The residential real estate market is confusing. On the ground, the stats remain ugly. Twenty percent of American homeowners are underwater, meaning they owe more on their homes than they’re worth. For these people, their home is a ball and chain limiting their mobility and opportunities. And a constant reminder of a bad financial decision. But in the media, it’s a different story. And on reality TV and rich neighborhoods in New York or San Francisco, it’s as if 2008 never happened. A San Francisco realtor wrote in a letter to SFGate: “Television shows brought real estate into our living rooms and made the buying, selling, flipping and preparing of properties a national pastime. As a Realtor, I feel like a celebrity at times when I go to parties with people asking questions and fascinated by aspects of my work. This certainly was not what I expected when I started in this career.” Realtors feeling like celebrities? That’s heady stuff. And now a celebrated Wall Street housing analyst is calling the new home market by the n-word. “Nirvana is not far around the corner,” Ivy Zelman, Institutional Investor Analyst Hall of Fame Member, told CNBC this week. Zelman grinds the numbers everyone looks to in the homebuilding space. With her bullish outlook and face for TV, we’ll be seeing plenty more of her. The comely brunette doesn’t hedge her opinions. “I think we’re going to see things rip when we see the weather thaw and customers coming out.” Shortage of Homes? Ms. Zelman insists there is a shortage of available product for buyers to choose from. She’s probably getting her intel from the likes of Pulte Homes CEO Richard Dugas, who says business will be good because of “low interest rates, a limited supply of new and existing homes, and an ongoing, albeit modest, recovery in the broader economy.” However, they’re both missing a crucial point. Supply only seems restricted because of a kink in the foreclosure fire hose, which prevents houses from gushing onto the market. Mortgages were furiously bought and sold during the boom to satisfy Wall Street’s hunger for mortgage-backed securities. These mortgages were transferred electronically through MERS (Mortgage Electronic Registration Systems). All was well and good with this until borrowers stopped paying and lenders wanted to foreclose. That’s when innovative finance banged up against a legal system that in most jurisdictions was accustomed to paper-and-ink assignments. Judges wanted proof that mortgage assignees had the standing to foreclose, and in many places, the lack of old-school written assignments impeded that process. So we’re left with an unknown number of foreclosures languishing in the pipeline, just waiting to hit the market. Also, states like Nevada and California have passed “homeowners bill of rights” legislation, forcing lenders to jump through numerous hoops before they can start foreclosure proceedings. And of course in states with judicial foreclosures (where the court dictates the foreclosure timeline, not statute), the process can take years. In other words, the notion of “limited supply” is merely an illusion. Real estate attorney Shari Olefson, the author of Foreclosure Nation, says banks are pocketing a “slew of shadow inventory.” She gives the example of a bank foreclosing on a $200,000 mortgage, knowing the home is only worth half of that. The bank will then hold the home—at that inflated value—on its books. Why? First, because it hopes the market will come back. But more importantly, the bank needn’t recognize the loss until it sells the unit. Once upon a time, bank accounting wouldn’t have allowed such nonsense. But in the wake of the financial crisis, the American Bankers Association lobbied the Financial Accounting Standards Board to change accounting rules FASB 157, 115, and 124. These changes allowed banks greater discretion in determining prices for certain types of illiquid securities on their balance sheets. That’s how a bank can say a $100,000 house is worth $200,000 and get away with it. Drowning A whopping 9.3 million Americans are still underwater 25% or more. And as interest rates rise, these people aren’t going to stick around to pay even more into their equity-draining homes. They’re likely to walk away. Seven states have underwater percentages well above the national average. It’s no surprise that over 30% of homes are underwater in sand states like Nevada, Florida, and Arizona. But the Midwest is struggling too, with Illinois, Michigan, Missouri, and Ohio all having about the same percentage of mortgages underwater. Certain cities have it even worse. Las Vegas, Orlando, Tampa, and Chicago each have negative equity percentages between 33% and 41%. Despite this financial devastation, the 20-city Case-Shiller Housing Index for December is up 13.4% from a year ago. Since March 2012, the Index has risen 24%. That’s one of the scariest parts: though prices have improved considerably, homeowners are still way underwater. For example, homes in Las Vegas now fetch 43% more than in March 2012. But 41% of mortgages there still remain deeply underwater (defined as 25% or more). It’s a similar story in Orlando, where prices have jumped 20% last year, but 36% of the area’s homes remain underwater—and Tampa, with 35% of underwater mortgages, despite home prices rising 25% since March 2012. Yet even with this massive shadow inventory hanging over the market, builders are bullish on providing new housing. “What we hear from builders right now, they did not have enough communities to meet demand in 2013,” Zelman said. “They were caught by surprise by the surge in demand, so they didn’t have enough developed lots to open up new communities. This year they caught up, they’re very prepared, we’re going to have double-digit increases in new communities.” Builders are never shy about providing supply. Nirvana? Historically, Americans, no matter their income bracket, spend half their incomes on housing and transportation, Derek Thompson notes in his piece titled America’s Weird, Enduring Love Affair with Cars and Houses. Interestingly, that high percentage is unique to the US. Thompson wonders about the ramifications if Americans began to spend more like the Japanese, Canadians, or Brits, who spend much more than Americans on culture, food at home, and alcohol, instead of houses and cars. “It would be rocky for the real estate and auto industries who have come to rely on a steady stream of spending,” Thompson writes. Well, guess what? “This isn’t a vision of the future. It’s a description of the way a lot of young people live today,” he explains. Maybe that will pass when the recession does. Except while everyone knows we’ve been in a recession since December of 2007, the government says the downturn ended in June of 2009. On average, “official” recessions have hit the US every six or seven years in the US since 1947. The clock’s ticking, as 2009 is already five years in our rearview mirror. Predicting when the next “official” recession will hit is impossible. The point is that sooner rather than later, the economy is actually going to get worse than it is now. That won’t be great for selling homes. When realtors are rock stars and analysts call a market “nirvana,” we’re near a top. The top of a market built on the flimsiest foundation of false scarcity. New supply, a worsening economy, and higher interest rates will bring about a fall. Thankfully, it won’t be from the heights of 2006. But it will be anything but nirvana.