One of the most impactful news items heading into 2011 is the announcement by Bank of America that foreclosure activity is being suspended , and the decision by government agencies to increase scrutiny on the foreclosure process. In the wake of this announcement, nobody completely knows how long this increased scrutiny will last, how intense it will be, and what impact it will have on market activity.

One thing that we know will occur because of this move is that prices will be temporarily strengthened as the inventory of foreclosures is artificially constrained. During this time, people will be held out of the rental pool while they are living in a house (without paying rent) until the foreclosure process rolls through. The impetus behind this is quite clear, since the politicians in charge of government policy are attempting to curry favor with their constituents by helping people to stay in the houses that they cannot afford.

Over time, this decision will play out and the market will regress back to equilibrium. In many markets, this will take the form of short-term price stabilization or increase, followed by softening of the market prices as the foreclosure inventory that had been held off the market comes back on. In conjunction with this, there will be people moving out of the ‘owner’ population and into the renter pool. This will strengthen rents as the population of renter’s increases faster than the supply of rental properties. This will remain true even if investors purchase some of the foreclosed properties because the displaced owners will become renters, but less than 100% of the foreclosed properties will be purchased for investment.

In some markets with low land values, the wave of foreclosures has pushed market prices below the cost of construction. Fundamentally, this means that buyers have ‘built-in’ equity since the low prices have ground new construction to a halt and future demand increases will push market prices up toward replacement cost before new construction begins. This Regression to Replacement Cost is expected to be an upward force on future market values in some areas. Conversely, in markets such as California and New York with high land costs, there is considerable room for price compression since the values exceed replacement cost by a very large margin. It is not likely that land value in these markets will compress to zero, but whenever land value makes up a high percentage of your total market value, there is more downside risk exposure.

In the end, the only situation that can create a fundamental market recovery in real estate is if there is an increase in the number of people who can pay their bills. With national unemployment in excess of 9% with a broad unemployment rate exceeding 16%, there is considerable slack in the labor markets that will stand in the way of a fundamental recovery. It is likely that real estate will lag the overall market recovery, as there need to be more people who are employed and paying their bills before there can be a sustainable increase in the number of people purchasing homes. For astute investors, there continued to be tremendous opportunities available to purchase properties in healthy economic areas for prices below the cost of construction (Top image: Flickr |RambergMediaImages).

The Jason Hartman Team

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