Frankenstein real estate market – $3.5 trillion in commercial real estate debt and $10.3 trillion in residential real estate debt. Will we reach a 50 percent underwater market where 25 million Americans sit in homes worth less than their mortgage?
The real estate market has morphed into a beast that is largely sinking the overall economy into the ground. If we combine the commercial real estate market ($3.5 trillion in debt) with residential outstanding mortgages ($10.3 trillion) we arrive at a figure that nears the annual GDP of our country. What makes the figure even more troubling is the amount of leverage found in the real estate market. Many of these loans will default yet banks are maintaining the notion that at some point par value will be reached; for many the par value scenario is the worst case they have mapped out, and this is highly optimistic. We have created a real estate Frankenstein that now has a mind of its own and will do everything it can to stay afloat going forward, even at the expense of the real economy. In fact, the real estate monster thinks it is the economy.
There is a flip side to housing values falling which seems to be ignored since most of the mainstream rhetoric is guided by the FIRE (finance, insurance, and real estate) experts. The most obvious benefit is those looking to buy their first home don’t need to put themselves into so much debt that they risk their entire financial future for a home. The next subtle change is the amount of money diverted from housing related spending to other sectors of the economy. This last change will take time to sink into the overall economy but there is definitely a benefit of moving away from an economy highly dependent on Wall Street finance and real estate.
If we look at the current nationwide situation, the amount of distressed loans is stunning:
I think that the above disaster in distressed mortgages is causing very little reaction because we have somehow adapted to the current shocking situation. Over 10 percent of all U.S. mortgages are at least one payment behind and another 4 percent are already in the process of foreclosure. This figure is incredible given the entire mortgage market is made up of over 51 million active mortgages. In 2007 if you were to tell someone that prices in California would fall by 50 percent (even 10 percent) many would have ignored you. Now, it is standard practice for the market.
As a country we are much too reliant on real estate. Commercial real estate is the next tragic saga in the RE bubble bursting with prices already falling by 42 percent. At one point, CRE values in the U.S. were up to $6.5 trillion (now this was a rough generous estimate at the time). Today, CRE values are down closer to $3 to $3.5 trillion; this is roughly the same amount of CRE loans outstanding. This has pushed defaults through the roof:
The exponential rise is cause for serious concern. There is little energy or political will to bailout the enormous CRE market. This probably won’t stop the Federal Reserve and U.S. Treasury to game the system yet again and put taxpayers on the hook. They created this massive monster and now want the public to fight it off with pitchforks. The above chart is disturbing and the amount of bank failures we are seeing is directly related to the above trend. Many smaller banks are deep in the trenches with CRE debt and much of this is now going bad. How many strip malls do we really need? Maybe having 20 Taco Bells in a one mile radius probably isn’t such a good idea. Many of the commercial projects were built in the anticipation of sky high residential prices to justify their absurd underwriting expectations. The above results have no excuse and are largely a reflection of massive delusional speculation in all things real estate.
Now that expectations are coming more into line and the fantasy world of Alt-A, subprime, and option ARM loans are behind us, most people have to qualify to get a loan with actual real income which many are now finding less of. Banks lending virtually all government money, are now beholden to stricter (aka basic due diligence) in order to give out loans. Yet if we look at the negative equity situation, the real estate monster grows scarier:
Over 20 million mortgage holders are underwater. It is amazing that a few years ago, Deutsche Bank estimated that at the ultimate trough of the housing market, nearly half of all mortgages would be underwater. This “doomsday” scenario seemed extremely farfetched. Today, another 10 percent nationwide price decline would put us there. Even without prices declining further, having 20 million Americans underwater is not a good sign going forward. You figure over 7 million people are one payment behind or in foreclosure. But what about the other 13 million? This enormous group is basically a large cohort of renters but in a worse financial situation. They are stuck.
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