Foreclosure Overhang Hinders Home Price Appreciation

A number of the industry’s closely-watched home price gauges indicate that stabilization has been slowly creeping into the picture since mid-2009. Analysts at Barclays Capital agree that the tail risk of a sharp decline in housing continues to recede with every passing month.

But they caution that there’s still a bit more of a drop in the cards and little chance of sustained gains any time soon thanks to an inflated supply of foreclosures.

Barclays predicts that home prices nationally will drop another 4 to 5 percent before officially hitting bottom. The firm called this further decline “limited” because lately new foreclosure growth has been curbed, which means these properties can be more easily absorbed by the market without pressuring prices down.

Mortgage modification programs and other policy measures have ensured that the millions of foreclosures yet to hit the market will do so over an extended period of a few years instead of a few quarters, Barclays said, noting that this smoothed-out supply should limit any future decline in home prices.

Barclays says the stability we’ve been seeing in home prices has been a direct result of slowing down the supply of foreclosures. But the company’s analysts warn that stability in the present comes at a cost to the future of home price appreciation.

The overhang of distressed inventory is a “huge negative technical,” according to Barclays, because it suggests that any price rise will probably be met by increased distressed sales.

As a result of the resolution paralysis caused by modification delays, the distressed supply of REOs has stayed low relative to the number of foreclosures, Barclays said. Every time home prices start to rise, distressed sales, which trade at a discount, should pick up as banks and investors holding these properties try to take advantage of the price rise, Barclays explained.

Unabated foreclosure moratoriums and massive modifications with low re-defaults would be needed to keep distressed supply permanently off the market, Barclays says. In addition, the firm contends that fundamentals such as mortgage credit would have to loosen quite a bit and incomes would have to rise sharply.

With all these constraints, Barclays expects home prices to remain disproportionately low without any form of a notable rebound for years to come.

“In sum, policy makers might have managed to engineer a soft landing in U.S. home prices, at least from the second half of 2009. But the by-product of these policies is that home prices look set to simply muddle along not only in the short term, but also over the next few years,” Barclays analysts wrote in their report.