Home construction continues to struggle against headwinds created by - excess housing supply, and tight credit, but the Administration has the ability to change this restrictive paradigm, even without congressional approval.

The Administration has the policy option of expanding FHFA’s REO rental pilot, which could eliminate a small, but not insignificant share of the housing supply in the market.  As of the forth quarter of 2011, Fannie Mae had 118,528 in REO inventory, Freddie Mac had an inventory of 60,535 properties, and FHA had 32,170 properties. These REO properties account for over eight percent of the housing supply.

The Administration can also facilitate the market need for financing for creditworthy local investors with smaller scale lending programs such as FHA’s 203(k) program to alleviate pent up investment demand. The National Association of Realtors estimates that the percentage of all-cash real estate transactions has lingered around 30 percent since 2009.

Two key construction indices will be released this week – the U.S. Census Bureau’s and the Department of Housing and Urban Development ‘s (HUD) New Residential Construction Report and the National Association of Realtors (Realtors) Existing Home Sales Report.

Existing home sales declined from April to May by 1.5 percent to a seasonally adjusted annual rate of 4.55 million in completed transactions, according to the Realtors.

The Census Bureau and HUD reported that privately-owned housing starts in May were down 4.8 percent from April to a seasonally adjusted annual rate of 708,000 units, and single-family housing completions declined by 6.3 percent.

Although the declines reported don’t show dramatic declines in home sales and home starts, total housing inventory in May grew from the preceding month. May’s housing inventory represents a 6.6-month supply.  While this is half of the inventory’s peak in July 2012, when the housing inventory represented a 12.1-month supply, this inventory still poses an obstacle to generating positive growth in the housing market.

The extra housing inventory, tarnished demand, tightening credit underwriting criteria, and the shadow inventory of properties that will enter the market as foreclosures or short sales in the future, because homeowners are currently seriously delinquent on their mortgages, place additional strain on the housing market to generate demand to clear this inventory. 

One interesting development to clear the housing units on the market is the Federal Housing Finance Agency’s (FHFA) pilot program to sell real estate owned (REO) properties maintained by HUD and FHFA.

FHFA began a pilot program in February of this year to allow investors to buy REO properties in bulk and transition them to rental properties. The program included 2,500 Fannie Mae properties in specified cities. If the program is a success it is likely to expand to Freddie Mac properties and additional inventory.

Two weeks ago, on July 3, FHFA announced the winning bidders in the pilot program.  FHFA described the market response to the program as “robust with strong qualified bidder interest.” Investors had to endure a strict evaluation process to participate.

FHFA will likely look to expand the program to both Fannie Mae and Freddie Mac properties, but will this be the move that the housing market needs to boost housing demand.

There are several practical limitations to the effectiveness of an REO program.  The intention of the pilot is not only to clear the government balance sheets, but also help move the properties off the market.  Investors may find it difficult to sell these properties quickly; moreover, many of the properties that have been foreclosed for an extended period of time require rehabilitation work.  

Other programs may offer an investment opportunity for smaller investors, such as the Federal Housing Administration’s (FHA) 203 (k) Rehabilitation Loan Program, which allows investors to acquire financing to rehabilitate distressed properties.  In 1996, FHA issued a moratorium on the program, however, industry advocates in the U.S. have encouraged reopening the program.

Ultimately, though, financing for distressed properties also offers a great return on investment if investors can sell the properties and there is certainly no shortage of supply for these properties. An additional stimulus for housing demand are today’s record low mortgage interest rates. In May, 30-year fixed rate mortgage rates averaged 3.78 percent, and 15-year mortgage rates were at 3.04 percent.  These levels were virtually unheard of in the past.

Notably, the Federal Reserve’s actions to keep interest rates low, FHFA’s reo pilot program, and the expansion of FHA’s 203(k) investor program or a similar program, all serve the best interest of the Administration.  As generating housing demand can also drive job creation.

The Bipartisan Policy Center estimates that the housing sector is directly responsible for 2.9 million jobs. The housing sector has also contributed to GDP growth, which is linked to overall employment, and will likely impact the results of this November’s election. The housing sector has historically contributed five percent in residential home investment, including construction, remodeling and broker’s fees according to the National Association of Home Builders.