Caldera Asset Management

back to December 2010 issue

Continued Single Family Slump Could Weigh Down Multifamily Recovery

By Karsang Sherpa, Senior Vice President
Caldera Asset Management, Denver
ksherpa@calderaassetmanagement.com

A silver lining to the continued single family housing market slump has been the increasing affordability, due to the reduction in cost of ownership, for many home owners. According to the U.S. Census Bureau, the monthly median cost of ownership in 2009 was down to $1,000 – fairly comparable to $808 for renters. This difference of $192 has been the lowest in the past twenty years. The gap may further narrow down as the housing market continues to go down. In addition, the effective multifamily rents have recently begun to show signs of improvement in most markets, and that could further shrink the gap between ownership costs and rental expenses. If this trend continues, it could impact the multifamily market.

Based on the latest U.S. Census data, there are close to 37 million renters, among which about 12 million rent single family homes while only a little over three million live in multifamily complexes with 50 or more units. The Census also reports that among the total vacant units available for rent, there are 1,098,000 single family homes, clearly dwarfing the approximately 468,000 vacant units on multifamily properties with 50 or more units per property.

Vacant Rental Units (including Single Family and Multifamily)

[Source: U.S. Census Bureau
These are national figures, and just as the number of foreclosures have varied across the nation, the impact of single family foreclosures on multifamily market will also vary from region to region.]

Looking forward, the single family market is not showing any sign of imminent improvements. The latest reports from Case-Schiller Index and the National Association of Realtors (“NAR”) suggest that the single family market continues to wobble at the bottom. According to the NAR report, the inventory for single family market in October was ten and half months, approximately 45 percent higher than the year before. In the same month, the median price of existing home sales was about one percent lower than the year before, although the mortgage rates dropped to a historical low of 4.23 percent in October.

Foreclosure and the “Delivery” of Rental Units

Foreclosures initially help multifamily market since the majority of home owners become renters after their homes have been foreclosed. However, when these homes are taken through the entire foreclosure and Real Estate Owned (“REO”) process by the lenders, these can potentially be delivered as “rental units” if are acquired by investors, and these can directly compete with multifamily rental units.

According to RealtyTrac, more than 1.2 million loans are in the process of foreclosure nationwide while over five million loans are seriously delinquent. Considering the number of current vacant rental units is a little over four million, while the combined number of homes in foreclosure and with seriously delinquent loan is more than six million, even a fraction of foreclosed homes added to the rental pool could significantly impact the existing pool of total vacant units.

More Foreclosure Candidates

According to Professor Alex Edmans of Wharton School, only 12 percent of U.S. homes had negative equity in 2009, but they accounted for 47 percent of all foreclosures. At the end of the third quarter, 22.5 percent, or 10.8 million of all U.S. residential mortgages had negative equity, presenting a potentially large pool of foreclosure candidates.

Unlike commercial property owners with negative equity on their mortgages, residential property owners have generally resisted defaulting on their mortgages primarily due to the social stigma attached with foreclosures. However, that stigma has lately begun to wane. Professor Edmans argues that 31 percent of U.S. foreclosures in March 2010 were strategic-- a 9 percent increase compared to only 22 percent twelve months earlier. This trend is likely to continue as more reports of bank mismanagement on foreclosure processes come to light, and the trend gets onto national news, including coverage on “60 Minutes”.

Downward Pressure on Prices vs. Excellent Pickings for Investors

The robo-signing fiasco and foreclosure freezes announced by major lenders, combined with a federal investigation into the foreclosure process has cast another cloud over the single family market. This has simply delayed the housing market correction as the lenders hold onto assets longer and potential buyers get hesitant to invest on foreclosed properties.

Furthermore, foreclosed properties usually sell at around 25 percent discount to regular transactions, creating further downward pressure on the price. The reductions in price means rental investors can acquire assets at attractive prices, allowing them to get more competitive on their rents, and lower effective rents.

Rental to Ownership Transition

The other impact of lowering prices for single family homes will be increasing affordability for many current renters. Despite the ongoing turmoil in the housing market, majority of Americans strongly aspire to own a home, as per findings from a study released by Fannie Mae. In fact, 44 percent of current renters believe that they would be better off owning their homes, given their financial situations. This percentage is likely to go higher as the job market improves and consumer sentiment returns to normalcy. With housing becoming more affordable, these current renters could transition to ownership, directly reducing the renter pool.

Conclusion

The single family market is not likely to recover anytime soon. It will most likely worsen due to the foreclosure process mis-steps by major lenders, depressing unemployment picture and low consumer sentiment. This will not only allow current renters to jump to home ownership, but also allow investors who acquired properties at discounted prices to reduce their effective rents. Considering that there are only 4.2 million vacant units (including both multifamily and single family combined), of which 1.1 million are single family and almost half a million institutional multifamily units, an overhang of 1.2 million homes in foreclosure and over 5 million seriously delinquent could potentially derail improvements in the multifamily market.

About the Author
Karsang Sherpa is a senior vice president at Caldera Asset Management, a turnaround management and restructuring consulting firm specializing in multifamily assets. Caldera’s team has experience working with lenders, equity investors, lawyers and other consultants to solve complex problems associated with distressed multifamily assets including turnaround, refinancing, stabilization, restructuring, dispositions and property management. For more about Caldera, please visit www.calderaassetmanagement.com