Since the summer of last year, the housing narrative being relayed to the public is of how hot the housing market is. This is not a false narrative. Prices are up about 16% from July of 2020 to May 2021 via the Case Shiller National Home Price Index.

Many cities are up more. Places like Miami have seen a rise in both rents, which have increased 24% year over year, as well as home prices, which have bumped up 20% year over year. Most cities are not seeing the rise in rents that Miami has, just experiencing the rise in home prices. This lends credence towards an explanation that a segment of wealthy home buyers are moving into new markets which also happen to be limited in their supply by the forbearance plan put in place by the federal government in March of 2020.

Forbearance, coupled with a dearth of new home construction which has been going on post 2008, as well as a newly mobile and wealthy segment of the populace (looking at you millennials buying homes with money from their parents), has combined to fuel a surge in prices in a number of markets, especially those that are cheaper and adjacent to already expensive markets, think Riverside county outside of L.A. as an example.

This has been a boon to homeowners across the US as well, with prices increases across the board lifting the equity of homeowners and low rates allowing them to refinance at a cost similar to what they may have been paying on a monthly basis before.

However, there are some headwinds quickly approaching the market and no one knows exactly how these are going to play out. How they do, may not only dictate the direction of the housing market but may determine the strength of the economic recovery here in the US.

Forbearance Changed the Game

First of all, it’s important to note that there is a new factor at play now in the housing market and that is the advent of the concept of forbearance. What the government has essentially said to homeowners in 2020 is that we will force a shutdown which may cause you to lose your job. While we can’t help you if you are unfortunate enough to experience a job loss, what we can do is take care of you while we have forced you out of work due to this national health crisis we have. The government did this through a top up in unemployment as well as offering forbearance for mortgages and a moratorium on evictions.

The moratorium on evictions has proven harder to enforce because it pushes many situations into legal limbo. Although the CDC rules forbids evictions based on non-payment of rent, they can’t stop evictions because of an expired lease. This is at the same time that the same landlord may be able to skip out on payments due to forbearance. This is not uniform across states and some states are still making it very difficult to evict, but in states like Texas and Florida, which are allowing evictions, evictions that skirt the CDC rules are up and almost at pre-pandemic levels.

That evictions are still going on despite the rules intended to put a stop to them may be one reason that rents are not budging in some markets. The end of the forbearance programs though, which are quickly approaching this week, may prove to have a drastic effect on prices.

It will also involve a lot of human misery and pain, which isn’t politically expedient given the academic and popular narrative active today which focuses on social equality and justice. It’s likely for this reason that Congress has kicked the can down the road until July 31st on ending the forbearance program, past a number of deadlines which came earlier. Yet Congress is aware that the forbearance program cannot go on forever and the home price surge is providing more fuel for them to stick with the ending they have marked for this week.

Before I get into how that may affect the current market, it’s worth noting that forbearance was an unprecedented and totally new policy tool by the government that had never been tested. The same goes for the way that we exit the program. We cannot avoid the fact that some people are still not able to pay their mortgage, even after the economic recovery that has taken place. What is ideal for everyone however, is for a slow adjustment of prices to meet the new supply of foreclosed homes which are due to come to the market when the forbearance program has ended. This would avoid a dramatic boom and bust scenario which is within the cards if this is not managed correctly or gets hijacked by populist politics.

I can almost guarantee as well, that this will definitely not be the last that we see of the forbearance program. It has kept people in their homes during a recession, something that has bucked the trend from past recessions and will prove to be popular with a narrow but very intensely self interested portion of the population: struggling homeowners. Forbearance in the long run threatens to further entrench the home owning class from the renter population, some of whom provide the rents necessary to make the mortgage payments of those very owners. Despite the good intentions, the long term effects of forbearance could end up permanently limiting supply and limiting even more the affordable options for potential home buyers.

Prices: Slow Rolldown or Drop?

To see how the end of the forbearance program may impact housing supply it helps first to see how it’s going to be rolled out. The end of forbearance will not be a drop off of a cliff as many have assumed, but rather a gradual roll over the next year which will build steam and add more housing supply to much of the market. Below is a schedule provided by the FHA of the various forbearance periods and when they will end.

So if we follow the above, we have to take into account the fact that some people, just through good luck, were already well overdue on their mortgage before the pandemic and this forbearance plan saved them from having to be evicted. The extreme example is a borrower who was 90 days delinquent around March 2020 and was able to max out forbearance for 18 months. If these borrowers are still not able to pay their mortgage, their homes will start to go through the eviction process beginning at the end of September. Every 3 month period after that will see another wave of evictions which will stretch well into 2022.

One of the main variables in all of this which no one knows for sure, is whether many of the borrowers who were distressed during the pandemic have righted the ship and are now able to avoid foreclosure. Yet an article from The Economist this week doesn’t bode well for them:

Surveys conducted by the Census Bureau do indeed show worrying signs. One in four renters and one in ten mortgage-holders have little to no confidence in their ability to pay for housing in the next month. Some 2.8m households, containing 7.4m Americans, are behind with the rent. The same surveys show that 1.9m households, in which 6m Americans live, are behind on their mortgages.

Now, to say 1.9 million Americans are behind on their mortgages doesn’t mean much without context. According to the Mortgage Bankers Association, this represents about 6.4% of all loans. Within this figure, 4.7% of all loans are seriously delinquent, meaning they are 90+ days overdue on their mortgage, a figure not seen even during the crisis (see the second chart below).

Finally, The Economist also captured the disconnect between delinquencies and loans in foreclosure in the following 2 charts below.

This imbalance will eventually have to be rectified through an increase in foreclosures and subsequently, an increase in supply of homes to the market, which could drive down prices. Due to the nature of the forbearance exit schedule, and assuming these borrowers have not improved their situation, we can then expect a steady roll of foreclosures through next year which will in the best case keep prices stable as a strong economy and continued lending buoy prices, or worst case scenario, produce an accelerating decline in prices leading to a collapse in confidence and another housing crash.

Or maybe not? The wild card in all of this is that while the economy has improved, these same borrowers may have improved their own financial situation and have the ability to get caught up on their past due loans staving off foreclosure. The optimist in me says this can happen, the realist says it won’t happen with everyone and there will definitely be some number of foreclosures to hit the market from the almost nonexistent level now.

The government and the public may also find that all of this unintentionally smooths the cycle for housing foreclosures, avoiding the abrupt foreclosure jumps in the beginning of typical recessions. If a smooth run off happens and prices remain relatively stable, we could see a new and very powerful policy tool come into play for the government. Again, owners could find that this acts as a powerful barrier towards getting them out of their homes, further driving down the ready supply of homes as well as pushing up prices. Every solution to a problem creates new problems, time will tell which ones we will see come to fruition. Either way, the housing market over the next year promises to hold some interesting developments.

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