Bruce Norris is joined once again this week by John Burns of John Burns Consulting Services in Orange County.
They had just begun talking on FHA. Bruce wondered how important he views the FHA program for the health of the real estate industry over the next couple years. John said if the mortgage liquidity from FHA had not kicked in 2006 through 2008, there would have been no 80%+ loan-to-value loans made. We also would have seen home prices fall another 10-15%.
California has a $340,000 median price right now. When we were going up the last time and coming off the $97, headed up, and got to $340, the maximum loan in Riverside County for FHA at that time was $160 grand. Now the maximum FHA loan is $500 grand. That is very supportive of the market, yet they are most likely writing the safest paper they have ever written. John has had conversations with them about this, and their 2010, 2011, and 2012 books are performing really well. They are getting the highest insurance premiums ever; and even though they have not changed their policies that much, the banks have voluntarily not made loans to the people who are sub $600. They are going to earn their way out of it.
What is interesting is when you are trying to make policy decisions, a lot of times people are stuck in 2005-2007. They start saying if down payments are not 20%, that is a big problem and is Dodd-Frank’s idea. Sheila Bair is a big proponent of this. Their idea is 80% LTVs to people with $100,000 incomes and 20% debt-to-income ratios are safe loans. This is something with which John does agree. However, we cannot just roll to this overnight as this would kill housing.
Bruce said what is interesting is whenever you look at a performance chart for a portfolio of loans, the safest loan over the last 50 years is a VA no-down borrower. When somebody puts 20% down, they have a huge stake in the property. Then when you look at a chart that says you cannot tell the foreclosure difference up until this last ridiculous downturn where all the loans were stated income. Prior to that segment, you would not be able to tell the foreclosure rate from any program. They were all within 1/8th of a percent. To make a national change that is that radical for no reason is amazing. It is amazing that it gained momentum, and this is still up for grabs. John said he does not think this is really the consensus; the only real consensus in Washington D.C. is that nobody wants to see the housing market collapse. Whatever comes out of the Dodd-Frank when we receive the qualified mortgage and qualified residential mortgage is going to be relatively reasonable. What is absurd is that it has taken them more than two years to define what that is.
There is so much lobbying going on that it is unbelievable. The banks are telling everyone to tell them the rules, and they will play by them. Bruce said he knows they have had input on the rules, and this has been asked by Congress a number of times. Bruce asked John if he feels that Congress has a depth of understanding sufficient to make the correct decision. John said they do not, but he feels that the professionals in D.C. do. The folks at Fannie, Freddie, FHA, the Treasury, and the Fed are very smart people who have studied the issues and know these things. They hear the lobbyists too, but they hear what is reasonable and what is not reasonable. For the most part, most of the decisions that have been made in D.C. during the downturn have been pretty wide. We have really weathered this completely ridiculous five-year period; it’s not really as bad as it could have been.
Bruce asked what kind of mood the builders are in for 2013 and what they expect to happen. John said if you are a publically traded homebuilder, you are for it since your stock is up 150%, which Bruce wondered if this is getting ahead of itself. John said it definitely is, but he has a number of clients who have been buying the builders. What they tell him is to look at is what other industry you can count on to double in volume and be able to raise prices over the next several years. There are not many, and it is almost like a safe harbor investment for them. John said it may go down and he may be way ahead of himself, but at some point he thinks they will justify the current chair price. It is hard for them to choose other industries where they can feel as confident.
Bruce asked where the stock prices are now compared to 2005 and 2006. They are not remotely close to the peak of the fall, and John thinks they are not even halfway there. Bruce asked John where he thinks the market will be a year from now. He does not know which price structure John will mention since there is median price and a Case-Shiller price. However, he did wonder what real price movement we will have, whether it will be a positive movement in California, and if there is any price segment that still could be under pressure. Bruce wondered if there is any residual downward pressure for any price range because of financing being tough to get. John said he does not see any residual pressure downward at all unless we have job losses. You could the see a number of markets take a dip, and there are some pretty heavy defense markets like Colorado Springs that are not doing as well right now. John said they have their own price index since there are not enough of them out there right now.
John said when he rolled up all the markets that he saw having a 5% growth for next year and 6% the year after that, he compared it to the 113 economists that Shiller used to survey who were the most bullish. John said as he and Bruce were discussing, you could build a case that it could be a lot more than that if the economy continues to grow and mortgage rates stay low. Bruce said you do need the interest rates to stay low, but he does not think you need anything to be created job-wise. It is only because we foreclosed on so many people that if even 80% of those people have jobs, the quantity overwhelms the supply. Oddly enough, the question is what we are doing at one month’s supply. Whatever policies we have created has taken the inventory from six to one month, and he does not see any policy that is going to kick it back up to six months. You have maybe 6-8 months demand trying to buy one month of inventory in California. This is usually the problem in a way in that when you are trying to create national policies, you probably have 45 states asking what they are talking about; particularly when you talk about the $500,000 cap on mortgage interest deduction in 45 states that don’t even care. People are looking for where they can get the low-hanging fruit.
Real estate seems to have a few targets, and the one that Bruce said he never understood in the first place was the idea to sell your house every two years and make $500 grand free. First of all, you have to be in the right state for that, and it probably is not even possible for more than a few. Also, you would think this is a lot of money and if it should be under discussion to just forget about it. John said he does not think the money they are playing with is that significant. If they cut the mortgage interest deduction from $1 million down to $500,000, that only raised $5 billion a year for the IRS. They have a $1 trillion problem. He would imagine this tax thing is even less. Losing the mortgage deduction becomes less likely since it is not such a great revenue generator. The lobbyist he is paying the most attention to is what is being discussed the most in D.C. regarding putting a cap on all your deductions, either $25 grand or $35 grand. This seems to be the way they are leaning toward taxing the rich. Bruce wondered if this includes charitable, but John said it does not as this would be a real problem.
AMT is another interesting problem. Bruce looked over the last three years of tax returns, and he has paid $40 grand in AMT tax. This is over and above what the chart proves, but for some reason you are getting too many goodies, so here is your tax bill. They are talking about if they don’t make some of those changes that a lot more millions of people will have a tax bill they had never seen prior. It would have much more of an impact in California too because somebody who makes $150,000 a year in Arkansas is incredibly affluent and doing great. However, a two-income couple in coastal California is an entry-level buyer. It is hard to do these national numbers fairly.
Bruce also asked about Proposition 13. We had an election that was pretty well dominated, so Bruce wondered if this changes the outcome for Prop 13. Bruce wondered if it can now be voted out. John did not know the answer to this, but if it were to change Bruce wondered if it would have a very negative impact. John said if they go to Oregon to assess your property and you pay 1% or more of this, it would have a huge negative impact on older people who have lived in their home for 40 of 50 years on fixed incomes. John said if they do that, he is betting they will exempt those folks. The real benefit of going to property taxes theoretically is to keep a more stable income base, but our home prices go up and down so much John is not sure property taxes are stable either.
Bruce had a well-known economist on the radio show within six months talking about Proposition 13, and he was a big proponent of it changing and taxing certain people. Bruce brought up the older people who would probably not be able to afford their taxes and have to leave their home. He said this is the purpose of reverse mortgages, and Bruce could not believe he would say this. This is not very sensitive, but Bruce thought maybe this is how some people think. John said this is not how the majority thinks, to which Bruce said he would think this would be pretty politically the third rail and something you should not do.
John said the most amazing thing to him about the recent election is the lack of voice in seniors. The ones who are really being penalized with these low interest rates are savers and people in their 60s and 70s who thought they would have 5% interest income per year for the rest of their lives, and they are getting 0.5%. They never spoke up, so who is speaking for them? Bruce said this is a game changer because you then take risk of principle since you are now being aggressive on return. You have to go buy junk bonds and a lot of other things just to get a 7% return.
Cal Poly Pomona had a demographer come in, and he was talking about how radically different construction would be in the future. He was talking about people living in high rise communities in California that you see underway in Irvine. Bruce wondered if this was a true statement or if people always prefer to live in their single-family home. John said this is something you cannot really generalize. Molly Carmichael leads all of their consumer research, and it basically showed there would be a growing percentage of boomers who want to live in some kind of high rise as a retirement style. You will most likely see some growth in this area. The younger generation values their time more than their parents did, so they are going to be less likely to spend two or three hours a day on the road to have a backyard rather than having a small yard and the amenities being with your friends and around your family. John said he does see this as kind of a trend, but he does not see the young people in high rises since they are expensive.
One person in Utah was potentially saying that the family law in California was completely dead. Bruce could barely keep his mouth shut as he was listening to this. He was sitting right next to him before he stood up and started speaking. A very smart person with a PhD certainly believes he is telling the truth since he is out there. However, the PhD does not necessarily mean you know what you are talking about. However, regarding demographics, this is something that plays a big role in the next 20 years. When a builder is looking to build something, the question is if he is really looking at if we have built all the 3-4,000 square foot homes we need and are going to concentrate on another segment.
In coastal California we are seeing a lot of affluent foreigners move in, and if you come from a lot of these countries where it is not as safe to live, the affluent people live in high rises for safety and are more accustomed to this type of living. There is likely some demand here. With the demographics, it is not just the US growing and people have children. There is a lot of immigration coming in from all over the world. Despite our problems, people still believe the United States is one of the best places to live in the world because it is safe, our schools are better than theirs, and our medical system is good. John said he is pretty bullish on immigration, and this is where the builders have been spending a lot of time now because they have been noticing that homes are being built for people like them. Homes are being sold to people of completely different cultures, and we really do not understand it.
Bruce said he remembered John mentioning a builder in Utah not understanding the lay of the land up there and being surprised. You might have multi-generational housing more often in, for example, a Hispanic culture. In the U.S. culture it is weird to live with your parents when in the rest of the world people do want to live with their parents. If you bring up Lennar primarily, they trademarked what is called NextGen Housing where they are building some homes that are really designed for two sets of adults living in the home together but having the same kind of privacy that you might want. This could include your own garage entry or your own little mini kitchen area. It is like a quasi-duplex. It is a bit of a zoning challenge, but if you look in the neighborhoods today, you have to see how many people are living with their parents. This could be a 25-year old living with mom and dad or an 80-year old living with their children.
What is interesting is this is all like shadow household formation. You would probably have a lot of instances where this is an economically-driven decision, not necessarily a lifetime preference. As soon as jobs are created, you will probably have a lot of households emerge from the back bedroom, and maybe they are not being calculated. John said what is interesting is there has been a fair amount of research done, and for the baby boomer the badge of honor was to get out of the house. The echo boomer seems to like their parents more, and vice-versa, so there is an economic reason as well as a good situation. Bruce said he remembers the marriage age for the echo boom generation is around 26 and 28 for a male and female. This is very different from Bruce’s generation when the marrying age was low 20s.
This is what demographers sometimes look at in studying. The people want to be mobile and move where the job market is. They find they want to get married, and then they become just as stable as everyone else. What is surprising to John is the mobility has turned it down, but what has turned it up is two incomes. It is not as easy to pack up and move to Dallas when there are two of you who have to go. It seems to be that single owners would probably represent a pretty health percentage of the marketplace. John said this is true, especially single women. Asking the question about what to build, these would be people who would not want a 3,000 square foot house.
One of John’s former clients specialized in affordable town homes, primarily for single women. They would find placed where a new hospital was going in or a university was expanding, and their business did great. However, it just expanded too fast. Bruce was curious about the builders who went through the last 5-6 years and if the national builders survived better than the local ones. John said they did, although technically it was the public builders who survived better because they had a different debt structure. Private builders have a construction loan on every single asset, and almost every single asset had distress and you had to deal with the bank.
The public builders tended to have big bond offerings that may not be due for four or five with no lien on the asset. They were not being called to the carpet by the bank, and the Federal Government did a lot of bailout programs that were not necessarily intended for the builders. However, they intended to benefit the builders and allow them to go back and capture taxes paid over the last 20 years and put 100s of millions of dollars on each of their balance sheets. Then when interest rates fell, it opened up the debt markets and allows them to get low-cost debt and stick to the maturity for 10-12 years. A different debt structure really saved the public builders.
Bruce wondered if John thinks what we will do in the next four years is a Reagan immigration forgiveness year and say “welcome to the fold.” What would be the most brilliant thing to do would be what Canada does and let those in who have a net worth. Those people are not criminals, don’t take jobs, and start companies. They invest locally, and he believes this would be a good business policy for the United States to allow affluent immigrants easier access.
Bruce asked John where he thinks Fannie and Freddie will be five years from now and if they will be radically changed. John said it would be foolish to radically change them. First of all, they are back making money again. They owe us a lot of money, so why not let them pay us back. They were set up in the 1930 to provide mortgage liquidity in a crisis, and they did this. You certainly would not want to get rid of the ability to have mortgage liquidity in a crisis. They are very efficient at the securitization process, which keeps everybody’s interest rates down. They were mandated by Congress to go get more aggressive high-risk loans in 2004-2007. By doing so, the CEOs at the time were able to line their pockets. If you put the controls in place that this will never happen again, then they should be fine. Politically they may need to be called something else and then maybe they will be broken up the way AT&T was broken up. Then the structure can exist.
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