Negative Equity Down and Home Values Stabilize, but Keep the Champagne in the Fridge

September 2009 saw real estate values remain flat from the prior month (-0.1% change in the Zillow Home Value Index from August), but fall almost 7% from their values one year ago. That brings the national market down 21% from its peak in the second quarter of 2006, taking home values back to levels last seen in April 2004.

Some of the hardest-hit markets continued to show poor performance, albeit with some improvement in their downward trajectory. Las Vegas home values, down 56% from their peak, reported almost 32% annual depreciation in September and were down 2.8% from August. Riverside, Calif., was down almost 22% from its level a year ago (53% decline from peak). Phoenix was down just over 22% from a year ago and dropped 1.4% from its August level. Miami-Fort Lauderdale was down 17% from a year ago, down just under one percent from August, and 45% below its peak level.

Some hard-hit markets that continued to show strong stabilization in September included San Francisco, San Diego, San Jose, Los Angeles and Boston. Home values in all these markets were down substantially from their peaks, but all showed positive change from August to September. In addition, all those markets showed at least four consecutive months of month-over-month home value gains.

The New York metropolitan statistical area is another with positive month-over-month gains. The market reported 5.6% annualized depreciation, but was up 0.3% from August, and has now seen four months of positive monthly appreciation. Of course, the New York metro numbers mask the continued slump being experienced in Manhattan, where home values were down 17.4% from last year and dropped another one percent from August levels.

These short-term improvements are encouraging, and if we can stand more good news, negative equity nationwide actually declined in the third quarter, dropping from 23% of single-family homes with mortgages underwater in the second quarter to just 21% in the third quarter. The drop in negative equity was directly attributable to flat or positive home value appreciation between the two quarters in the major metros with the most negative equity.

Overall, the third quarter saw pretty encouraging performance; in fact, very encouraging performance considering the recent context. Home values nationally basically tread water, which they haven’t done in quite some time, and lots of our large metro areas saw big reductions in their annualized depreciation rates, with many now showing a string of positive monthly changes in home values.

Of course, most of this strong performance was expected, given the stabilization in home values that we’ve seen over the past six months, which was fueled in large part by historically low mortgage rates, the first-time homebuyer tax credit, and large increases in Federal Housing Administration lending.

So, where’s the happy face?

As we’ve been saying, what’s keeping the champagne in the fridge are big concerns about some key aspects of the housing market that will pose difficulties in the near- to long-term. Chief among these concerns are foreclosures. We believe that we’ve currently got close to three million homes in the foreclosure pipeline, which have not yet been foreclosed. We think we’ve also got an un-estimated number of foreclosures that have been taken by banks, but haven’t yet been added to the inventory of for-sale homes.

Adding to our concerns about foreclosures are negative equity, high unemployment and the possible higher-than-expected default rates in the FHA portfolio, which makes up an increasingly large percentage of our outstanding mortgages. Low down-payments on FHA mortgages and the fact that they are accounting for large percentages of new lending in markets still seeing large declines in home values suggests that future defaults could come.

What we don’t know is the speed at which these foreclosures will enter the marketplace. It’s this fact, combined with the uncertainty of how much demand will be created by the extension and expansion of the homebuyer tax credits, that makes it hard to say what’s going to happen over the next two quarters. Before the extension of the tax credits, we felt pretty confident that September would be the last month of improving home values (i.e., smaller month-to-month declines) and that we would begin to see monthly depreciation begin again as home sales fell and foreclosures entered the marketplace. We expected these monthly declines to continue until sometime in the second quarter of next year.

In terms of pure probability, this still seems the likeliest scenario. But, if the tax credits do end up fueling lots more demand and all those foreclosures seep rather than cascade into the marketplace, then the next two quarters could remain more stable than we previously expected. An additional wildcard about the tax credits is how much supply they might create relative to the demand they create. That is, now that they have been expanded to existing homeowners, it is conceivable that this could contribute to a sharp increase in supply in the short-term as move-up and move-across homeowners put their homes on the market before buying new ones.

The two indicators we’re watching are inventory numbers and foreclosures. The two will likely determine what prices are going to do in the short term. Regardless of whether you’ve been a bear or a bull about the near-term prospects for a housing recovery (we’ve been more the former), it is clear that now more than ever during the recent housing downturn, there are very large forces pushing and pulling in different directions (tax credits, affordability, mortgage rates, housing prices, foreclosures, inventory, FHA lending) and it is far from clear how these forces will combine and be reconciled over the next two quarters. That will make these next six months compelling ones to watch, to say the least.

Dr. Stan Humphries is a real estate economist and real estate expert for Zillow. Stan is in charge of the data and analytics team at Zillow, which develops housing market data for most major metropolitan statistical areas in the U.S., and provides economic research for current real estate market conditions. He helped create the algorithms for the popular Zestimate® home value and the Zillow Home Value Index (ZHVI).