Have real estate prices really bottomed out?

Practicing family law actually provides some, imprecise, insights into the state of the economy.  For example, there have been periods the past two years when it seemed that even middle-class prospective clients were searching for the lowest priced lawyer, experience be damned.  Most of my peer were struggling for business six months ago.  Further, for most of my peer uncollectible receivables seemed to be increasing; i.e., clients were slow in paying or simply not paying their bills.  Now business seems to be reviving.  Most of my peer are busier and collectibles are going up.  From my admittedly-limited perspective this is a sign that South Carolina is emerging from the recession (assuming this won’t be a double-dip recession).

One area in which family law attorneys have an excellent vantage is the real estate market.  Back around 2007 I began noticing middle-class and upper-middle-class clients with homes and mortgages that they clearly could not sustain based on their household incomes.  In my years of practice up to that point (I was first licensed in 1991 and began practicing family law in 1993) this was something new.  It’s an iron law of economics that trends that cannot be sustained won’t.  For example college tuition and health care cannot increase at double the rate of inflation, as they’ve been doing for the past twenty years, forever.  Housing prices in 2007 were unsustainable and, while it was impossible to pinpoint when the trend would reverse (the stories of geniuses who made a killing shorting the housing market in 2007-08 ignore the stories of geniuses who lost their shirts shorting the housing market in 2003-05), it was obvious the trend was going to reverse at some point.  By late 2007, I began advising my family law clients to let their spouse keep the house.  None of my clients from that time period did well financially but those who decided to forgo the house did less poorly.

Lately, I’ve been seeing a new trend: middle-class and upper-middle-class clients who have simply stopped paying their home mortgages.  Yesterday’s New York Times had an article describing what I’ve been observing: Owners Stop Paying Mortgages, and Stop Fretting.  I commonly see such clients going through a divorce in which they stopped paying the mortgage 12-24 months ago and the bank still has not begun foreclosure proceedings.  The assumption seems to be that the mortgage holders won’t come after them for any deficiency and many of these clients have few assets that can be seized.

I didn’t see anything like this in 2008-09 and, for a couple of reasons, this trend augers very ill for the real estate market. There is a tremendous backlog of delinquent-mortgage homes that have yet to enter foreclosure and this backlog may be increasing even as the economy exits the recession.  The mortgage system seems unable to process delinquent mortgages at the rate the mortgages are becoming delinquent and thus the time gap between delinquency and foreclosure is significantly expanding.

Unless mortgage holders get more aggressive in putting delinquent mortgages into foreclosure, it will probably take years before foreclosures levels return to historic norms.  Since foreclosures tend to greatly depress real estate values (it’s hard for home sellers to compete with mortgage holders simply looking to unload unproductive properties) it will be almost impossible for home values to rise with foreclosures remaining at their current level.  Yet, given the backlog, it’s likely that foreclosures will actually increase, which will further depress real estate values.  Should these mortgage holders seek to collect on the deficiencies, I suspect some of these same clients will be forced into Chapter 13 bankruptcy, in which they will be required to pay a portion of their wages to the mortgage holders for five years.  This will further depress the economy. While it’s possible that foreclosures will stabilize if mortgage holders agree to accept reductions in mortgage balances on these delinquent mortgages, such cram-downs will depress real estate values.

A real estate market that allows middle-class customers to squat in their homes for two years is simply unsustainable. When the gap between delinquency and foreclosure returns to its previous norm of three to six months, this will be a sign that real estate prices are truly stabilizing. Until this happens, I advise caution to clients who want to give their spouse liquid assets in return for keeping the marital home.

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