Will the foreclosure freeze hurt or help the housing recovery?

tT"u HousrNc eusr after the boom I years in 2002-2006 has been without historical precedent. The cause of this cycle was not tight money, but rather the correction for the overbuilding and easy lending standards during the bubble phase. As we have stated on several occasions, the problem this time is an inventory correction. Despite record low mortgage rates and high levels of affordability, home sales have remained depressed, except for the small surge due to tax incentives.

An inventory correction process in any industry requires that production remain below demand until the excess inventory is eliminated. Only then will you see a sustained rebound in production (housing starts). The excess inventory has three components. One is vacant stock of "owner" units (primarily single-family, but also condominiums). Using historical vacancy rates and estimates of foreclosed units that are vacant, this excess inventory is about 1.3 million units.

Another inventory problem is in rental units. The current vacancy rate of lO.6Vo would suggest about l-1.2 million units of excess rental units. Finally, there is the "hidden" inventory of units that are yet to be foreclosed. Currently, about 8Zo of all home loans (or 4.2 million loans) are either in the foreclosure process or over 90 days delinquent on payments.

The recent freeze in the foreclosure process will have a profound effect on the crucial questions facing business- es dependent on the housing industry. When will sustained recovery begin? What will the shape of the recovery look like? What will the mix of units be?

At the time of the freeze, almost I million houses would have been taken over in the foreclosure process during 2010. The problem is not that people could fix the problem if given more time, but rather that they have fallen behind on payments for one of two reasons: either they have lost theirjob and cannot make the payments or they choose to quit making payments because the house value is now less than the outstanding mortgage. The financial system became overloaded by the sheer volume of foreclosures and a rush to get the troubled assets off the balance sheets.

Although a rapid elimination of this "hidden" inventory is highly desirable, it does need to be done legally and carefully. However, this freeze will delay the correction, not eliminate the need to correct the problem. Home sales will plummet, since aboil 30%o of existing home sales were foreclosed units. The financial institutions will have to add staff and ensure proper legal procedures are followed to proceed again. Although this slowdown might take some pressure off of home prices in the near term, it just means an even bigger problem in 201 l. The backlog of foreclosures will build, adding to the uncertainty on home prices in 20ll and2012.

With 4.2 million homeowners already behind on their payments. foreclosure rates will remain hish through 2011. Although home pric-es rebounded this year (up about 3.52o nationally according to the CaseShiller index), some housing experts believe home prices will fall again next year. This means the negative equity problem is not going to be eliminated by rising home prices. Shifting foreclosures from 2010 into 2011 increases the probability that home prices will fall further next year when another surge of foreclosed units hits the market. If potential buyers are concerned about house prices, then they will defer purchasing for at least another year or two.

With the foreclosure process getting more difficult and expensive, the financial system will become even more careful in making new loans. Already restrictive lending standards could become even more stringent. So unlike the easy lending period in 2002-2006, the current criteria will force younger families to defer ownership until they can save enough money for a down payment or get sufficient verifiable income to meet lending standards. Because of the easy lending standards, home ownership in 2002-2006 rose above 69Vo and the share of single-family units for that period was abovel1%o.

Although it is too early to tell how the freeze will affect the overall housing recovery, it is likely to have a profound effect on the mix of units built over the next three years. By delaying the inventory correction of singlefamily units, lowering expected home prices, and making lending standards even more onerous, the multifamily segment could benefit. People who lose their homes have to live somewhere. Younger families will have to defer ownership. No one believes housing will be a good investment (unless you can get a great deal on a foreclosed unit). After defaulting on a mortgage, these households will be excluded from ownership for several years.

Thus, as the economy rebounds and employment recovers, we should see the vacancy rate for rental units drop quickly in 2011. Unlike singlefamily units, multifamily units are financed as a commercial property and the due diligence depends on the projected financials of the project, not on the owner's income.

Bottom line: the freeze in the foreclosure process is likely to delay a sustained recovery in single-family starts and is likely to contribute to a shift in construction towards multifamily units. This will dampen the recovery in wood products demand given the much lower lumber and panel usage in multifamily units compared to single-family starts.

- Dr. Lynn Michaelis, former chief economist for Weyerhaeuser, is a senior associate of RISI. He can be reached at (206) 434-8 1 02 or lmichaelis@risi.com.

RISI is a leading information provider for the global forest products industry and publisher of Crow's Weekly Market Report, the longest-running source of prices in the North American lumber and panel industry. Sign up for a free trial subscription to Crow's at www.risiinfo. com/crows.

Two Coat €xterior Prime

0ur two-coat process starts with an atkyd seater to block tannin migration, foltowed by a high-performance acrytic primer. The resu[t: RESERVE quatity, inside and out.

Superior Wood

Made of quatity, clear, finger-jointed Western Red Cedar or Redwood, these products are naturatly designed for exterior use-both species are ideaI for enduring extreme weather.

Surfacing + Sizes + Lengths

RESERVE products come in a wide range of sizes, [engths and f inishes. Whether the project catts for S1S2E or 54S. we offer [engths ranging from 16' to 20'. Pattern stock is also avaitabte.

3.x4 - 1"xt2 s/ayQ - s/axl)

2x4 - 2xI2

The Finest Stock, TheBestCoating

Our Siskiyou Forest Products RESERVE line is specially manufactured and treated to create the highest quality product available. Using state-of-the-art application and curing equipment, our premium Western Red Cedar and Redwood stock is made to last for many generations. We are proud to offer a beautiful, durable product that is ready for installation and final painting the moment it reaches the craftsmen.

By Carla Waldemar