It’s not uncommon in the current environment to find articles about a coming wave of foreclosures in 2020, similar to what we saw in 2008-2009 (i.e., GFC or Great Financial Crisis). These foreclosures will be attributed to COVID-19 and the economic shutdown. To show how such dire forecasts will play out, there are often parallels made between the high unemployment rate and declining economy from 2008-2009.
While on the surface, the housing market and economy may look similar to the GFC, digging a little deeper shows that they are nothing alike. In this article, we’ll explore why these two events are not the same and how today’s economic shock will lead to a different outcome.
GFC Vs. 2020 Lockdown
The 2008 real estate crisis was driven by debt (i.e., banks). Bank loans to real estate investors and residential home buyers were bundled into securities and sold. To move these loans, banks reduced their lending standards. With pressure from management and incentivized by commissions, loan officers began approving loans that would have otherwise had little chance of being approved. The culmination of these practices was the infamous no-doc loans (i.e., no documentation mortgages).
With so many bad loans flooding the market, further pushing up home prices, it was only a matter of time before it all came crashing down. The cracks in this facade began to show in 2006. By 2007, a decline in the real estate market was well underway.
As the lending market unraveled, banks were unable to get rid of their bad loans, leaving them with liquidity issues. This forced banks to foreclose on homes, further pushing down real estate prices and snowballing the problem. As home prices fell below their loan value, buyers simply dropped off the keys to their home at the bank and walked away, defaulting on their loans in the process. This added to the already falling prices of homes.
The legal ramifications overwhelmed courts. With no other options, banks continued foreclosing and short selling houses.
How 2020 Is Different
The current crisis has left millions of Americans without jobs. While government stimulus is certainly helping, how long it will continue remains a question. According to a June 27 announcement from the National Bureau of Economic Research, the U.S. is now in recession, which means many people without jobs will face undue hardship if jobs do not return.
On the positive side, banks are in a much better position today than they were in 2007-2008. Because of changes to regulations, banks have been reformed and are able to withstand economic shocks much better.
By foregoing share buybacks, banks have also been able to raise cash, strengthening their financial position. This may be one of the reasons banks have been so willing to work with property owners since the beginning of March. Through loan modifications and other arrangements such as forbearances and deferments, property owners are able to skip or pay reduced amounts of their payments.
To accommodate these skipped (i.e., not lost) payments, they are being moved to the back of the loan or bundled into a lump sum once the deferment period ends. These loan modifications could create hardships for borrowers down the road, but they at least stop the bleeding for now.
Unlike during the GFC, banks underwriting loans today have far more conservative loan requirements. Rather than needing to foreclose on a property because of a bad loan, it’s more advantageous for banks to work with borrowers who hold much higher-quality loans.
Additionally, because banks have higher liquidity than in 2007-2008, they are allowing more refinancing to occur. With rates at historic lows, borrowers are more than happy to refinance, saving money on their current loans in the process.
With lower rates, borrowers have an easier time refinancing into a lower-rate loan. Current loan restrictions may not allow some borrowers to pull out as much money as they’d like, but they’ll make up for it in refinance savings. An added benefit is that borrowers will reduce their foreclosure risk.
These favorable loan terms don’t mean that there haven’t been any foreclosures. However, with courts closed because of the pandemic, outstanding foreclosures are not being processed. This is holding back properties that would otherwise be available on the market. Many of these foreclosures may not make it onto the market until late 2021.
Expectations For Rents And Foreclosures
While it is still difficult to say what we should expect from 2020, there are a few hints based on what we’ve seen so far from lenders, borrowers, landlords, and what government policy responses may look like.
Many landlords have been accommodative with tenants when it comes to payment arrangements. This includes skipping and reducing payments. How landlords make up those payments is yet to play out. Depending on (or if) the second round of government stimulus and the jobs market outlook, landlords may have to consider taking a loss on some payments if they don’t want to completely lose a tenant. On the other hand, some property types have shown to be more resilient than others. As an example, professionally managed apartments have seen rent collection figures for May and June almost identical to rent collection figures for the same time last year.
Where Are The Deals In 2020?
You could look at foreclosures for deals or try something different by looking at owners who are ready to get out of real estate. These are landlords who were ready to move on before the pandemic and lockdowns started. They may be baby boomers who are ready to retire or new owners who’ve decided that real estate isn’t their thing.
The pandemic, with all of its problems, has likely pushed these owners over the edge, and waiting any longer just isn’t an option. However, don’t expect deep discounts on properties. Motivated owners will likely still be practical at any price. If you are realistic with an offer, you may be able to get a discount that’s more favorable than what you might find in a normal market.
While the real estate market's fate is somewhat unknown in the near future, the good news is that pending home sales have started to rebound which means things haven’t ground to a halt like we saw in 2008-2009. There will be deals beyond foreclosures, but finding them will take some time and patience with negotiations.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.
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