Consumer Wealth Impacted By Negative Home Equity (Opinion)

We are continually reminded that the consumer represents near two-thirds of all economic activity. Therefore, improvement in consumer sentiment is very important. If the consumer feels good about their own situation with respect to wealth, and the overall direction the economy is heading, then spending is likely to increase, which further stimulates economic growth. One of the ways the consumer measures individual wealth is the equity position in their home. Housing is estimated to represent nearly 15 percent of gross domestic product.

The purchase of a single-family residence is typically the largest acquisition most people will make in their lifetime. Home ownership is a major determinant of an individual or family’s net worth. Equity in a new home is increased by the combination of paying down mortgage debt, and appreciation in value. It is difficult for most homeowners to substantially reduce their debt by making additional mortgage payments. Therefore, appreciation in property value over the years is a major reason for improvement in home equity. When increased equity occurs, the homeowner has the opportunity to refinance or obtain a home equity line of credit. Home equity provides additional funds that the homeowner can put back in the economy through the purchase of other goods and services.

The low interest rates on single-family residential property that have been experienced over the recent past were projected to be a stimulus to refinancing existing higher-rate loans, and pumping money back into the economy through increased consumer spending by use of the equity funds. However, this has not occurred as projected. The reason is that a high percentage of homeowners cannot refinance due to negative equity in their property. It is estimated that nearly 23 percent of all single-family homes with mortgages in the United States have negative equity. The states of Nevada, Arizona, Florida, Michigan, and California are each estimated to have more than 50 percent of all single-family homes with mortgages with negative equity. The percentage in the Las Vegas metro area is estimated to be near 80 percent. These statistics depict why the low interest rates on single-family mortgages have not had as positive an effect as expected on consumer spending.

In Northwest Arkansas the situation with negative equity on single-family residential property is not as severe as in most parts of the country. However, it is still a serious problem. It appears that the single-family sector of the residential market in Benton and Washington counties is closely tracking the national average peak-to-trough decline in home values as reported by Zillow.com, a leading online real estate marketplace.

The Zillow Home Value Index reflects the average peak-to-trough decline nationally in home values will be 26 to 28 percent. This data was from the second quarter of 2010. Multiple Listing Service data for that quarter for Washington and Benton counties reflect year-on-year declines in the median home price of 4.9 percent and 1.1 percent, respectively. This includes both new and existing homes.

With respect to new homes in active subdivisions, based on property records research, the mean price in Washington County declined 3.25 percent between the second quarter of 2009 and the second quarter of 2010, while the mean price in Benton County increased slightly more than 9 percent.

This increase in Benton County has not been typical and was the result of several high-end sales in Bentonville and Rogers.

The supply of new and existing homes for sale in Northwest Arkansas, as well as the supply of available single-family residential lots, exceeds what is considered a normal and healthy market. This, along with the number of residential properties still in, or facing, the foreclosure process, will continue to exert downward pressure on residential home values.

Erosion of home equity negatively impacts consumer wealth, which, in turn, has an adverse impact on consumer sentiment and spending. 

Tom Reed is a partner in Streetsmart NWA which produces quarterly reports pertaining to the residential, multi-family, and commercial sectors of the real estate market. Company offices are located at 2804 Main Drive, Suite C, Fayetteville, Arkansas. The phone number is 479-575-9100.