This article examines the market factors influencing the decision to rent or buy in the wake of the Great Recession, and forecasts the future of the rental housing market.

Data courtesy of the US Census Bureau

The current state of homeownership in California

The traditional American dream of homeownership — permanent ownership of a single family residence (SFR) — is a wounded animal. While not fatally injured, it limps into the future with its back turned to a largely disillusioned public.

For those who remain optimistic about the short-term prospects of homeownership, a glance at the past and present trends evident on the above chart of homeownership rates is informative. Between 2006 and 2010, California’s homeownership rate declined by three percentage points statewide.

The drop was sharper in metropolitan areas; homeownership rates fell 4% in Los Angeles, 4.8% in San Diego, and 3.5% in Riverside (for comparison, the national decline in the same time period was 1.4%). To put these numbers into context, consider that California homeownership has not fallen so sharply at any time since World War II.

Moreover, homeownership rates are certain to fall further before current tenants decide to take up homebuying once again. first tuesday forecasts that homeownership in CA will drop well below 55%, the state’s historic point of stability, to around 45% or 50% before homeownership stabilizes around 2016. The driving force behind the continuing defaults is the underwater state of California’s mortgages. A loan to value ratio (LTV) of over 125% (like the majority of those statewide) leads to an imperative to strategically default. Such defaults will become still more common as homeowners become better informed of their options.

The massive decline in homeownership is not just a symptom of the current nationwide recession. In fact, it is the inevitable result of what have become overly aggressive government policies which not only encouraged homeownership, but also bribed homeowners to purchase more, and larger, properties than they should have, and in unnecessarily remote locations.

Over the past two decades, the unquestioned government position has been “homeownership for all!” With that stance in mind, the policies of the HUD, FHA, Freddie Mac and Fannie Mae were altered to qualify large additional segments of the population as buyers and make homes more available. Meanwhile, regulations upon lenders fell to the wayside.

The housing market boomed in response, and then, as we all know, it exploded and fell in on itself. At the same time, Wall Street’s collapse took away the financial basis for the illusory wealth that homeowners had come to depend upon.

In the absence of the government intervention needed to limit risks to society, the financial crisis birthed by Wall Street plunged the private mortgage markets into a condition of total rigor mortis. The only signs of life from 2008 until early 2010 came from the Federal Reserve, which directly funded mortgages via the bond market, and from the US Treasury, which acquired and recapitalized Freddie, Fannie and Ginnie. The financial repercussions of Wall Street’s unregulated excesses will be felt on home sales even beyond 2018; the next anticipated high point in cyclical real estate sales.

Bad lending practices, current job stagnation and the lack of available employment have thus led to an ownership apocalypse; a crisis which continues to manifest itself in an unabated flow of foreclosure sales statewide The state will experience a minimum of 400,000 more foreclosures before the rate of default returns to normal, probably sometime in 2013. Many have already lost the homes that the government’s housing policy encouraged them to buy, and many more losses due to ill-advised purchases by tenants are taking place daily. [For more on foreclosures in California, see the first tuesday Market Chart, CA NODs and Trustee’s Deeds.]

Exacerbating the problem further is the trepidation felt by potential buyers, who are made nervous by their perception of the market for mortgage financing. Mortgages remain available, and on excellent terms, for those who make the effort to seek them out, but potential buyers, uninformed by their agents, see only tight credit and cautious lenders.

Until agents learn to navigate the world of lenders, and begin getting their clients pre-approved by multiple lenders as a standard business practice, homebuyer hesitation will remain a significant factor in depressed home sales. This lull will continue to be the case until the quantity of foreclosures drops to commonplace numbers. [See first tuesday Form 320]

In lieu of ownership, potential buyers will take advantage of their only other option: renting, often in detached single family residences (SFRs), which are currently the target of many investors. The rental activity of would-be homeowners will be one of the driving factors increasing rental occupancy rates in the upcoming years, although it has yet to exert any upward influence upon the economy. [For more on the problem dissonance between homebuyer confidence and sales reality, see the first tuesday article, Homebuyers Feel Ready and Willing to Buy, But Not Financially Able.]

Current homeowners not exempt

The drama will not end with Wall Street’s eventual recovery, since it is an economic fact of life that the 2,500,000 California homeowners with negative equities who presently occupy their property can no longer really be called “owners” — especially in California. As reviewed in The Homeownership Gap staff report written by Andrew Haughwout of the Federal Reserve Bank of New York, a homeowner who lacks equity in his residence has effectively been denied all the economic benefits of property ownership, and is reduced to the de facto status of a tenant.

A homeowner with a positive equity stake in his property benefits from any future increase in the property’s value. Also, any principal reductions by amortization or other principal payoff of the loan are directly added to that homeowner’s existing wealth.

This is not the case in negative equity situations, however, since all these financial benefits go directly to the lender until the loan-to-mortgage (LTV) ratio drops to below 94%. The owner, on the other hand, is left making overpriced monthly payments to his “landlord,” the lender, frequently at twice the rental rate of the home, with no financial advantage until the LTV hits 94%.

The New York Fed’s report concludes that the homeownership rate depicted on the chart above is actually an inflated number, especially in California, since negative equity homeowners are simply not economic homeowners; they do not experience any of the homeownership incentives enjoyed by a homeowner in a positive equity position, with the exception of their raw possession.

The Fed estimates that the national homeownership rate (presently 67% and dropping fast) would be 25% to 45% lower if the rate of ownership were changed to exclude the massive population of negative equity homeowners (2,500,000 of whom are in California) who are not (except under legal phraseology) owners.

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Copyright © 2010 by first tuesday Realty Publications, Inc. Readers are encouraged to reprint or distribute this information with credit given to the first tuesday Journal Online — P.O. Box 20069, Riverside, CA 92516.