Is Housing Nearing the Floor?

The last piece of the last residential construction crane in Miami is coming down, and locals don’t expect to see another one for a while. Developers threw up some 23,000 housing units along South Beach and its environs beginning in 2003, many of them bought by speculators who thought they could flip the properties for a quick profit. Then the music stopped. “Our best guesstimate–and we’ve talked to lenders and developers–is that you will not see a residential construction crane in the sky in downtown Miami for a generation,” says Peter Zalewski, a real estate broker and founder of Condo Vultures, a realty-intelligence service. “Well, at least seven years,” he says before modifying his forecast yet again. “Let’s go with a decade,” he finally concludes.

When it comes to the U.S. housing market, it’s sensible to plan for the worst. The latest Case-Shiller Home Price Index for a 20-city composite showed that prices recorded a 1% drop in August and were down 17% for the past 12 months. Miami had a 2% monthly drop and a 28% tumble over the last year; in San Francisco it was −4%, and −27% for the year.

But the picture is brightening in pockets of the country, where there are nascent signs of a bottoming: the rate of decline slowed in August, according to Case-Shiller, and in September, existing home sales rose 6% nationally. That means buyers are finally being lured to the market by low prices. In Los Angeles, and even in Miami, there is evidence that the housing market is lifting its head off the deck, even as foreclosures continue to pile up and prices edge downward. Some banks are grudgingly agreeing to short sales–that is, selling below the mortgage amount–and doing some workouts. For owners, buyers and policymakers, such signs of a recovery raise a big question: Will a recession that is gaining momentum break through housing’s floor again? In other words, is this real estate’s dead-cat bounce?

Oddly enough, talk of a possible federal mortgage bailout is slowing deals. “Recently, a lot of the financial institutions have stopped accepting short sales to find out if the government is going to buy their loans that are in default. They’re waiting to see what happens with the recent rescue plan to buy back mortgages,” says Fred Arnold, president of the California Association of Mortgage Brokers. In Miami, banks can’t wait to throw underwater mortgages into the government’s pool. Says Zalewski, “I can see the Federal Government giving them a mulligan and allowing them to sort of do a do-over.”

He can expect a do-over from the outgoing Administration, but not a paper-over that would rescue speculators. FDIC chief Sheila Bair has been pushing to use new loan-guarantee authority passed under the $700 billion banking bailout to adjust troubled homeowner mortgages. The plan would provide $50 billion from the government to be tapped as insurance for banks willing to adjust mortgages in a loss-sharing agreement. The FDIC would guarantee any losses on loans readjusted for homeowners who can show a 38% debt-to-income ratio, similar to what the FDIC worked out for the 60,000-odd bad loans it ate when it closed IndyMac bank.

The idea is to save people whose loans are salvageable from being tossed out of their homes, thus preventing even more inventory from being dumped on the market. “We still think foreclosures are a major issue for borrowers, homeowners and the housing market generally,” says a source familiar with Bair’s negotiations with the Treasury Department. A deal of some sort is expected within weeks.

How much the next President would further change any plan isn’t clear. Both John McCain and Barack Obama have promised aggressive, but as yet vague, action on housing. McCain’s proposals are more radical: getting the government to buy a large swath of the bad mortgages at cost and replace them with FHA-guaranteed, fixed-rate ones. But that plan could be seen as having a dampening effect on any bottoming in the housing market. Why? If owners know they can dump their illiquid home loans cost-free on the government, they have little incentive to sell.

Obama has proposed slightly less market-skewing alternatives. He wants to create incentives for banks to buy or refinance existing mortgages. He supported the so-called cram-down rule that would allow judges to modify mortgages when homeowners file for bankruptcy, a measure that was axed from the Wall Street bailout package.

Whatever the government does, home sellers had better resign themselves to lower prices. Nationally, the inventory of unsold homes is still large. In the greater Miami area, there are 110,000 single-family homes, condos and town houses for sale. Some 55,000 new foreclosures were filed in the first nine months of this year, and an additional 19,000 properties were taken back by lenders. In California, the median price for houses has dropped 41% in a year, according to the California Association of Realtors. In the L.A. area, the outlying suburbs of San Bernardino and Riverside have been hardest hit because of the number of homes owned by more marginal borrowers.

But even without government intervention, sales of distressed properties are up significantly. In and around Los Angeles, housing sales were up 83% in September over the prior year, with distressed properties notably contributing to the surge. “We’re seeing a significant increase in sales activity over the past four or five months, but it is the moderate to low-end distressed properties–including foreclosures and short sales–that are showing really very significant increases,” says Leslie Appleton-Young, chief economist for the California Association of Realtors.

Not all areas of the country are suffering equally. In Dallas, which never had a bubble, there has been no bust. Houses are selling on average in 81 days, below their 90-day historical average. Only the million-dollar homes are slow to move. In late September, Donald Trump stood atop his new, 92-story condo-hotel tower just off Chicago’s Michigan Avenue. “There’s an economic disaster going on in the country,” Trump dryly acknowledged. “A lot of things you think will be built in Chicago and elsewhere will never happen. But we got this one built, and we’re proud of it.”

Getting it built and getting it sold are not the same thing. Many of the gleaming building’s units remain unsold, and The Donald’s lenders are looming. Roughly 75% of the 4,900 condominium units under construction in downtown Chicago are already sold. That’s good, but next year the number of new units coming onto the market is expected to drop to 4,600, and only 60% are sold, according to Appraisal Research Counselors, a consulting firm that tracks downtown Chicago real estate.

Experts say some areas of downtown Chicago are most likely to recover first. But it is the areas that were just beginning to experience redevelopment, or any development, where recovery is likely to be the most drawn-out, if it happens at all.

There are too many moving parts in the economy now to say when things might hit bottom. But what is in place–realistic pricing, some banks willing to deal and maybe a mortgage bailout–should provide some friction against a big slip. That should allow home buyers to take some comfort–and sellers to make some cash.