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On October 14, 2011, The Norris Group returned with its award-winning event I Survived Real Estate. An expert line-up of industry specialists joined Bruce Norris to discuss current industry regulation, head-scratching legislation, and the opportunities emerging for savvy real estate professionals. 100% of the proceeds support the Orange County Affiliate of Susan G. Komen for the Cure. This event would not have been possible without the generous help of the following platinum partners: ForeclosureRadar and Sean O’Toole, Housing Wire, the San Diego Creative Real Estate Investors Association and President Bill Tan, Investors Workshops with President Shawn Watkins and Angel Bronsgeest, Invest Club for Women and Iris Veneracion and Bobbie Alexander, San Jose Real Estate Investors Association and Geraldine Berry, Real Wealth Networks, Frye Wyles, MVT Productions, and White House Catering. The event video can be found on isurvived2011.com.
Bruce asked the panel if they see anything in Dodd-Frank or the changes in qualified mortgages that threaten a 30-year mortgage for some of the stratuses of loans. Debra said she does not really see anything in the QM or the QRM that would specifically attack the 30-year mortgage. For the most part this has been a product that housing in America has depended on. Debra does not worry about the 30-year mortgage going away as a result of the regulation. Bruce also wondered if there was any discussion on where Fannie and Freddie will end up. In response, Debra said our fragile housing market right now is delaying the government’s desire to shrink the footprint in housing. The white paper at the beginning of this year would launch the debate for the future of the government’s role in housing, the future of the GSEs, and how to rebuild the nation’s secondary mortgage markets. Debra does not believe the debate is really going to get going until most likely after the elections. The future of the GSEs is uncertain. There are a couple bills that have been introduced that would suggest all the way from completely privatizing what would now be Fannie and Freddie to maybe private companies with a government wrap for the securities that are issued. However, she reiterated to say debate would probably not start until the end of next year.
Sean O’Toole, Doug Duncan, and Eric Janszen returned to continue the discussion with Sara, Gary, and Debra. The first thing Bruce talked about with all six panelists was a recent Moody’s report he read that talked about the qualified residential mortgage in place, and it talked about FHA only being about 10% of the market. This really surprised Bruce because in California, even on the low side first-time buyers were 30% on the low side and 50% on the high side in the market right now. He wondered how FHA could only be 10% unless it was really being restricted. He wondered what would be the restriction that would prevent it from being a normal percentage as this would be the loan to which you would think those kinds of people would go. Debra said if you look at what the government is willing to do to get FHA from a 30% market share down to a target of 10-15%. They have already raised the mortgage insurance premiums, so an FHA loan is slightly more expensive than it was. We have just seen the stimulus loan limits expire, so that is another nudge toward a smaller market share. There has been talk about possibly looking at a median income restriction somewhere in our future. We will most likely not see anything like this anytime soon, but we will most likely see small moves to get the market share down from about 30%. Doug Duncan said part of the discussion will be getting the private market more involved. If you go back to some of the history of the FHA loans, the underlying theory for FHA was that there was part of their credit spectrum that would not get served by the private market. This was because the returns most likely did not reach private market returns, and therefore there were external benefits encouraging home-ownership by providing a subsidy through the FHA program to get credit to the households. In return for that, there was also a ceiling on the size of loans that was available in the market. We may see some discussion on this come up again, but Doug said it will all be done in context of what is done with Fannie Mae and Freddie Mac.
Bruce wondered what would happen if we lowered the loan balance. For instance, in California we had a median price of $600,000, and we now have a median price of under 3. Even though we reduced the loan limit, it has to serve more households with a new loan limit than it served with the big loan limit because there are a lot fewer expensive homes at least when it comes to going forward. At the same time, you might have a problem with refis. Bruce wondered if we are supposed to have government program that is over twice the median price of an area. Doug said if you looked in their book of business between the previous limit and the conforming limit to where it dropped; it was less than 5% of the book. The problem is it is regionally targeted, so you will see California, New Jersey, Maryland, Washington, and all your high-class markets hit more than the national. Debra said from modeling their business she could see the impact is very small, although you really have to question anything right now that would be negative to housing and if this is what we really want to be doing.
Sean O’Toole discussed how one of the things he has always found interesting about the federal programs is that it’s at the county level. One of the biggest drops we had in California was in Monterrey County where you have Watsonville, which is close to Carmel, Pebble Beach, and Monterrey. You have two completely different markets, even though they are 15 miles apart, so Monterrey and Carmel are going to take a $200,000 hit on the conforming loan limit; whereas in other areas such as San Jose and Contra Costa County that are not as desirable, they are not going to take as hard a hit. It does not make any sense, and it happens in any place where this kind of decision is made. This would not be a factor in Santa Ana, for example, but it would be a factor in Newport Beach. It goes back to applying a broad-based national policy to anything that overrides the local conditions and requires some of the expertise that was being talked about in the appraisal space and a whole host of other things that relate to real estate. Doug said for a long period his company looked at the national home price, and then they talked to their friends and neighbors about how all real estate is local.
Bruce mentioned a document that talks about saving $2-$4 trillion off of the budget going forward, and real estate would be an actual target for trying to get some of our chips. Bruce wondered if we have ever thought about what might be okay to take of if we cannot have anything. Bruce said he had a questionnaire, and one half of the people said it was not okay to take anything, but Bruce wondered if it will not happen one way or the other. For example, if an interest rate went down to $500,000, Bruce wondered if this would be that impactful to our market. Gary Thomas answered that the National Association of Realtors does believe it would be impactful. They do not think this should be touched at all because of the unintended consequences. One of the proposals is to take the interest rate down on second homes in resort markets. However, you have to ask what this will do to the resort market and what it will do to the communities where you cannot resell properties. The unintended consequences are it affects the grocery stores, the pharmacists, and everybody. It does not only affect the person who owns the property and cannot deduct it anymore.
Eric Janszen agreed with Bruce in that it is most likely a real target since it is a government subsidy, and subsidies in both of the ideological camps are obvious targets for cuts. It is always the other person’s subsidy that is the bad one. If it did happen, Eric was not sure if it would have as big an impact as everyone thinks it would. The real big problem we have right now is incomes and employment. We are not really going to fix the housing problem. All of these are marginal issues and marginal solutions until we start having job growth. Riverside County is 15% unemployed, and usually we really count on construction. However, we have a price per square foot on some inventory that is half of the construction cost. It is almost like the dominoes have to fall backwards before they can fall forward. We have to get rid of a lot of what we would consider shadow inventory. We first have to know what shadow inventory is and what to do about it. Until you end up with that disseminated into the marketplace to where no one fears it coming out later below replacement cost, you won’t be able to go forward. Sean O’Toole jokingly said the newest version of shadow inventory moves to help provide cover to whoever got it wrong the first time.
In 2008 when the subject of shadow inventory first came up you had foreclosures just on a tear, banks taking back lots of property, and we were not seeing the property back on the market. It occurred to them that the banks were really holding a lot of property that was not making it through the market. This is what Sean O’Toole originally talked about with shadow inventory and had a lot of statistics on it. A lot of people talking about the foreclosure way and other issues needed to change this over time, and it has grown to then include everyone in foreclosure and everyone who is delinquent. It also includes negative equity, and Sean said he has heard people say it also includes all those who would like to sell at the prices that are in 2006 but now cannot. This has been nicknamed the “delusional inventory.” However, if you start talking with people about it, you will see that there is a lot of “delusional inventory” and a lot of property that should be and would be on the market if people were not still holding out some hope that there is going to be some fix in Washington. This is as big a problem as anything else.
Bruce noted in some markets you have 3,000 square foot houses that cost a lot to build being bought for $140,000. There might be a pile of them, so the shadow inventory is not only what the lender owns, but what is being refused to be foreclosed on. Bruce said this is where he would go with shadow inventory. It’s a ball of two-year late people that for some reason are not being forced to the finish line. Whether credit for this goes to MERS or robo-signing, long before this became a front-line issue it looked like lenders made a decision to not foreclose on specific things. The question is what the reasoning is for waiting so long. The last time we had this problem was in the 90s, and lenders began to wait. People were getting close to a year behind, and then the FDIC came in and said this was not okay. Bruce remembered the chart and remembered how there were foreclosures declining in California back in ’95, yet delinquencies were increasing. There was a rule passed that said when you were 100 days late you had to file an NOD. This came basically from instruction. This time, however, it seemed not only was there nothing in the instructions, but it seemed like people were getting free passes and being told, “Whenever you want to or don’t want to, it is okay.” Eric said the thing that changed was there was just not a large enough pool of credit worthy buyers by the new definition of credit worthy. Bruce would say if you want to sell it to investors, you would have all that you can give to the market. However, Bruce does not believe that there is a fear of there not being enough cash because with everything that is bought at trustee sales a month, there is a lot of money spent.
Debra does not get the sense that lenders are purposely delaying foreclosure by design as much as working through the process, meeting regulations, meeting investor requirements, state requirements, and other requirements unless there are REOs that have not come back out on the market. She does not get the sense that lenders are purposely delaying the foreclosure process by the same token that lenders are going overboard right now to make sure they are doing the responsible loss mitigation activities that they need to do to help keep borrowers in their homes, structure short sales, or whatever the appropriate process is one buyer at a time. It’s possible they are also trying to figure out who owns the loan.
Sean mentioned how we had more than double the foreclosures that we have today in 2008. The idea and the notion that the lenders need more time to figure things out is ridiculous. They have had plenty of time to figure it out, and we are four years into this thing. This is not really the problem. Doug touched on earlier the notion that Fannie and Freddie don’t really want to talk about principle balance reductions. They are worried about foreclosures because ultimately these losses flow through to the taxpayer. The taxpayer is not in much of a position to take them right now, and neither are the banks. If you start looking at just the seconds that a bank has where maybe the first are held by Fannie and Freddie, but they have a portfolio of seconds that are on their portfolio that exceed the equity of the institution. When you really start clearing things through, you have a much different problem than simply processing the paperwork. You are talking about banking and government solvency.
Doug said it is a grand social experiment of the question, “Would the welfare of the economy and the populace be better served by a rapid and deep clearing of inventory, which would bring into question the solvency of the significant part of the financial system; or do you obtain a better result through a variety of policies to make a slow move to bring prices back into equilibrium?” Sean said the latter would be great, except now it is extend and pretend because you have to confess and say you have more losses than you can afford to bear. You have to tell the American people that this is really the situation and we’re going to on purpose drag this out so we have an orderly disillusion, like back in Grease, rather than a disorderly one. We cannot continue to extend and pretend and not have a conversation about how bad it really is. We created $4 trillion of excess debt; and we have worked through half a trillion of it. So far we have $3 ½ trillion to go, but we cannot afford it today. Therefore, we have to have a solution.
One of the things Bruce noticed was back in 2008, we really had a lot of price damage and when he was buying houses for $.18 on what the lender was owed. That was really the number because there were so many inventories. At that time our default was about 3.4%, and our foreclosures were 1.2%. About 9 months later, our defaults were 11%; and our foreclosures were .08%. They had just stopped foreclosing, and you had tripled the default. One of the disservices this does is there are gentlemen in the audience at the time of ’08 who had 800 REO listings. They had a business plan around that volume and were never told that the listings were going to turn into 200. One of the things that would have been helpful would have been to tell an industry that they will simply not do it at that pace anymore and could have had a better business plan. This was one thing that would have been frustrating for mortgage people and appraisers as well. This is all business that is turning in a red ball behind us that is not producing a fee, a commission, or a rental.
Bruce wondered if the losses that are in a second position behind the firsts that are a 200% loan-to-value are being booked at zero value or face-note value. Sean mentioned that back in 2008 when Paulson announced TARP, everyone thought it was about loans to banks. However, if you go back and read his statement, it was really about how we should not force banks to sell specific properties into a distressed market at certain distressed prices. This sounded good on paper except that the issue was not a distressed price but rather a reversion of the mean and the price at which things were supposed to be. The losses were real, and we need to figure out how we recognize them and deal with them. Four years later, we have not even started having honest discussion about recognizing and then dealing with them. Bruce wondered what would happen if we were to say, “Let’s foreclose on the red ball.” Do you absorb $4 trillion and survive? Sean reiterated saying Doug may have been right and that we need to think about a different social experiment. At the end of the day, what we need is a clear housing policy because what most people realize that extend and pretend is not working, and that is one of the reasons we are not seeing home sales take off in Riverside where it is now an incredible bargain. It is hard to take risks when you don’t know the rules of the game.
Debra said you have a lot of uncertainty in the lending community right now waiting for regulation and waiting to understand the government’s role. Doug said he had been surveying 1,000 people a month for 16 months and publishes the report on his website, so he asks what their expectation is on interest rates and prices. In the most recent quarter, Fannie Mae also asked them what they thought about stability when it came to unemployment. 26% of the people who were employed were worried about not being able to stay employed.
To find out more, tune in next week for I Survived Real Estate 2011, part 7. The Norris Group would like to thank their gold sponsors for the event: Adrenaline Athletics, Coldwell Banker Pioneer Real Estate, Conaway and Conaway, Delmae Properties, Elite Auctions, Inland Empire Investors Forum, Inland Valley Association of Realtors, Keller Williams of Corona, Keystone CPA, Kucan & Clark Partners, LLC, Las Brisas Escrow, Leivas Associates, Mike Cantu, Northern California Real Estate Investors Association, Northern San Diego Real Estate Investors Association, Pacific Sunrise Mortgage, Personal Real Estate Magazine, Raven Paul and Company, Realty 411 Magazine, Rick and LeaAnne Rossiter, Southwest Riverside County Board of Realtors, Starz Photography, uDirect IRA, Wilson Investment Properties, Tony Alvarez, Tri-Emerald Financial Group, and Westin South Coast Plaza. Visit isurvived2011.com for more details.
For more information about The Norris Group’s California hard money loans or our California Trust Deed investments, visit the website or call our office at 951-780-5856 for more information. For upcoming California real estate investor training and events, visit The Norris Group website and our California investor calendar. You’ll also find our award-winning real estate radio show on KTIE 590am at 6pm on Saturdays or you can listen to over 170 podcasts in our free investor radio archive.
