Bruce Norris is joined this week by Sean O’Toole. Sean is the founder and president of ForeclosureRadar.com, a website that has pretty much revolutionized the trustee sale-buying business.
Bruce wondered if there were any surprises at the end of 2012 Sean was not expecting to happen. Sean said he was expecting foreclosures to drop, which they did more dramatically. Sean was one of the few people who thought they would drop at all since there is always the big glob of something that was supposed to show up in droves that ended up never showing up at all. Sean said many have predicted foreclosure wave after foreclosure wave that have yet to come to fruition that they have still not seen happen. Sean can understand why they would predict it since it probably should happen or should have happened. It’s still not expected to happen since it is a political-driven market rather than an economics and fundamentals-driven market.
Bruce asked Sean if there was some reaction at the the end of the day when you remove foreclosures from the market. He said yes and that there is no question that some removal of so many foreclosures has left a lack of inventory throughout the state, even in areas where you would not expect a lack of inventory. Where there should be a lot of foreclosure activity, instead there is nothing to buy. It has really come about gradually and then increased. Bruce said he looked through the charts, and in the first half of the year it bounced along and was reduced by 20%. All of a sudden, six months ago it made a beeline from six months down to a month in most of the counties in Southern California. Bruce wondered what policy decisions drove this and what Sean’s policy decision for 2013 is that would reverse this trend.
Sean said there were a lot of things coming together, but the biggest thing that changed in 2012 was everyone realizing that yield, the income return from rents on real estate, was more important than price. That led banks to say that maybe they were disposing of things they should not have been or there was a better way to dispose of it or resolve it. This brought in some major new investor players, some that started in 2011 but really got underway in 2012 with large hedge funds coming in and buying up property. Those things conspired to both reduce inventory further and get the banks to question their foreclosure practices and look at other alternatives. This came with the policy decisions around the attorney general’s settlement and the Homeowner Bill of Rights.
A lot happened in 2012, there is no question about that. It seems like not one of the policies was responsible for a bulk of it. It has really been a historic disappearance of things for sale. Going forward, unless they change policies, Bruce feels pretty comfortable that we will have a hard time getting from one month to six months of inventory. However, he does not know where this will originate. Sean said for those predicting it will come from a foreclosure wave, they just have to note that it takes 6+ months for that to happen, and there is no sign of it happening now. The chances of it happening in 2013 are slim-to-none.
Regarding the potential for people still in California, Bruce wondered how many people are 90 days late or in foreclosure. He wondered what numbers of people are in trouble and why this will probably not cause a problem because the policies to be foreclosed on at all. Sean said right now the number of foreclosures is roughly 180-190,000 homes. These either have notices of default outstanding in pre-foreclosure, are scheduled for auction, or they are bank-owned. It is about equal. 60,000 are pre-foreclosure, 66,000 are scheduled for sale, and 62,000 are bank-owned. None of these are terribly scary numbers if they had to deal with them. Sean said they sell 40-50,000 homes a month in California, so even that is not that much inventory.
The bigger issue is the people who are delinquent, which is somewhere around 450,000. A lot of these folks are in the process of a short sale or a loan modification, so some of them may make it into foreclosure while others won’t. Many have been sitting for an awfully long time. The biggest number, however, is the number of people who are underwater, but they seem to be hanging in there and continuing to make their payments. Altogether, it is a quarter of homeowners in California who are either underwater or in trouble already. It’s a terrible housing market if you think about it from a commercial standpoint. Historically, it is an unprecedented number, even if it has improved a ton.
A price increase of about 23% takes care of half of the underwater people. It makes a big difference and also encourages the other half to see that they are almost there and are about to get rewarded for hanging in there. To Bruce, what is important in 2013 is the strength of a price movement really starts solving a lot of these things. Shadow inventory all of a sudden becomes half equity sellers. There is no question in Sean’s mind that Ben Bernanke and the Federal Reserve agree with Bruce and are trying to create an asset bubble to get out of this problem. This will probably ultimately lead to long-term inflation even though they have never said this. It’s the easiest way to solve the problem of too much debt when you take control of your own currency. You devalue, and the debt becomes less because you have pushed asset prices up. Sean thinks it is absolutely the goal of the administration and the Federal Reserve.
Bruce asked Sean if he thinks 2013 will be a fairly significant price movement in California. He said he read Bruce’s prediction of a 20% across-the-board increase, and his only issue with this is he does not think these dynamics are exactly the same throughout the state. This is where he takes some issue with it. Bruce said whenever they do predicting, it was always a discussion on median price, which is an inaccurate number anyways. It is a 20% price movement and will probably include more high dollar sales than 2012. There is a fudge factor there where it makes sense you will end up with more move-up buyers since people are starting to have equity. There are fewer foreclosures at the low end, and the one place they were quick to foreclose was in the lowest end properties. These seemed to be foreclosed on much more quickly than the higher end properties. Having to move up in median because of this is reasonable, and having real price appreciation in areas where payments are significantly below rents in areas such as San Bernardino and Riverside, it makes perfect sense.
It is quite possible we will see a 20% median increase. What he would hate for a listener to take away is this means that their house is going to go up 20% when they could do better or worse. Sean is in Northern California and is familiar with more pricey areas than Bruce is, who lives in the epicenter of foreclosureville. Sean lives in an area that probably has a higher dollar median price by quite a bit. Bruce wondered if he is seeing price firmness or acceleration in these areas. Sean said it is a mixed bag, especially on the peninsula. Here we have a very strong technology market that is moving beyond the social media bubble as it were. Silicon Valley continues to be very strong on the employment front. There are still quite a few winners here financially putting pressure on that area. The Bay Area is very strong, and there is a lot of investment buying when you come into the Central Valley. There is an awful lot of investment buying, and prices are still low compared to rents. However, they are catching up pretty quickly, and he does not know how much room there is here. Sean said he does not expect much appreciation in these areas, and you will have a lot of different pockets. It’s almost hard to say by city since it is almost by areas.
The difficulty in predicting something is there are so many micro markets inside of the picture. Sean feels a lot of the price has been driven by a cap rate mentality that is about to get uninteresting. If you are willing to take prices up because you are willing to take a 7% return while the current market is 8 or 9%, prices will move pretty quickly. You don’t want to get to 7%, unless there is an appetite for 6 or 5%, he does not see any indication of them continuing to move up. Bruce feels pretty strongly that even though the Bull Run has been dominated by the cash buyer, the small guy, medium-sized guy, and giant guy, there is a very big underlying owner-occupant crowd that was foreclosed on in 2008 and 2009. This is now an overwhelming number of people that will carry on the boom even if for no other reason it saves them money monthly over rent.
Sean said he certainly hopes people are smarter than they were in 2004 and 2005. They may be willing to pay a little bit more than rent to have the stability of a home, but we had in some areas returns that were down to 1-2% when you looked at price versus rent. You would be better off putting your money into treasuries. Sean said he just does not see us having the kind of boom that we saw from the end of 2000 to 2006. Sean thinks what we are doing is recovering to where our prices should be, and this is really where prices should be given these artificially low interest rates. We will probably recover to a point where it makes sense given the low interest rates, but not where it would make sense long term. This sets us up for some longer-term challenges. Bruce completely agrees with the longer-term challenges, and he would feel a lot more aggressively comfortable with it getting to that uncomfortable number just because of the unprecedented rates.
Bruce and Sean went back to Washington D.C, did a little research, and saw that the interest rate has just not been seen since the 1900s. This is an unprecedented interest rate, so the question is what unprecedented dominoes fall because of that. Sean said on the one hand the low interest rate for purchases are certainly unprecedented as far back as we could find. On the other hand, Sean’s thoughts on what a reasonable return on investment was on real estate should have been 8-10%. Everyone is up in arms about these hedge funds wanting to come in and accept 7%. Sean does not understand the business, and the people don’t understand how hard it is to rent single-family homes. As we look back to that, even as far back as the 1800s, returns on real estate in the 5-7% range, are far more the norm than 8-10%. This actually made Sean a little bullish than when they showed up in Washington.
Sean mentioned inflation, which Bruce thinks is a very likely outcome. By fixing a payment, if you are talking about a premium today of your payment versus rent, that is one thing. But you are fixing that payment for 30 years. Your renter next door is not going to have that same rental bill ten years from now. This is where the wisdom of the decision kicks in. Sean said the problem he has with this is that the average person believes the Fed when they say we are in for a period of unprecedented low inflation and that inflation is not a problem or a risk. There is not a perceived risk of inflation to push them accept a significantly higher payment. It is up to the point where there is that really truly widespread risk of inflation. This will be offset by rapidly increasing interest rates. Only a handful of folks are smart enough to realize that we have this belief that there is not going to be inflation when in fact this belief is wrong. With these low interest rates, that is a pretty sweet spot that probably will not exist for a long period of time.
Being the normal guy rather than the investor guy, Bruce said he would want to control his own environment and pay premium for it. Whatever premium it is will be whatever the lender will allow him to qualify. It seems there is still a willingness to own something if the lender will loan them the money. Here there is an interesting transformation. Sean has some great charts that showed while prices really progressed, payment was amazingly consistent because the loan programs became so aggressive that the payment did not move very much at least for the first-time guy. We went from the median price of $250 to $550, and you could have the same payment if you were a median income earner in California. You could have the same payment at $250 and $550 six years later.
In a way, you do not have a loan program that is doing that, you have an interest rate doing this. Bruce said this is why he thinks there could be price aggression since never before has a $100 grand price increase meant so little monthly. However, this interest rate has been in place now for some time and will most likely not go dramatically lower over the ne t year. There is no emphasis for it to dramatically change over the next year. Bruce said this will definitely not be the case for interest rates, and Sean thinks this is also true for price. Easier lending will definitely not be a driver behind price increases this year.
Sean said he thinks the primary driver is going to be the two things Bruce touched on earlier in terms of median price. One is the fact that we are going to have a mixed shift to higher-end homes, which does not mean prices did not change at all. It just means the homes that are selling are higher-end because the low-end foreclosures have been going away. It is not a change in price, it is a change in median because of the mix of homes being sold. Sean thinks we have certain areas in the state, possibly half the state at most, where payments are significantly below rents. Those areas will most likely go up to at least match rents if not to have payments exceed rents as they traditionally have.
Bruce said one of the things that he noticed when he looked up loan programs is we will most likely not see anytime soon stated income variety, but we have a very aggressive FHA program in the sense of its available quantity of money. In Riverside it is $500,000, while in the most expensive counties it is in the ballpark of $700,000. We have a $340,000 median price the last time on our way up from the ‘90s when we got to $340,000 at the time when the FHA loan limit was $160. Bruce thinks this is a significant change, and he doesn’t know that we need the subprime world. We have FHA, who wrote the safest book of business ever in 2011 and 2012. They might be allowed to loan to some of these other people that had a foreclosure, even though we already know they will. This is where Bruce is looking at this huge glob of people that could get a loan with a 3 ½% down payment and improve their monthly cost. Even if it is a premium to rent, Bruce thinks they make the decision. We are so far away from this on a monthly basis, and you could have price aggression. 20% of $340 is $68, and if you back this off into a monthly cost, it seems a reasonable number to Bruce.
The only thing on the other side of this is FHA is under a lot of pressure because of their drawing share of the business to tighten their credit requirements and other things to tighten up. There are definitely some in Congress who are worried about the loans that they are making and creating in other bubbles. Whether they will be allowed to this time is the question. This is definitely the big question when we talk about things that matter. If there was an announcement saying that if FHA will now have a loan balance of the median price of California, for Bruce this would be a big uh-oh. Even this month they are making changes to if you have a lower credit score since you now have to have a lower debt-to-income ratio and some other things along those lines. Regarding larger down payments, there are also new changes coming in if you have a lower credit score.
What is interesting is in the credit world, what is starting to happen is you can improve your credit faster. Whoever has changed the rules here used to take 2 ½ years and now takes 9 months. It seems like we are bound and determined that somebody is going to be able to buy a house, and if it takes too long for their credit to improve we should improve it more quickly. If we can’t change it on one end, let’s change it on the other end wherever there is the political will. If you help people fix their credit score faster, then you are helping homeowners. If, on the other hand, you tighten up credit scores you are showing prudence. Prudence does not seem to be the fiscal cliff. The stock market had a big day when we basically completely ignored the fact that we have to at some point cut back.
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