. Three of the largest mortgage orig- Troubled Asset Relief Program for incen- inators—Bank of America, Wells Fargo tive payments, several programs were cre- and JP Morgan—signed up for 2MP in ated or expanded. Under a new initiative, recent months. the government will encourage servicers to Formed to assist borrowers who either provide temporary payment reductions to do not qualify for HAMP or who have re- affordable levels for eligible unemployed defaulted on the HAMP-modified loan, homeowners for three to six months in an the Home Affordable Foreclosure effort to reduce the number of unemploy- Alternatives Program (HAFA) aims to ment-related foreclosures. Additionally, encourage mortgage stakeholders to sub- loan modification efforts will be enhanced mit to foreclosure alternatives such as short through increased proportionate incentive sales and -in-lieu. HAFA was payments for principal write-downs by announced in November 2009 and will be investors and servicers of both first and in place by April 2010. HAFA provides second liens through the expansion of compensation to borrowers, servicers and HAMP, 2MP and HAFA. Modified loans investors when a successful short sale or will then be issued with FHA insurance -in-lieu of foreclosure is completed. through new lenders, further reducing the Originally, borrowers qualified for a risk to investors. Incentive payments to $1,500 relocation assistance payment borrowers were also increased for several while servicers and servicers received up to programs. Under the enhanced program, $1,000 for each successful foreclosure servicers will be required to consider an alternative. Additionally, second lien hold- alternative modification approach, includ- ers can gain up to $3,000 per short sale in ing principal reductions, for those owing exchange for extinguishing the loan. more than 115 percent loan-to-value, On March 26, 2010, the federal gov- helping some underwater homeowners. ernment enlarged the range of options for Finally, the announced plans included loan modification with a goal of offering a incentives to help homeowners relocate to second chance to three to four million more . homeowners through 2012. The HAMP In February 2010, the administration program was expanded to reach more bor- announced $1.5 billion in funding for

THE WHARTON REAL ESTATE REVIEW, VOL. XIV, NO. 1, SPRING 2010 innovative strategies aimed at homeowner avoid blight and the price declines associ- assistance in the hardest hit housing mar- ated with proximity to abandoned, bank- kets. This program applied to states that owned properties. have posted a drop of 20 percent or more In addition to these national programs, in the average home price from its peak. a number of states and localities enacted Although the details have not yet been their own foreclosure prevention and announced, the federal government will homeowner assistance programs. All of the work with state and local housing finance federal and local efforts on behalf of the agencies to fund a variety of programs to housing market will help a number of assist residents coping with the effects of homeowners avoid foreclosure, or at least high unemployment and significant home stay in their homes, contributing to the price declines. The initial $1.5 billion went stabilization of house prices in 2010. to the states with the largest declines in sin- gle-family home prices—California, Nevada, Arizona, Florida and Michigan. FUNDAMENTAL In March 2010, another round of funding IMPROVEMENTS was announced, this time targeted at the states with the highest proportion of resi- Several fundamental improvements in the dents living in counties with unemploy- single-family housing market are con- ment rates of more than 12 percent. Up to tributing to increased demand for for-sale $600 million in emergency aid will be dis- housing, bolstering the aforementioned tributed to agencies in Ohio, North government efforts and supporting a real Carolina, Oregon, South Carolina, and single-family housing market recovery. Rhode Island. Positive trends, including improved Fannie Mae and Freddie Mac have also affordability levels due to price declines started programs to help stabilize the hous- and low mortgage rates, are critical to a ing market. In November 2009, Fannie single-family housing recovery and price Mae announced its “Deed for ” pro- stabilization. gram, which rents-out properties to own- Affordability is measured as the num- ers who do not qualify for loan modifica- ber of households with sufficient income tion. Borrowers will transfer their to purchase the median-priced home uti- to Fannie Mae, which will then rent the lizing a conventional, thirty-year fixed rate same property back to them at market mortgage with an 80 percent loan-to-value rents. Freddie Mac has a similar initiative. ratio and spending 31 percent or less of These programs will help communities household income for mortgage payments

THE WHARTON REAL ESTATE REVIEW, VOL. XIV, NO. 1, SPRING 2010 and property taxes. Affordability is a pri- percent annually during the same period. mary driver of housing demand as it indi- In addition to the demand that tradition- cates the share of households that are able ally stems from owner-occupiers, strong to afford a median-priced home in a given demand from speculative investors inflated area. Affordability was at record lows at the the home price bubble. In Miami and Los peak of the boom, despite relatively low Angeles, 15.2 percent and 11.2 percent of mortgage interest rates, because strong mortgages, respectively, were used to pur- demand and speculative investors drove up chase investment property in 2005. As the the median price in many markets. For price of a single-family home grew unaf- example, in Miami affordability fell to a fordable for the majority of households, low of 16.4 percent in 2005 from 40.2 many chose to utilize exotic mortgage percent in 2001. During the same period, instruments to stretch their income further the median price of a single-family home in order to purchase a home. The negative increased by an average of 22.5 percent consequences of these practices are now annually from year-end 2002 through widely understood. year-end 2005. Similarly, affordability As the bubble deflated, home values dropped to 11.8 percent in Los Angeles in dropped and contributed to a jump in 2005 from 32.9 percent in 2001, while the affordability levels. In the largest 75 met- median price increased an average of 21.9 ropolitan statistical areas, 58.3 percent of

Figure 5: U.S. Single Family Housing Affordability

60%

55%

50%

45%

40%

35%

30% 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

THE WHARTON REAL ESTATE REVIEW, VOL. XIV, NO. 1, SPRING 2010

1,600 25%

1,400 20% 1,200

1,000 15% 800 10% 600 Thousands Market Share

400 5% 200

0 0% Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Households Buying FHA Homes FHA Market Share of Homes Purchased households were able to afford the medi- many areas increased sharply. When an-priced home in the third quarter of adjustable rate mortgages began to reset 2009, up from an annual low of 40.1 per- and many households found themselves cent in 2005. Sustained high affordability unable to afford the monthly payment, levels will be a major demand driver going foreclosures started to increase, further forward, helping to stimulate sales activity compounding the effects of high invento- and stabilize the market. Already, ry levels. Partly as a result of these negative improved affordability is fueling sales at trends in housing, the national economy the low end of the market, with first-time entered the “Great Recession” and sky- homebuyers taking advantage of the feder- rocketing unemployment contributed to al tax credit, FHA loans, and cut-rate an increase in the number of foreclosures. prices to purchase homes. Coupled with All of these factors resulted in price improved affordability levels, the expan- declines, bringing the median price back sion of the tax credit is also driving to a more affordable level. With the econ- demand for mid-range, “trade-up” homes. omy now entering a recovery phase and Through the remainder of 2010, housing affordability back to sustainable improved affordability levels will lead to levels, demand has picked up, particularly higher sales volumes, driving the overall with the aid of government intervention, stability of the single-family housing mar- thus creating a market environment that ket. Notably, it was the decline in prices supports home price appreciation. during the last four years that pushed During the fourth quarter of 2009, the affordability back to sustainable levels. national median price of a single-family Improved affordability levels are largely home declined 4.0 percent year-over-year a result of a decline in home prices, as well to $172,900. However, this is an improve- as historically low mortgage interest rates. ment from the low of $167,300 during the The decline in home prices, however, first quarter of 2009. Government inter- stemmed from oversupply, weak demand vention in the housing market helped sta- as a result of fewer credit options, and poor bilize prices during the last three quarters economic conditions. Strong demand for of 2009 and, despite modest increases, single-family housing during the boom still-low home prices will contribute to period, prompted by low mortgage inter- demand through the remainder of 2010. est rates and easy access to credit, caused Because prices have stabilized, with the builders to construct homes at a rapid national median price averaging approxi- pace, in some cases ahead of demand. As mately $175,000 during the final three the market unraveled, inventory levels in quarters of 2009, we expect a slight annu-

THE WHARTON REAL ESTATE REVIEW, VOL. XIV, NO. 1, SPRING 2010 Figure 6: Median Home Price Appreciation

20%

14.3% 15% 14.1% 12.8% 13.6% 10.6% 11.0% 9.8% 10% 8.8% 8.8% 8.2% 8.5% 6.7% 7.4% 6.9% 6.0% 6.1% 6.7% 5% 4.5% 4.5% 4.4% 4.5% 4.7% 4.8% 4.6% 3.8% 3.7% 3.5% 2.8% 3.2% 2.0% 2.4% 2.3% 0%

Annual % Chg -0.8% -2.8% -5% -4.0% -6.1%

-10%

-12.4% -15% 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010f

al increase in the median by the fourth However, compared with November, quarter of 2010. Even with the expected when the tax credit was initially sched- increase in mortgage interest rates, afford- uled to expire, existing home sales ability will remain relatively high, stimu- declined by 16.8 percent, reflecting a lating sales activity among buyers with sta- “bunching up” in demand. The extension ble incomes. Additionally, buyer demand of the tax credit to include homes closed will be driven by improving employment by June 2010 and the expansion to most conditions during the second half of 2010, buyers could create a surge in home sales which will further stabilize home prices during the spring of 2010, with more and preserve the price gains produced in sales occurring during the final months the first half of the year. before the program’s expiration date as Already sales activity has improved buyers scramble to take advantage of the with the implementation of government credit. People who were planning to pur- programs and improving demand-side chase a home in 2010 may accelerate drivers, particularly benefiting sales in the their purchase to the first half of the year. low- to mid-price ranges. Home sales Although a drop-off in sales activity is activity increased by 12.7 percent year- inevitable once the credit expires, we over-year in December 2009 according to believe the drop-off will not be significant the National Association of Realtors. enough to stall the housing recovery.

THE WHARTON REAL ESTATE REVIEW, VOL. XIV, NO. 1, SPRING 2010 Figure 7: U.S. Months Supply by Price Range

18 $1M+ 32.4

11.9 $750K-$1M 19.7

10.5 $500K-$750K 17.9

8.5 $250K-$500K 12.1

7.1 $100K-$250K 8.6

5.7 $0-$100K 6.3

0510 15 20 25 30 35 Months of Supply Dec-08 Dec-09

Sales have been concentrated in the was 7.1 months. In contrast, the months’ low- to mid-price range, as the tax credit supply of homes priced at more than $1 initially applied only to first-time buyers. million was 18.0 months in December However, inventory levels have come 2009. Competition for assets at the low down markedly at all price ranges, reflect- end of the market effectively raised the ing strong demand. The supply of existing home price floor. This trend countered the single-family homes declined 11.3 percent negative skewing effect foreclosure sales year-over-year to 2.8 million homes in previously had on median price statistics December 2009. Even as credit has been and as a result home prices have stabilized. expanded to include all buyers, these buy- Builders are eager to capitalize on this ers are mainly targeting entry-level and trend and have been building more homes trade-up homes, rather than homes priced in the entry-level and trade-up price ranges far beyond the median price. Therefore, to take advantage of increased demand in the months’ supply of low- and mid-priced these segments, as well as to compete with homes is markedly less than the months’ foreclosures in some markets. supply of higher-priced homes. In Single-family housing starts have December 2009, the months’ supply of picked up in conjunction with declining homes priced from $100,000 to $250,000 inventory levels at the low- to mid-price

THE WHARTON REAL ESTATE REVIEW, VOL. XIV, NO. 1, SPRING 2010 range. Some builders are taking advantage will drop off during the second half of the of cheap land opportunities and the year when the tax credit expires, mirroring demand created by the extended and the trend in sales, but this will control expanded homebuyer tax credit. Some inventory levels through the remainder of builders lost sales during the last quarter of the year. 2009 because they did not have enough An increase in the number of new homes available for sale to buyers wishing homes will add to inventory levels in the to take advantage of the initial tax credit. short term, but a majority of these homes Single-family housing starts reached a are entry-level or trade-up homes, and will recent peak of 508,000 units at a seasonal- be in demand from those utilizing the tax ly adjusted annualized rate in September credit to purchase a home. The increase in 2009 as builders hoped to take advantage starts signals builder confidence in the sin- of the then-expiring tax credit. Starts gle-family housing market recovery as dropped to a 471,000 seasonally adjusted much as it reflects their desire to take annualized rate in October 2009, but advantage of the tax credit to boost their increased to 502,000 seasonally adjusted own sales. Although home sales activity annualized starts in January 2010. Starts could surge during the spring of 2010 in have increased at a marginal level, howev- response to the tax credit, seasonality fac- er, limiting the risk of oversupply. Starts tors should sustain a reasonable level of

Figure 8: Single Family Housing Starts

1.8 1.7 1.6 1.6 1.6 1.4 1.4 1.4 1.4 1.4 1.3 1.3 1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.1 1.2 1.1 1.2 1.1 1.1 1.1 1.1 1.1 1.1 1.0 1.0 1 0.9 0.9 0.9 0.9 Millions 0.8 0.8 0.8 0.7 0.7 0.6 0.5 0.4 0.4

0.2

0 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009

THE WHARTON REAL ESTATE REVIEW, VOL. XIV, NO. 1, SPRING 2010

18 $1M+ 32.4

11.9 $750K-$1M 19.7

10.5 $500K-$750K 17.9

8.5 $250K-$500K 12.1

7.1 $100K-$250K 8.6

5.7 $0-$100K 6.3

0510 15 20 25 30 35 Months of Supply Dec-08 Dec-09 demand through the fall of 2010 because The greatest headwind to the housing more homes are typically sold in the market recovery is the foreclosure prob- warmer spring and summer months. lem plaguing most markets. Even if Additionally, as employment conditions employment conditions improve as continue to improve, demand should expected, foreclosures could continue to strengthen. These factors should keep mount despite government intervention. inventory levels from increasing to unsus- Those who own a home worth less than tainable levels, particularly in the low- and the value of their mortgage, considered mid-priced ranges. “underwater,” have less incentive to repay Despite the many positive factors ben- their loans despite the negative stigma efiting the single-family housing market, associated with strategic default. In some notable headwinds remain and could cases, these households are able to afford threaten the housing market recovery in the mortgage but choose not to repay 2010. Affordability has improved, employ- because the value of the asset has declined ment conditions are stabilizing, and inven- to such an extent that it makes little tory levels are more sustainable; however, financial sense to continue, despite the high long-term unemployment could credit risks associated with such practices. exacerbate the foreclosure problem, which In the same vein, many households are could drag down prices. Additionally, simply unable to pay their mortgage higher mortgage interest rates and restric- because of employment troubles or high- tive lending requirements could further er monthly payments following a rate temper demand during the second half of adjustment on their loan. Further, those the year. households with a home valued at less While we think the bottom in the sin- than the value of the mortgage are often gle-family housing market has been unable to sell their home at a price high reached, the recovery faces significant hur- enough to cover the mortgage, and with dles. Even as the first signs of recovery few options available are forced to endure emerge, headwinds persist for the housing a short sale. market in the form of ongoing foreclo- Already, problem loans are at all-time sures. Additionally, mortgage qualification highs. The share of loans considered requirements may tighten further when delinquent, or more than thirty days late, certain government programs end. This, increased to 9.5 percent during the fourth compounded with higher mortgage inter- quarter of 2009 from 7.9 percent in the est rates, could further hurt demand in the fourth quarter of 2008, and from 5.8 per- second half of 2010. cent during the same period in 2007. All

THE WHARTON REAL ESTATE REVIEW, VOL. XIV, NO. 1, SPRING 2010 Figure 9: Total Non-Performing Loans by Type

45%

40%

35%

30%

25%

20%

15%

10%

5%

0% 2Q05 4Q05 2Q06 4Q06 2Q07 4Q07 2Q08 4Q08 2Q09 4Q09

Subprime Option ARMs Alt-A Jumbo prime Agency prime

of the problems facing homeowners credit policies also pose a similar risk, as could push foreclosures higher, which private lenders could respond by increas- would drag down prices in some markets ing their mortgage lending standards to and stall the housing market recovery. the same effect. These federal actions rep- Further compounding the foreclosure resent another uncertainty that could problem, the employment recovery could prove a headwind to the housing market be weaker than we expect, which would recovery. stifle demand during the second half of In addition to the risks posed by high the year. Sustained high unemployment unemployment and a spike in foreclo- levels and lack of job creation could both sures, a rise in mortgage interest rates decrease home sales and add to foreclo- beyond our forecast could prematurely sures. Should this occur, home prices will stifle demand for housing while the mar- recover more slowly as demand falls and ket is still recovering. Higher mortgage supply increases. interest rates would decrease affordability Similarly, a pullback in the number of and cause many households to delay mortgages guaranteed by the government home purchases. This drop-off in would lead to stricter mortgage qualifica- demand would weaken sales and price tions, putting homeownership out of growth, representing another headwind reach for many households. Tightening to a housing market recovery.

THE WHARTON REAL ESTATE REVIEW, VOL. XIV, NO. 1, SPRING 2010 CONCLUSION an home price during the next few months. Additionally, the expanded tax We expect the median price for existing credit to higher income and repeat buyers single-family homes to increase by 2.3 will increase trade-up activity. The com- percent in 2010. This relatively positive bination of increased competition, partic- outlook is due to increased housing ularly in the low and middle price range, affordability across the country and and rising confidence should serve to sta- aggressive policy moves made by the bilize home prices. Federal government in the past year. A Government policies will start to be high level of affordability will drive phased out in the next year, but we demand for housing; however, improved believe the national economy and job sit- affordability does not mean that everyone uation will be improved by year-end, sus- who can afford to become a homeowner taining housing demand through the will choose to buy. Instability in the job remainder of 2010. Those who are market is still a major factor in acquiring already considering buying a home in a loan and in making purchase decisions. 2010 could advance their purchase to the As such, even as sales improve compared first half of the year to take advantage of with the lows of recent years, market con- the government programs. Additionally, ditions will remain fragile, with prices sta- because many households prefer to pur- bilizing but not improving much through chase a home in the spring and summer the short term. As consumer confidence months, seasonality will play a role in sus- grows with the recovery of the overall taining housing demand. The tax credit economy, increased sales at the middle will result in sales “bunching up” toward and upper ends of the market will con- the first half of the year, but as the overall tribute to an increase in the median price economy improves and the employment during the next couple of years. situation stabilizes, demand during the On the supply side, foreclosures will second half of the year will be healthy remain elevated, but not spiral out of enough to support median price growth. control, in part due to government action as well as stabilized employment. Most of the homes that do become bank-owned will add to entry level-priced inventory, the exact segment of the market being stimulated by the federal housing tax credit, reducing the impact on the medi-

THE WHARTON REAL ESTATE REVIEW, VOL. XIV, NO. 1, SPRING 2010