This article explains the effect of negative equity on homeowner mobility, identifies the factor which influence migration and advises how brokers and agents can counsel homeowners considering relocating under the conditions of this Lesser Depression.
The great migration debate
The ability to pack up, pick up and move on in search of new beginnings is a quintessential part of the American spirit. Yet the frost of the current Lesser Depression is changing this; fences are being drawn ever more tightly around the once highly mobile American and nothing explains the present epidemic of migratory lockdown more than the negative equity condition which afflicts real estate.
Migration tends to be procyclical, that is, it rises during periods of economic expansion and falls during periods of economic recession. Economists agree on this matter, however lately they have disagreed over the matter of whether negative equity keeps a homeowner from moving. This condition, known as house lock, and which we reference as a statewide and nationwide occurrence called migratory lockdown, is debated in studies issued by the Federal Reserve Bank of Minneapolis (FRBM), the Federal Reserve Bank of Chicago (FRBC) and the Federal Reserve Board of Governors (FRBG). Largely, researchers at those institutions argue negative equity has little to no bearing on a homeowner’s ability to move. [For more information on the argument against house lock, see the December 2010 FRBM paper, Negative Equity Does Not Reduce Homeowners’ Mobility, the September 2011 FRBC paper, How much has house lock affected mobility and the unemployment rate? and the May 2011 FRBG paper, Internal Migration in the United States.]
On the other side of the debate, the Brookings Institution and UCLA make a case claiming negative equity does inhibit homeowner mobility. The Brookings Institution singles out the housing crisis as one of the reasons for why more Americans are stuck in their homes. 11.9% of U.S. residents moved in 2008, the lowest recorded rate since World War II. This migratory lockdown in turn lowers and delays broker participation in relocation services up to three years (read: the time it will take until shortsales and strategic defaults finally become the kings of real estate transactions, getting underwater properties moving on the market).
UCLA goes further and argues loan modifications pursued by negative equity homeowners in a desperate attempt to salvage their underwater properties not only inhibit migration but also add to the unemployment rate since these individuals locked in by housing debt are prevented from relocating to better labor markets. [For more information on the historical decline in migration, see the December 2011 Brookings Institution paper Americans are increasingly stuck at home and the December 2009 Brookings Institution paper The Great Migration Slowdown; for more information on negative equity’s effect on employment, see the July 2011 UCLA paper Labor Market Dysfunction During the Great Recession.]
It’s settled, California homeowners are in lockdown
first tuesday – and 77% of readers in a first tuesday poll – agree homeowners are not moving because of negative equity. California regrettably provides an excellent example proving the case of migratory lockdown.
First, we look at the state’s negative equity condition, which is widespread relative to the rest of the nation. 2,030,292 properties were underwater in the third quarter of 2011 – nearly one out of three homeowners owed more on their mortgage than the fair market value (FMV) of their home. [For more information on California’s negative equity plague, see the December 2011 first tuesday article, Negative equity gains and losses.]
Second, we turn to the state’s interstate and intrastate migration. With California’s negative equity condition in mind, it is no wonder the number of people moving out of the state (interstate migration) and the number of people moving within the state (intrastate migration) have declined. The number of people leaving California decreased from 201,000 in 2005 to 71,000 in 2009 – a 65% drop after the housing crisis hit, according to the Carsey Institute’s analysis of 2010 U.S. Census Bureau data.
Not only are fewer people moving out of California, but the number of people moving within California decreased from 1,587,914 in the 2006-2007 period to 1,115,698 in 2008-2009 period – a 30% decline and the decade’s quickest and most dramatic drop, according to the California Department of Finance. Sour job market aside, it is clear negative equity is a big reason why Californians are increasingly trapped from moving on. [For more information on negative equity’s paralyzing effect on American households, see the November 2011 first tuesday article, Americans imprisoned in their homes.]
Why they’re wrong
The reports by the FRBM, FRBC and FRBG insufficiently evaluate migratory lockdown in California because their studies lack the following considerations:
- Statistics after the Millennium Boom: Data in the FRBM report argues negative equity does not keep a homeowner from moving, and in fact, extremely negative equity homeowners are more likely to move than slightly negative equity homeowners. There are two flaws to the report. First, it is not surprising extremely negative equity homeowners are more likely to move because they have no skin in the game. They are underwater up to their eyeballs, making it a lose-lose game of ownership for them in which they are no longer invested. Ironically, they can “afford” to move. They aren’t homeowners anymore – they’re tenants. The second flaw in the report is the source of the data, taken from 1985-2005. In order to accurately capture the effect of the housing crisis on migration in California, we need to focus on data from after 2007 (read: relevant data);
- Specific migration circumstances within individual states: The FRBC report points out homeowner migration rates from 2005-2007 to 2008-2009 would have changed more significantly in comparison to renter migration rates if negative equity kept homeowners from relocating to better labor markets. But the report contains a caveat: it defines each individual state as one labor market. This definition doesn’t work for California, which is a country of its own with a sizable economy (the seventh largest in the world with a gross domestic product (GDP) matching Italy or Brazil). California is far too dynamic an environment to be roped off as a single labor market. To determine whether negative equity inhibits homeowner mobility in California, we need to also examine migration within California’s several labor markets and distinct economic regions; and
- Differentiation between what affects migration in the short and long-term: The FRBG paper concludes low migration rates are not a direct phenomenon of the housing crisis, but simply a continuation of the migration slowdown which started 30 years ago. It’s true. Americans have moved progressively less with each passing year since the last migration peak of the 1980s. Still though, the factors which influence migration regardless of whether or not there is an economic downturn (long-term independent factors) must be distinguished from the factors which influence migration under the conditions of a historically fixed and unique event like the Lesser Depression (short-term dependent factors).
In first tuesday’s analysis of the great migration debate, we argue the hard reality of migratory lockdown by focusing on the last consideration listed above. We distinguish between the short-term dependent factor (negative equity) which has inhibited homeowner mobility after 2007 and the long-term independent factor (homeownership) which has depressed homeowner mobility since the 1950s.
Migration’s short-term dependent factor: Negative equity
These are unparalleled times for real estate in California – properties depreciated in value, foreclosed and empty. In such times, we must take note of the condition characterizing this historically unprecedented landscape: negative equity. It is a short-term dependent factor on migration, that is, it affects homeowner mobility in the short-term and is dependent on historically unique conditions – hugely leveraged homeownership never before experienced going into a recession.
Consider a homeowner who continues to make payments on his underwater home (and nearly 90% of underwater homeowners will do this). His mortgage payments consume most of the household’s monthly income, leaving little to spend on other amenities for the family. He is presented with a job offer. The job prospect makes better use of his skills and talent and will contribute more to the household income (and the recovery). But pursuing the offer will require him to uproot the family and relocate. Due to this concern, unique to this Lesser Depression, the homeowner is reluctant to relocate and instead chooses to stay put. The inability to sell due to the greatly depreciated value of his home pressures him to fulfill the obligation on his mortgage.
Moving blocks of negative equity
The homeowner had the opportunity to move and obtain better employment, but his negative equity threw two obstacles at him. The first obstacle was financial rigor mortis. Because mortgage payments locked up most of the household income, the steep cost of relocating (read: shortselling the home or strategically defaulting and thus suffering the related credit damage) far outweighed the perceived benefits. [For more information on the financial paralysis of homeowners in the housing crisis, see the October 2011 first tuesday Market Chart, Homebuyers feel ready and willing to buy, but not financially able.]
The second obstacle was a mental rigor mortis. Due to the mandate contrived by lenders, the government and credit agencies which religiously equates a mortgage payment to a moral obligation, the homeowner is locked into the blind mentality of paying:
- even if the value of his home has grossly depreciated;
- even if the payments keep him from investing in the home and the community; and
- even if staying put means pulling from the savings and retirement account.
He loses the freedom of choosing to move, while the Big Lenders who are at fault for the housing bust are bailed out of their indebtedness and insolvency with the ability to freely move about the country as they wish. [For more information on homeowner moral obligations to lenders, see the January 2012 first tuesday article, The morality of strategic default: businesses vs. homeowners.]
Reality check for homeowners
During the last 20 years, economists have been too preoccupied with analyzing existing numbers, creating formulas and producing charts to bother taking the time to actually talk to homeowners, gather data on the deeply felt reasons behind their behavior and try to divine some understanding about what negative equity is doing to them. Society, persuaded by lender do-gooder rules, asks the underwater homeowner this: “Would you rather stay true to your promise to pay on your mortgage, or bail and move out, only to commit a moral hazard encouraging others to do so and suffer unforgivable damage to your credit score?”
Brokers and agents however, persuaded by considering the best interests of their clients, must ask the underwater homeowner this: “Would you rather move up to a better economic situation and get a better job to take better care of your family, or continue to sink with this underwater home, now a virtual black hole asset?” [For more information on the predicament of the underwater homeowners, see the March 2010 first tuesday article, The underwater homeowner, his future and his agent: a balance sheet reality check – Part I.]
Brokers and agents can and may help negative equity homeowners fully understand their negative equity situation is keeping them from moving out of the Lesser Depression and marching on into a recovery. As it is said, recessions are personal.
Migration’s long-term independent migration factor: Homeownership culture
Though negative equity is responsible for the decline in migration within the context of the Lesser Depression, there are other reasons for why migration in the U.S. has been in slowdown mode since the 1950s.
11.6% of Americans moved between 2010-2011 – the lowest since 1948, according to the U.S. Census Bureau. This didn’t happen overnight so factors such as employment, age, education, income and culture also play a role in migration, but the long-term independent migration factor most consistently driving the gradual downward trend in migration has been the homeownership culture so espoused by brokers, builders and lenders and propagandized and subsidized by state and national governments. It acts as a shackle influencing the migration of both positive and negative equity homeowners in the long-term and works its inhibitions independent of periodic economic downturns. (Ireland and Spain, in contrast to Germany, suffer high rates of unemployment due to homeownership rates of over 80% which inhibit the ability of the Irish and Spanish to pick up and leave for greener pastures.)
Homeownership’s immobilizing strain
Our bet for the underlying cause of the long-term decline in migration is the widespread social desire and inclination towards homeownership in the U.S. Homeownership rates, bolstered by government housing subsidies and fostered by the American Dream, are among the highest in the world. 45% of Americans owned a home in the 1950s. This rate jumped to 62% in the 1960s and then peaked over 69% during the Millennium Boom. Naturally, with greater percentages of homeowners comes a gridlocked population. [For more information on the history of homeownership in the U.S., see the June 2011 first tuesday article, Subsidizing the American dream.] The homeownership culture has its high points – it can positively contribute to low-density communities since owners are more likely to invest and become civically involved in the area where they live to the benefit of all. But homeownership becomes problematic at the point when it inhibits moving people to a labor market where their skills, talents and education can be applied to a more productive end and elevate the family’s standard of living. This has a detrimental domino effect on all facets of human activity in the U.S.:
- The skills and talents of the unemployed and underemployed cannot be allocated to proper labor markets;
- Businesses cannot acquire the necessary workforce to maintain production and foster growth, a condition known as mismatch;
- Household earnings and consumer buying power remain stagnant;
- Construction industries are denied the market for new housing starts due to low buyer and renter demand;
- Empty neighborhoods and communities suffer from a declining standard of living with family incomes that do not keep up with the rising rate of inflation; and
- Cultural centers suffer from a drain of artistic and intellectual creativity.
The American Dream for homeownership has proven unstoppable, even through recessions and financial crises, so it is likely the homeownership culture will continue to slow future migration. And that isn’t inherently a bad thing as long as it keeps people from moving when it’s in their best interest. We can only hope one of the consequences of the negative equity condition (one of them being migratory lockdown) will be the public’s increased awareness that there is nothing wrong with homeownership, provided it is on solid financial ground. [For more information on the changing public perception of homeownership in the U.S., see the December 2011 first tuesday article, The homeownership confidence shift.]
Migration basics for brokers and agents
Though real estate conditions are grim in the Lesser Depression, we still have the need for housing to keep the real estate industry going. Interpreting the fundamental trends of migration is important for brokers and agents because it will tell them how to connect the supply of homes for sale or rent with the demand.
Some important migration patterns to keep an eye on in California today are:
- the movement from suburban neighborhoods to urban hubs;
- the concentration of Generation Y (Gen Y) in cities where there are opportunities for jobs and culture; or
- the settlement of the Baby Boomer generation in affluent, coastal areas where they will retire with their accumulated wealth [For more information on migration trends in California’s population, see the June 2011 first tuesday article, Golden state population trends and the October 2011 first tuesday article, The distribution of California’s human resources and Age and education in the golden state.]
Keeping these local trends in mind and using knowledge of California-specific demographics equips brokers and agents to advise both positive and negative equity homeowners considering a move.
Positive equity homeowners must be counseled on issues such as how to retain ownership of the home and keep it as rental property, how to obtain a property manager if they do decide to rent out the home or whether it would be best to sell the property and move on up to a replacement home. Agents must perfect such relocation advice and assistance services since the need for them will only increase.
Negative equity homeowners must be told they do not have to remain imprisoned in their homes. They have other options and brokers and agents are responsible for laying these options out as they can and may do so. Negative equity homeowners who want to and need to move have only two immediately viable options – a shortsale or a strategic default:
- Shortsale: Negative equity homeowners, with the help of their agents, can work with their lender to obtain approval to sell the underwater home at a short payoff. The homeowner suffers a loss (inevitable due to his negative equity condition and credit scoring procedures), but at least he is free to move [For more information on shortsale procedures for brokers, agents and homeowners, see the September 2011 first tuesday article, How to facilitate a shortsale transactions and You’re sure you’re a shortsale specialist?]; or
- Strategic default: Agents may advise negative equity homeowners of their right to exercise the put option in their trust deed for the lender to foreclose before they walk away from the underwater home. This is a homeowner right reserved only to a nonrecourse state like California resulting from similar issues during the Great Depression in the 1930s. Again, the homeowner will experience credit damage and experience lender scorn, but this is a far better option as it frees the homeowner to devote his income to better use for his family and to relocate and take advantage of a better situation. [For more information on the benefits of a strategic default, see the July 2011 first tuesday article, Strategic default smarts.]
California’s economic recovery will drag out as these homeowners remain in migratory lockdown. Let’s hurry up and get a move on things.