EconSouth (Third Quarter 2008)
Foreclosures Chill Once-Hot Southeast Housing Market|
Housing markets in the Southeast once sizzled like an August afternoon, helping to heat up the region's economy. But a cold wave of foreclosures has crashed through many of the region's housing markets, and its ripples have spread through most corners of the region. The eventual toll this foreclosure wave will take on the region's economy remains to be seen.
During the housing boom of 2004–06, Atlanta's Pittsburgh neighborhood briefly emerged as a magnet for new home construction. Builders saw opportunity in a previously neglected area across Interstate 75-85 from Turner Field (the Atlanta Braves stadium), an area that provides easy access to Atlanta-area jobs.
For a while, prices of newer homes with top amenities in the gentrifying Pittsburgh neighborhood approached $400,000. But in 2007 these prices began tumbling, and within months foreclosures began to spread quickly from house to house.
Today, boarded-up windows and overgrown landscaping characterize this once up-and-coming community. For sale, for lease, and foreclosure signs proliferate like the dandelions in the lawns. LaShawn Hoffman, chief executive officer of the Pittsburgh Community Improvement Association Inc., which promotes economic and community development in the Atlanta neighborhood, said new working families began moving into the area a few years ago. Many of them were renters who have now been forced out as banks repossess properties from absentee speculators who failed to pay their risky mortgages. The dwindling number of remaining residents find themselves constantly on guard against squatters trying to move into abandoned properties.
Foreclosure spreads its tentacles
Since 2005, foreclosure rates in Southeastern states have risen. The hardest-hit state is Florida, followed by Georgia, where the chief problems are in parts of the Atlanta metropolitan area.
Foreclosures have swept through communities with surprising speed. Just three years ago, Florida was below the national average in foreclosures. But the state now has the highest foreclosure rate in the Southeast, with almost 4 percent of mortgages in foreclosure in 2007, according to the Mortgage Bankers Association (MBA). Florida's foreclosure rate in 2008 has continued to climb.
In Georgia, 3.23 percent of all mortgages were in foreclosure in 2007—up from 2.56 percent in 2006. As in Florida, Georgia's foreclosure rate surged in the first half of 2008 (see the maps).
But the rate is not as high throughout the region. For example, according to data from the MBA, the foreclosure rate for Alabama at the end of 2007 was 2.37 percent—the lowest rate in the Southeast and below the national average of 2.84 percent. Foreclosures in Tennessee and Louisiana are also below the national average but are up from a few years ago. Mississippi's foreclosure rate has increased sharply, to about 3.5 percent at the end of 2007.
Housing price depreciation is a key culprit
Frame traces today's foreclosure problems to the rapid increase in house prices that took place a few years ago. U.S. house prices appreciated more than 55 percent between 2001 and 2006, driven primarily by income growth, low interest rates, and, in certain markets, supply constraints.
As housing affordability declined, subprime lending increased significantly with the availability of new and untested mortgage products. By 2006, about 20 percent of new residential mortgages were subprime; in other words, one in five mortgage borrowers had either low credit scores, high levels of debt compared with income, high mortgages compared with their homes' value, or unverified income. Many of these high-risk borrowers were buying houses with minimal or no down payments just as prices were peaking.
"The path of house prices appears to be very important—in both theory and in practice," Frame said. "Negative equity [owing more than the house is worth] is a necessary, but not sufficient, condition for foreclosure."
In principle, if they have positive equity, homeowners can either borrow to cover temporary shortfalls or sell the house. But owner-occupiers do not default simply because they have negative equity. Typically foreclosure involves a significant trigger event related to household budgets such as job loss, divorce, or large medical expenses.
When such events lead to numbers of foreclosures in a subdivision or community, the consequences can be severe—not just for those who lose their homes but also for builders, lenders, and others in the community with good credit. Examining how these various stakeholders are adjusting to the impact of foreclosures in the Southeast provides a window into the housing crisis in the region.
Homeowners work out the workout process
The increased housing counseling at CCCS this year reflects a deepening foreclosure crisis that began with low-income borrowers and spread to families with more substantial means. For the first time in 2008, the average household income of CCCS clients seeking housing counseling exceeded $40,000.
Along with additional foreclosure-related activity, CCCS has continued to receive calls from people struggling with credit card bills, medical expenses, and other types of unsecured debt.
"Demand for our counseling services is rising significantly as people try to avoid foreclosure and bankruptcy, as well as cope with rising gasoline and food costs," Boas said.
In response, CCCS is hiring about 80 more counselors using the proceeds of a $2 million grant from the Ford Foundation. Counselors help borrowers negotiate with loss mitigation departments of mortgage servicers and often help provide information that can lead to a loan modification, or workout. Typically, workouts involve investigation and time-consuming back-and-forth negotiations that vary depending on the situation. Such delays can be costly for borrowers and lenders alike. Recently, however, CCCS began testing a new software program to standardize and speed the workout process, Boas said.
A window on Florida's housing woes
With their patience and knowledge of the financial landscape, credit counselors and other nonprofits have played a crucial role in helping address the foreclosure crisis in south Florida, said Ana Cruz-Taura, regional community development director in the Atlanta Fed's Miami Branch.
In the climate of rapid house price appreciation between 2002 and 2006 in south Florida, many potential homebuyers abandoned the traditional go-slow approach of saving for a down payment to buy a house. Rather than paying more later by delaying their purchase, they instead chose to take a chance on a subprime loan in the hopes of getting into a home before property values increased further. Speculators fueled house price increases and worsened the affordability problem that drove ordinary borrowers into risky mortgages.
But when the housing market cooled and prices began to decline, overextended borrowers began to have credit problems. Between May 2007 and May 2008, Miami-area house prices fell by more than 28 percent, according to the S&P Case Shiller 20 City Composite Index, which tracks home values in 20 markets around the country. Still, even with this recent drop, house prices in Miami now are still much higher than in 2000.
Now, many homeowners who bought at the peak of the market a few years ago have negative equity. Others lost equity by borrowing against the price appreciation that had already occurred. Homeowners drained the equity gained with price appreciation and found themselves in trouble when their homes depreciated. Faced with the possibility of further price declines, many potential buyers have stepped aside, leaving distressed sellers with few options. Many borrowers who fell behind on payments have responded to this adversity not by reaching out to their lenders but instead by simply walking away from their homes.
"It's human nature that people tend to be afraid to confront bad news," said Janet Hamer, community development manager at the Atlanta Fed's Jacksonville Branch, who has worked on mitigating foreclosure problems in northeastern and central Florida. "There's an embarrassment factor that prevents people from asking for help."
With the oversupply of housing in Florida amid a worsening foreclosure problem, construction employment in the state has pulled back sharply, and the state's labor market has suffered. From January 2006 to July 2008, Florida lost more than 115,000 jobs, including 49,000 construction jobs, according to the U.S. Bureau of Labor Statistics. The combination of job losses and foreclosures has provided a painful double whammy in certain markets such as Palm Bay, along the Atlantic Coast, which has also suffered from cutbacks in funding to NASA's space shuttle program.
In community after community, foreclosures set off a domino effect. Foreclosures led to an oversupply of housing on the market, and the oversupply deepened price depreciation and intensified foreclosure, which led to even more oversupply of housing and a resulting sharp construction pullback and laid-off workers.
The decline of house prices throughout Florida has created one bright spot: the opportunity for value investment. This time, many investors, including those from overseas, plan to wait for the right time to buy—at the bottom of the market, ahead of the next cycle of appreciation.
The shifting lending landscape
For Southeastern lenders that have targeted residential markets, the recent spike in foreclosures has been costly. A number of the region's mortgage providers have gone out of business, and many Southeastern banks have struggled with the loans they made to small builders. Also, many of the home loans ending up on bank balance sheets are not primary mortgages but instead are nonperforming second mortgages or home equity lines of credit, including many loans backed by vacation homes.
Repossessing, maintaining, and selling foreclosed properties in a declining housing market have been major challenges for lenders, who have been looking for alternatives to adding to their real estate inventories. For example, lenders have devised new outreach programs such as enhanced Web sites targeting at-risk borrowers (see the interview with Barb Godin).
Lenders also have strengthened ties with credit counseling organizations, which have provided a vital link between lenders and distressed borrowers who are interested in making an informed and good faith effort to renegotiate their mortgages in the hope of obtaining more favorable loan terms.
But following an extended period of easy credit, lenders face their own constraints. Underwriting standards and regulatory oversight are changing the way mortgages are made and, concurrently, subprime lending has ceased because lenders have lost their appetite for these loans. Regulated financial institutions are bound by underwriting guidelines that require more careful scrutiny of loan documentation and more substantial down payments among other steps to ensure credit quality, said Pamela Cross, vice president and senior community development officer in the Atlanta office of North Carolina–based Wachovia Corp.
Cross noted that the concentration of foreclosures has become a factor in residential appraisals, especially in harder-hit areas of Atlanta. "Values now are lower than they were a year ago, and our lending ability is based on appraisal," she said.
Lower appraisals and other restrictions make it harder for owners to refinance and possibly avoid foreclosures—a scenario that might not have occurred with more stable real estate conditions. "In some cases we are seeing a huge difference between the present value of the mortgage and the newly appraised value of the home," said Arthur Fleming, first vice president and director of community investment for the Federal Home Loan Bank of Atlanta. In such cases, he added, "refinancing is a big issue."
Lenders can take solace in the relatively uneven distribution of foreclosures. Subprime loans account for less than 10 percent of homeowner mortgages, but they make up more than half of all foreclosures, according to the National Association of Realtors. In more affordable markets where subprime mortgage lending was not widespread, foreclosures have been much less problematic.
State by state, the landscape changes
Even in the overbuilt Atlanta area, population growth has helped to support housing demand in the more stable communities, especially those with convenient access to intown jobs. And some areas have been relatively unaffected by the foreclosure crisis. "Outside of Atlanta, the foreclosure issue in the rest of Georgia is not as severe," said Connie Bryant, community development officer with Wachovia Corp.
Bryant said isolated foreclosures have been problematic in Macon and Dalton, where subprime borrowing was prevalent and the carpet manufacturing and chicken processing industries were laying people off. But the scale of the problem in these areas is moderate, as it is in much of Savannah and Augusta.
During the peak period of subprime lending, Louisiana experienced only modest growth in both population and house price appreciation. As a result, the state did not attract much of the type of lending activity that set the stage for foreclosure problems in other states, said Nancy Montoya, the Atlanta Fed's senior regional community affairs manager for the Gulf Coast. In the New Orleans area and along the Mississippi coast, many of the outstanding loans were on a voluntary foreclosure moratorium because of heavy losses from Hurricane Katrina in 2005. Once vulnerable homeowners received their insurance proceeds, many chose to pay off their loans.
Greg Gonzalez, Tennessee's banking commissioner, said declining asset quality was a concern in his state. But he noted that his office has not received a large number of complaints about foreclosure and that the incidence of foreclosure statewide has not been severe. "The problem is evolving, and we're trying to get information and respond appropriately," Gonzalez said.
Builders offer discounts, concessions
During the housing boom, residential developers had plenty of options for borrowing money. Lenders competed to finance construction projects in fast-growing markets across the Southeast, and regional banks were also heavily concentrated in real estate lending. Their activity is now clearly evident with the boom of condominium construction on Florida beachfronts and along Atlanta's Peachtree Street.
These properties, some of which have taken years to build, are now being marketed in a real estate environment much more difficult than developers anticipated when they received financing and broke ground on their projects. In recent months, demand for new construction in major Southeastern markets has been weakened substantially by declining consumer confidence, less credit availability for purchasers, and increased competition from resales, including market sales, short sales, and foreclosures, said developers in the Atlanta area. In response, developers have offered concessions, including price discounts.
With the decrease in qualified demand and more supply coming into major markets from the large influx of condominiums that were started from 2002 to 2006, house prices have stagnated and in some cases declined. These developments, in turn, have boosted the foreclosure rate and a greater concentration of foreclosures, particularly for condominiums and homes delivered and purchased in the past three years, developers said.
In the close confines of a condo building, a few foreclosures can have a ripple effect on sales. Residents who stay in buildings with rising vacancies or foreclosures often end up paying more for shared expenses such as maintenance and insurance under the broad umbrella of association fees, said the Atlanta Fed's Cruz-Taura. Also, because of the uncertain value of the collateral, lenders have become increasingly wary of originating mortgages to buy condominiums in buildings that have been tainted by foreclosure. In many cases, prospective buyers have simply walked away from their deposits—because they either couldn't get a loan to close the purchase or were deterred by the declining market.
With less financing available for purchases, demand for rental properties has increased. Also, developers have begun to convert some condominium properties into rental units. "People who can't get mortgage financing are back in rental," said Egbert Perry, president of Integral Group, a real estate development and management business in Atlanta. "We're starting to build in rent increases after a period when rental rates were artificially held down because of demand and credit for buying houses for sale."
An upside of the foreclosure problem is improved affordability of housing, especially in the most expensive markets in the region. In this environment, however, most of the improvement in affordability has been offset by higher taxes and other costs, said John O'Callahan, president of Atlanta Neighborhood Development Partnership. The need for more affordable housing is as pressing as ever, he noted.
But first-time buyers with good credit and ample savings for a down payment are well positioned to become homeowners. Whether or not they face more house price declines is uncertain. The abundance of foreclosed properties provides opportunities for bargains but also tends to drag down the rest of the market. Given the severity of the problem in neighborhoods such as Atlanta's Pittsburgh and the additional supply coming into already glutted markets in parts of the Southeast, projecting the bottom of the housing market is difficult.
Signs of progress are appearing, though. Distressed mortgage borrowers have become more aware of their options, and lenders seeking to avoid additional and perhaps preventable foreclosures have devised creative ways to keep families in their homes.
Fed Chairman Ben Bernanke stressed the importance of such efforts in a May speech: "Most Americans are paying their mortgages on time and are not at risk of foreclosure. But high rates of delinquency and foreclosure can have substantial spillover effects on the housing market, the financial markets, and the broader economy. Therefore, doing what we can to avoid preventable foreclosures is not just in the interest of lenders and borrowers. It's in everybody's interest."
This article was written by William Smith, a staff writer for EconSouth.