The U.S. housing recovery is real and underway. The end-of-year numbers are in for the primary housing measures. Existing home sales were up 9 percent in 2012 from 2011; new home sales were up 20 percent in 2012 from a year earlier and housing starts were up 27 percent this past year compared to the previous year. Granted, these advances were based off historically low bases but we will take what we can get after six years mired in a housing recession. Perhaps a more telling statistic for the nation’s housing outlook is appreciating home values. Over the past six months, home prices increased between 4 and 9 percent, according to the major home price indexes. Lean housing inventories (both existing and new home supply are below 5 months) combined with fewer distressed homes for sale, portend favorably for future gains in home values. The drivers of housing demand are in place for a sustained recovery: high affordability; job growth (albeit modest); strong investor demand; rising buyer confidence; lean home inventories; home price appreciation; and fewer distressed homes for sale. However, there are two factors that stand out that could influence the housing outlook. Foreclosure Situation Overall, foreclosure filings and inventories are declining, an indication that most states have worked through the bulk of their foreclosure problems, reducing downward pressure on home values. Foreclosures are down 18 percent year over year. However, an agreement between the Federal Reserve/Comptroller of the Currency and the ten largest mortgage servicers in the nation is expected to generate a mini-wave of foreclosures in the near term, exerting some downward pressure on home prices. The agreement marks the end of the robo signing scandal and permits servicers to halt the burdensome review process on mortgages that were foreclosed in the 2009 to 2010 period in exchange for $8.5 billion to eligible homeowners, including a $3.3 billion payout to borrowers and the remaining funds going to loan assistance. The settlement will likely increase the pace of foreclosures that have been caught up due to a lengthy review process over the next twelve months. But in the longer term, the agreement provides incentives for servicers to offer loan modifications and principal pay downs rather than foreclose on troubled homeowners. In addition, more and more lenders/servicers are leaning towards short sales over foreclosures. Short sales have smaller price discounts than foreclosure sales. The bottom line: banks/servicers are increasingly avoiding foreclosures in favor of loan modifications and short sales, creating a more favorable situation for home prices. Congress Budget Agreement The passage of the American Taxpayer Relief Act of 2012 has both positive and negative implications for the housing sector. The positives: (1) the Act extended the tax break to homeowners who undergo a short sale. The IRS will not count the amount forgiven by the mortgage holder as income to the seller, thus giving distressed borrowers incentive to sell short rather than default; (2) restored the tax deduction for mortgage insurance premiums that expired at the end of 2011; (3) the mortgage interest deduction untouched; and (4) tax relief for mortgage debt forgiveness was extended another year; providing homeowners tax relief on loan modifications, short sales and foreclosures. The negatives: (1) higher income tax rates for high income households reduces household disposable income which is likely to constrain sales of high-end homes; and (2) the capital gains rate on high income households increases from 15% to 20% which could also constrain high end home sales. Looking Forward The housing recovery is solidly in place but some risks remain, particularly from the broader economy. The economic recovery is still on shaky ground. GDP growth for the fourth quarter of last year fell 0.1 percent. Although most of the weakness was comprised of temporary factors like a large drop in defense expenditures, weaker inventory accumulation, and worries over the fiscal cliff crisis, the lower-than anticipated growth number raises concerns. GDP grew by only 2.2 percent for all of 2012, a modest growth pace for an economy in full recovery mode. The housing recovery is highly dependent on job and income growth as well as consumer confidence. If the economy does not pick up the pace, the magnitude and pace of the housing expansion will be in question. Fortunately, the economy appears poised for stronger expansion if Congress and the Administration resolve the fiscal/budget crisis. With politics behind us, prospects for 2014 are rosier than this year, with GDP growth accelerating closer to 4 percent, compared to the projected 2 percent growth pace this year. That healthy growth pace is needed if the nation’s housing sector is to finally experience a robust expansion.