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'Housing: You've just gotta have it!'

January 22, 2003

By Steve Kropper

Last week, a friend told me her friend's astrologer predicted a decline in housing prices for this summer. I was trained as an economist, so you might think I would feel threatened when palm readers make real estate forecasts. But I am a humble economist, and I believe in the free market. I have always believed that regulating fortunetellers, but not economists was unfair. It is the quality of the results, not the rigor of the analysis that matters. Besides, I am sure astrologers charge less than economists (and real estate agents) do. That's another reason to let them practice in peace.

But if you want more than an astrologers' view, I offer the following simple explanation of why I do not anticipate a fall in housing prices. The explanation has to do with sex in foreign countries. If people keep having babies abroad—a safe prediction--and they continue to view America as the promised land, then as long as our immigration floodgates remain open, demographics guarantee that house prices won't fall.

But let me distinguish my forecast from the astrologer's with some rigor.

Credit, war, the economy and El Nino weather patterns aren't the key long-term variables in resale housing growth. If you were to plot interest rates, growth in the gross national product (GNP), unemployment and even war against the long-term data on existing home sales, you would find these factors aren't the primary drivers of home sales volume. The reason is simple: housing is like oxygen. While housing may be a good investment, people buy homes because they need a place to live. Life-changing events like babies, marriage, retirement and merit salary increases are the primary drivers behind home buying. Housing: you've just gotta have it!

A related subject is the future of mortgage servicing and the retail channels, the lender's own branch operation and independent mortgage brokerages.

If and when the seemingly permanent refinancing boom ends, I see a cataclysmic reduction in employment among mortgage brokers. When interest rates rise, more than half of the mortgage origination and processing employment will blow away in the dust. It has happened before, although not as dramatically as it can be expected to happen this time.

Data from the Mortgage Bankers Association of America demonstrate that tremendous growth in mortgage lending employment continued throughout 2002.

An interest rate rise doesn't seem anywhere in the offing, but even if rates stay stable, surely the volume of mortgage lending has to shrink eventually. In time, every borrower--even those borrowers who have 550 FICO scores--will have refinanced and re-refinanced.

At that point, lenders' own retail channels also will shrink, but that process will be slower than the brokers', resulting in market share gains. And once the refinance boom is over, lenders will uncover a seemingly new but in fact old channel: real estate agents. The easy money of the refinance boom has caused mortgage brokers to neglect their historically close relationship with real estate agents, who are their primary source of referrals. Look for lenders to rediscover real estate agents late this year.

After mortgage brokerage gets decimated, lenders will have mixed feelings about what should come next. Origination income will shrink. But on the positive side, servicing portfolios will get some stability, impairment charges--the downside of the refinance boom--will return to normal and servicing may return to profitability if the average loan lifespan rises above the four-year break-even level.

When the flood of applications abates, I hope lenders will become concerned with retention, which is a miserable 7 percent. Yes, today 93 percent of mortgage borrowers don't stay with their current lender when they borrow for their next home. Only the funeral industry has lower customer retention rates! Customer retention is the low-hanging fruit for lenders looking for a new channel. Some major lenders are implementing programs that maintain relationships with their borrowers and tools that detect when a loan is at risk of runoff due to refinance or purchase prepayment.

But let's get back to real estate. Just as the new car market is supported by a healthy secondary or used (excuse me, "pre-owned") car market, growth in the housing market depends on first-time or new home buyers. First-time buyers nip at the heals of current owners and are the fundamental engine of volume growth in the resale market.

Housing market analyses often confuse the factors behind price increases and price declines. Different forces drive prices up and down. While fear and greed are part of the equation, price rises are mostly rational, while declines are irrational. Price increases are driven by excessive demand, low interest rates--the real lever on housing prices--and recently the excess cash injected into the economy from stock market profit-taking.

Price declines are very different. A near catastrophe is required to make prices fall. The reason is human psychology. People are more willing to sell stock and take profits than they are to acknowledge losses. Prices are very sticky in the downward direction. People are reluctant to sell stocks that have lost value because they think, "I may as well hold because the value might go up," and the same goes for housing. Consumers are very reluctant to recognize losses unless a catastrophe hits them over the head and there is no prayer of a recovery in the near future.

House prices dropped in Massachusetts in 1990, and there was a sharp drop in Southern California house prices in the early '90s. Low interest rates notwithstanding, a housing price decline should have started a year ago. But we are all stubborn about recognizing losses.

Steve Kropper is VP for strategy at Primedia, which owns RealEstate.com and Domania. He is focused on Boston-based Domania's customer retention and customer acquisition products for the real estate and mortgage sectors.

Copyright Inman News Service



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