20 million underwater mortgages by 2012?

Smart Real Estate News & Commentary by Chris McLaughlin August 5, 2010 

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20 million underwater mortgages by 2012?

More than 14 million borrowers were underwater as of Q110, and with a further 10.8% decline in house prices expected relative to Q409 levels, another 6 million borrowers are likely fall into negative equity by the end of 2011, according to commentary today by Deutsche Bank.  The presence of negative equity goes hand-in-hand with an increased likelihood of strategic default, as borrowers may sometimes not be willing to pay the mortgage when the house has lost substantial amounts of value.  The firm noted that, even when strategic default makes economic sense, many borrowers resist on moral and social grounds, as well as from fear of legal consequences.  The existence of recourse — when a lender is able to pursue a borrower’s other assets — also acts as a disincentive against strategic default. 

Deutsche Bank noted 11 states are considered non-recourse — though not all explicitly forbid deficiency judgments on homes or on purchase loans. Underwater borrowers are more likely to default in non-recourse states. The greater the negative equity, the higher the cumulative default rate.  “Walk away or strategic default from a house with negative equity makes economic sense, especially in locations that have less expensive rentals,” Deutsche Bank researchers said.  “Many existing academic studies model homeowners’ default decision based on the theoretical hypothesis that a borrower would exercise a default when it is in-the-money, i.e., when the borrower’s house has negative equity. Therefore, a homeowner with negative equity would default even though they can still afford to make their mortgage payments.

Final tax credit lift in prices

According to Clear Capital’s Home Data Index Market Report, July house prices gained 8.1% from the same point last year, slowing somewhat from the 8.8% growth measured in June as the effect of the homebuyer tax credit begins to fade.  July house prices increased 7.9% from the previous three months, an improvement from the 5.2% growth seen in June. Alex Villacorta, senior statistician at Clear Capital said home prices are continuing their growth from the beginning of the year.  “This trend indicates that the initial upward momentum created by the tax credit expiration is being sustained,” Villacorta said. “While quarterly gains are showing strong momentum across the country, these recent price advancements are just the latest turn in a volatile housing market that has seen ‘W’ shaped price trends over the last two years.” 

Morgan Stanley analysts warned that data from these large indices should be taken with a grain of salt as local markets can deviate from one another despite larger macro trends. Scott Sambucci, vice president of data analytics at Altos Research, brought up similar concerns when he predicted further declines through 2010.  Prices in the West have been stable compared to rest of the market, increasing 2.7% in July. It has bounced between a 1.6% drop to the latest gain in July since the start of 2010.  On the metropolitan statistical area (MSA) level, Charlotte, North Carolina demonstrated more stability than the nation, much like the West. Prices there declined only 13% since its peak in the middle of 2007, while, national prices have dropped more than 30% since its height in the middle of 2006.

Jobless claims up

The Labor Department says there were 479,000 initial jobless claims filed in the week ended July 31, up 19,000 from a upwardly revised 460,000 the previous week.  The weekly figure is the highest since April 10, when 480,000 initial claims were filed.  The number of claims was higher than the 455,000 claims expected in a consensus estimate of economists surveyed by Briefing.com.  The 4-week moving average of initial claims, which is calculated to smooth out volatility, was 458,500, up 5,250 from the previous week’s upwardly revised average of 453,250.  The government said 4,537,000 people filed continuing claims in the week ended July 24, the most recent data available. That’s down 34,000 from the preceding week’s upwardly revised 4,571,000 claims.   Economists surveyed by Briefing.com were looking for 4,530,000 ongoing claims.  The 4-week moving average for ongoing claims climbed by 25,750 to 4,575,500 from the preceding week’s upwardly revised 4,549,750.  The latest claims data has little bearing on the government’s closely watched employment report for July, due on Friday, as it falls outside the survey period.

Beazer homes posts larger loss than expected

Beazer Homes USA posted a bigger-than-expected quarterly loss as the expiration of the federal homebuyer tax credit caused orders to plunge in May and June.  For the third quarter, Beazer reported a loss of $27.8 million, or 41 cents per share, compared with the loss of 25 cents per share expected by industry analysts, according to Thomson Reuters.  Last year, the company reported a loss of $28 million.  Homebuilding revenue jumped 52 percent to $339.9 million.  Analysts on average expected the company to post revenue of $325.1 million, according to Thomson Reuters.  Home closings rose 73 percent to 1,643 homes as buyers and builders alike rushed to close on home sales before the tax credit’s June 30 deadline.  But orders fell 32.5 percent to 1,037 homes.  “Homebuyers continue to be concerned about employment, the impact of additional foreclosures and general conditions in the economy,” said Chief Executive Officer Ian McCarthy. “We believe employment growth and improved consumer confidence remain the keys to a sustainable recovery in the homebuilding industry.”  Atlanta-based Beazer, the eighth-largest homebuilder in the United States, operates in 16 states.

Tax the rich?

If Congress fails to act in extending the Bush tax cuts, taxes on most Americans would go up next year — adding $1,541 to the average household payment, by one estimate.  Taking that money, a total of $135 billion, out of the pockets of consumers and small businesses could be a devastating blow to the fragile economy.  Every American who pays federal income taxes would see them increase if the tax cuts expire, according to the nonpartisan Tax Foundation. A typical middle-class family with a median income of $63,366 would pay $4,964 in taxes next year if the cuts expire, well above the $3,423 tax it would pay if cuts were extended.  President Obama and Treasury Secretary Timothy F. Geithner want to continue the tax cuts for lower income people, but have made it clear they want big tax hikes on job creators – successful investors and entrepreneurs – by letting the Bush tax cuts expire in 2011. This is despite the troubling persistence of unemployment greater than 9 percent.   

According to Caroline Baum of Bloomberg, squeezing the rich is no way to spur the economy.  “What we do know, empirically, is this: Over time, federal revenue as a share of gross domestic product has stayed fairly constant at 17.9 percent. That’s true if the top marginal tax rate is 91 percent (1950s), 50 percent (early 1980s) or 35 percent (2000s). Now the government wants to take money from the rich and give it to the poor. “They are wrong,” Laffer says. “It doesn’t work that way. The rich can change the volume, timing, composition and location of their income. Poor people can’t.” The rich have the luxury to respond to incentives, to opt for more work and less leisure when the return on work is greater. They are motivated to take risks, maybe start a business, invent something, and get even richer while giving others the opportunity, through hiring, to do the same. 

The opposite is true for low-income workers. When the government raises taxes, someone struggling to put food on the table for his family may have to go out and get a second job to maintain his level of take-home pay. For this socio-economic group, higher taxes translate to more work.  The goal should be to incentivize individuals to work hard, save and invest in the future. It’s about growing the pie.  I, for one, would like to see the debate shift from class warfare over tax rates and targeted tax relief to tax reform. Either scrap the tax code and introduce a simple flat tax with no deductions, or scrap the IRS and move to a consumption tax.  If you want to get money out of politics, there’s only one way to do it. Take the tax code out of Congress’s hands.”

Now for our real estate education section…

Crisis Control

Real estate is like any other business…sooner or later you will encounter a crisis. It may come in the form of a nationwide financial meltdown that disrupts funding for millions or something as simple as an overtly negative individual. Whatever the form, learning how to mitigate damages and restore a positive attitude is a key component to success.

1. Don’t be Defensive. Many old-timers will tell you dog can smell fear…the same applies to an audience whether it be your banker or a real estate seminar. People understand power and often turn against those that are perceived as weak or on the defensive. Remember, actions speak louder than words so guard your voice, words and body language.

2. Never Repeat a Negative Question. Rather than reinforce a negative question, try to rephrase it or move ahead. It’s better to take a small hit than give more time to an issue unless it is absolutely essential.

3. Never Blame Others. It puts you in a bad light and tends to make people distrust you…plus, it leaves people wondering what you might say about them behind their backs.

4. Don’t Argue. You might be right but the chances of convincing someone else decrease the more they defend their position to you. Instead, validate their position and explain your own thinking or simply move ahead. Not only does it conserve energy but it frees your mind from the feeling of dependence and allows you to see things from a different perspective.

5. Irrelevant Questions. This is perhaps one of the most frustrating situations for an investor or real estate pro to encounter…endless, tiresome and totally irrelevant questions. Unlike overly aggressive, negative or argumentative clients it’s not possible to simply “agree to disagree” and move on; instead, you must assume the person simply doesn’t understand or has a different agenda. If it’s possible to anticipate where they went wrong, try to bail them out to help them “save face”…it shows concern and sensitivity.  For those with their own agenda, try to determine if it is “helps” or “hurts” your position then act accordingly.

6. Plan for Murphy’s Law. Remember Murphy? Whatever can go wrong will go wrong so plan ahead for it. Put contingencies in place especially when it matters the most. For example, when planning an open house be sure to plan for inclement weather. Putting together a big media blitz, find another venue to publish in case the first falls through. Taking out a private loan, have a second on standby.

See you at the top!

Chris McLaughlin
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Copyright Loss Mitigation Institute LLC 2010.

All Rights Reserved.

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About the author:

Chris McLaughlin is widely known as America’s top
Real Estate Attorney and Investment Consultant.

    * As the top Florida foreclosure and pre-
      foreclosure expert, he oversees more than
      100 short sale & REO closings each month
   * Long-time authority on real estate investing
      and rapid reselling of distressed homes.  Owns
      portfolio of nearly 100 high-value, high-profit
     properties
    * Owner of one of Florida’s largest Real Estate firms,
     running 4 different offices, supporting over
     400 agents, uniquely positioning him to help
     thousands of investors make money in the
     biggest market opportunity ever!
    * Highly sought-after speaker, consultant, and
      seminar leader for current trends and hot topics
      in Real Estate Investing, Entrepreneurship, and
      Wealth Building
    * Follow me on Twitter: http://twitter.com/mclaughlinchris
    * Join my Facebook Fan Page: http://www.mclaughlinchris.com
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