Podcast: 'Strategic' defaults in the recovering real estate market

March 17, 2010

The Phoenix resale home market rebounded slightly in February, according to the Realty Studies Report from the W. P. Carey School of Business. Compared to January, the number of transactions increased and prices were up a bit. Still, foreclosures accounted for 42 percent of the total market, and the sale of previously foreclosed properties made up 40 percent of the traditional sale segment. Meantime, market watchers are wondering what will happen when the many Adjustable Rate Mortgages (ARMs) reset this year and next. We asked  Jay Butler, associate professor of real estate and author of the report, what he thinks about that, and what else he noticed in the February data. (9:20)

Transcript:

Knowledge: The Phoenix resale home market rebounded slightly in February according to the Realty Studies Report from the W. P. Carey School of Business. Compared to January, the number of transactions increased and prices were up a bit. Still, foreclosures accounted for 42 percent of the total market, and the sale of previously foreclosed properties made up 40 percent of the traditional sales' segment.

Meantime, market watchers are wondering what will happen when the many adjustable rate mortgages reset this year and next. We asked Jay Butler, associate professor of real estate and author of the report, what he thinks about that and what else he noticed in the February data.

Butler: Well basically, you're beginning to see some stabilization of prices in some areas. They're not necessarily going up or anything, but they're not sort of in freefall; especially in areas that like Gilbert and Chandler, some of the more prominent home buying areas. Foreclosure activity as a share of the market is still very high, over 40 percent, but the absolute number is beginning to decline; leading to some expectation that later this year we will begin to pull out of the foreclosure mess. Any time you're in a transition year, it doesn't go smoothly. You get data that may conflict with other data. Just shows the market is in its throws of trying to change, hopefully, for the best at this particular time. We also know that a lot of lenders were had moratoriums on foreclosing homes around the holidays and should be picking up more activity in the next several months.

Knowledge: It's not time to breathe a big sigh of relief yet.

Butler: There is an expectation that Spring may be around the corner, but it is not definite yet.

Knowledge: Okay. We know that there are a large number of ARM resets, adjustable rate mortgage, resets expected in 2010 and even more in 2011. We were wondering what percentage of the market these represent and how significant of an effect will it be if a large number of them go into foreclosure? What do you think? What's up there?

Butler: Well, the issue on the reset is that your mortgage payment might go up, and there are all sorts of if, ands or buts. Some of these are preset. In other words, they will go to a certain interest rate; others only to a market rate. The question then gets to be can you afford this monthly payment, or do you want afford this monthly payment. So that's sort of the reset issue.

There is some discussion that some of the numbers that have been talked about probably aren't as accurate. It's really done on a survey-type process, and the feeling is that a lot of these people have already lost their homes in foreclosure. Or have refinanced if they can, because they know well what's coming down the line, so there is some concern.

There is no doubt that there will be some resets or presets coming up in the next several months that could add to the foreclosure, but it may be more of a choice situation, a strategic default. Your payment has gone up significantly. Your home value has dropped. You just don't want to maintain this particular home at this time.

Knowledge: What do the differences look like between the cities in the Metro area? Are the markets behaving similarly now as they have been in the past? Or are some areas improving? What's the shuffle out?

Butler: Well, some areas are improving faster or better than others. Areas like Gilbert and Chandler, they're well located. They have good housing stock, fairly solid income levels. They have the infrastructure. They have freeways, they have the shopping and they have good school districts in place. They're showing signs of stabilizing and actually beginning to show some signs of improvement and activity in home values.

The areas that were under heavy development activity, such as in Pinal County or the western communities, they lacked the infrastructure. People who are looking to buy a home, either for investment reasons or actually live in, have a wide range of choices. They would probably go back to the classic home buying thing. Where is it relative to work, my friends, my church, schools? Unfortunately, areas in the western communities and Pinal lack much of these things, so people would simply choose areas that are already well established and well known as being sort of the safe areas. Given that home builders are building less expensive housing, they have more price options than they used to in some of the more developed areas, more even  than they had even a few years ago.

Knowledge: So the growth of the new communities on the fringe, perhaps, will probably trail the recovery in areas like Chandler and Gilbert.

Butler: Yeah, they're being quite a bit slower. Then you have some areas like El Mirage and Maryvale, which are really falling behind because of the aging of their housing stock. The incomes of the people living in these areas are being really impacted during this particular recession. Some areas are showing better and will begin probably earlier recovery than others.

Of course, the problem with many people is what do you mean by recovery? For those who bought in sort of the hyper market, and they want to get back to those values, that could be quite a while. Others are just simply looking for a stop of the freefall and things to just look better. We may be getting into this transition where things will start to look better later in 2010 and early 2011.

Knowledge: As always, it seems like the job situation has a connection. If you've got a job, a solid job, and you feel confident that it's going to be there in three years, then as long as your mortgage payment isn't ridiculous or undoable, you can afford to sit and wait in your house you bought at the peak. Right? So, once again it all goes back to jobs.

Butler: Well, it goes back to jobs and the income it produces. The thing is you may have a job. The issue is furloughs, your hours worked, bonuses, a lot of other things. Really it's the income tied to that job is the key thing, along with do you really want to continue paying a mortgage on a home that was much higher valued than it is now. Then the issue gets to be, will it recover to some level of value. Are you happy in the home you're in or the neighborhood? Are there a lot of foreclosures in your area or rentals? Are there things that just don't make the area desirable to remain in at this sort of high-monthly payment relative to a low valued home?

Again, that comes back to the strategic default issue that is becoming more and more talked about of people making an economic decision to simply walk away from the home. There's all sorts of ethical issues that have been raised, legal issues, etcetera, but it is maybe, from a standpoint of a particular household, the rational thing to do. This is going to be a big discussion over the coming year as we see people increasingly make these kinds of decisions.

Knowledge: That's really, really interesting. If you have other goals for your life -- for example, saving for a child's college education -- maintaining really high payments on a house that isn't really worth that much anymore ay not fit your values. So that's the kind of swap out you're talking about here?

Butler: Well it is. I mean you're going to take hit on your credit report and other things, but a lot of people are looking at it. There's even some question about whether, for many households -- those of certain lower income levels or young households, will in the future want to own a home. They've seen what they've gone through in many instances since this is the group that got heavily foreclosed on.

They've seen maybe what their parents and friends have gone through. It sort of raised the issue of do we really want to own a home versus renting a home, or renting an apartment or something else. So a lot of issues that are -- that the housing market is going to be examining over the coming years, homeownership, underwriting guidelines, regulations. Just the areas of where you want to purchase your home.

Knowledge: Well, thank you Jay. As always, it was really interesting.

Butler: Thank you very much.