Doug Duncan Joins Bruce Norris on the Real Estate Radio Show #337

Doug Duncan, Fannie Mae

Bruce Norris is joined this week by Doug Duncan. Doug is the senior vice president and chief economist for Fannie Mae. He is responsible for managing Fannie Mae’s economics and strategic research group. In this leadership role Duncan provides all economic housing and mortgage market forecast, analysis, and serves as the company’s thought leader internally and with the external constituent groups. Doug was recently named one of the 50 most powerful people in real estate. He has been a friend to investors and has invited them back to talk with Fannie and FHA about loosening up some of the loans that were given to investors.

Doug said investors are a critical part of the market. A lot of times they do not usually feel that way when they look at how much financing is available. If they had to say what the definition of an investor was, they probably have to extend the blanket over to hedge funds. This is a new one. Doug said the public perception of the word has probably changed from the 2005/2006 time period prior to the crisis to today’s market. It is not only the perception that has changed, but also the reality. Hedge funds, REITs, and groups like that who might not have been talked about before are certainly in the conversation today.

In the middle of the heaviest downturn in 2008-2010, there was always a rumor of bulk tapes on which people spent a lot of time. Bruce wondered what the reality is of this today, if there are people buying things in bulk, are they the hedge funds, and are they in partnership with Fannie on anything that goes out for years in advance. With regards to Fannie, they have done a pilot under the guidance of the FHFA of some bulk sales. While monitoring the performance of this, there is no question that in some markets there has been significant bulk purchase activity by investors. Some of the REITs you see were institutions issued into the market by some of the hedge fund investors after they made the acquisition and spun the companies out as the REITs. One of the reasons they have been monitoring this is because in some markets the pace of price appreciation has been substantially impacted by that activity.

You take a market like Phoenix, for example, where there have been significant bulk purchases. If the demand curve in that market is constant, and you suddenly take a chunk out supply, which is already slow to react, then prices have to increase. In some of the markets where there has been significant investor activity and rapid appreciation, there dealings and activity with the rise in rates that has happened is likely to continue slowly. This is true particularly in the hedge fund space. Bruce said he could see this with the hedge funds, especially when prices get up to a certain price where your cap rate is affected. Bruce asked if this is where they are looking and seeing if they can buy for a certain type of cap rate, then find something else to do once this is over. Doug said this is correct and that they have very high return targets. They are opportunistic investors, and this is their place in the market. Doug thinks they will look for other opportunities.

One of the concerns that is getting on the time horizon is that in some markets folks are concerned about it will have a downward pressure on price should they all make an exit at a specific time. Doug said they do not actually have this specific concern, but they do believe that over time some of those products will come back onto the market and keep the pace of price appreciation from running as rapidly as it has recently. In essence, Doug is asking if these people are market-makers. He did allude that they were a market-maker when they purchasing in markets where they took significant inventory down to low levels and were somewhat responsible for price increases. Bruce was curious if they were market makers as far as rental value. Doug said he does not think they are in it for the long-term, particularly in regards to the hedge funds. They have a combination of capital gain and current cash income in which they are interested. When they get to that target, they are likely to exit. Part of the timing of this will depend on what the other opportunities are as the Fed goes about attempting to move us to a more normal macro-economic capital market environment, which will take a while. You can see what the early discussions generated in terms of excitement in interest rates. However, as this changes over time, then we might see more of this. It will depend on what the other opportunities are that emerge for them, whether they stay in this for longer rather shorter. However, they are a little longer than mid-term investors.

In 2011 in July, Doug authored a paper called “Unusually Uncertain.” Bruce asked Doug how he would say things are different in 2013 compared to summer of 2011. Doug said there are two or three important ways. One is a significant question about whether or not we were going to lapse back into a recession. The economic growth was very weak in that year, and there was a high probability of going back into a recession if the growth was less than 2%. They grew at about 1 ½ that year. This year we are better and are going to be above the 2% rate and will be around 2.1%. The second thing is that there was significant judicial monetary easing that took place subsequent to that time period. This put some stronger legs under the stock market, so there were some in the household who were impacted by this in their wealth. Housing is probably is the key turn since it appears to have turned sustainably into an uptrend and is providing some wind at the back to the economy. They are seeing in their monthly surveys of consumers that their view of their housing situation is improving.

One of the things they tracked was whether it was a good time to sell. He does not think anybody else asks that question. The reason they ask this question is because about 5 out 8 people who buy a house have to sell one first. If it is a bad time to sell, in their mind they will not be able to buy subsequently. This has been moving up steadily now for about 18 months from the prior 2-year time period where it was flat at 10%. Now there are around 40% of households who think it is a good time to sell. They have seen significant progress here.

Bruce said the flip side of this is they are willing to repurchase one literally right after they sell. Bruce asked if they are ultimately saying that they are comfortable with their decision to buy in the past and are going to re-buy another one. The bottom line is if they are going to re-buy something and if they feel that housing is going to treat them well again. Doug said yes and that the expectations of price improvement have strengthened significantly in parallel to this. He views the good time to sell as a leading indicator of whether people think they are coming out from being underwater. There are still a significant amount of people who owe more than the house is worth. They have asked about price expectations; and for the first time in the three years of the survey a majority of people last month expected prices to rise. This was the first time in the life of this survey that the majority of people were expecting prices to increase in the next twelve months. The degree to which they expected them to increase for the next twelve months rose to its highest level as well, and they were looking for about a 4% increase.

This survey as well as others has made it evident there is a lag in the consumer understanding that all prices are changing versus what you are actually seeing in the market. Bruce asked how expectations change actions. Doug said people will start to investigate the market. If they expect that prices will strengthen and they are at a pivot point where they might either want to move up or to a different location, then they start to look into the options. There has been a pickup in traffic. There is also the question of whether people will start to inquire about credit. There has also been some pickup in their attitudes about the availability of credit, so they are looking into that as well.

The price recovery is very aggressive in California. CAR just came out and said that we have literally set a record for year-over-year price increases. The median price has been inaccurate, but at least it has been consistently inaccurate for a long time. We have had a very good year as far as price appreciation, but what is odd about it is you have to ask why it happened since it normally is driven by job or migration improvement. We do not have any of these things. Doug said this is one of the reasons we are telling people to be cautious about the robustness of the overall housing recovery. They do not view it yet as robust, but rather their view is that the price increases at this point have been almost exclusively driven by supply-side factors. There is that question of bulk investor purchases.

There has been some improvement in the degree of underwater. The price increases that have occurred have brought some people out from under water. There has also been some improvement in this seriously distressed loan portfolio. In other words, the share of loans that are 90 days past due has been falling, and the short-term delinquencies have also been falling. The new home construction is still way below long-term normal levels, so you are still not getting much boost on the supply from new construction. Even modest improvement in demand faces that restriction on supply, which has mostly been driven by the supply side factors at this point. When you try to look at where supply is going to come from, it is going to come from REOs, short sellers, equity sellers, or investor flips. What is interesting is that the hedge funds are probably going to retain a lot of the properties at least for a while. In California you still have a fair amount of people who are upside-down.

Once you go from 6 months of inventory to below 2 months, going back to 6 months requires a tripling of inventory. Bruce was curious from where this could possibly come. Doug said part of it will come from people who are underwater. If the house price acceleration continues, then the people underwater will come out from here. Bruce asked about somebody was underwater and they had positive equity. If they were underwater and willing to make a payment for five years and want to be a homeowner, he does not see the likelihood of them selling to become a renter once they are on the positive equity. He is wondering if they just won’t stay there or will sell to receive another one and receive a low down payment FHA loan. Doug said this is certainly a possibly but really depends on where they are in the life cycle and/or whether their motive in selling is significant geographic relocation.

This is particularly true if they are boomers, which a lot of the folks that own those homes are since this is the way it works in the life cycle. Whether they have a retirement motive or relocation motive would also be a significant factor. If you are making the payments today and want to own a house, it is just a matter of selling that one and moving three miles away to buy another one, the problem will still be on the supply side. You have not gained inventory, instead you have just had it lag by a month. Bruce does not see how you gain supply. Doug said the other place is the construction business, but this requires the builders who let all the land go during the depth of the boom to re-acquire developable land and getting the permit process done. In some jurisdictions in California it is a pretty arduous and time-consuming process.

One of the things they have not been doing is creating any sub-divisions. In Riverside California, for most decent years you will have 300 sub-divisions created. For the last five years running we have had 20 sub-divisions created a year. In 2013, the first quarter numbers came out and he thought they will be significantly improved because of the market change. There were four sub-divisions created in Riverside. To Bruce, the builder is still looking at risk perception as saying he is not sure he wants to put the money out to create a building lot. He does not see how the inventory levels could be hugely impacted by builders on only existing building lots. This is about where it would have to come from. This puts an advantage to the investors who are holding the rental properties. This is what you are trying to calculate when you are an investor asking where you competition is going to come from since it does not look like the builders are going to be there in the front.

Bruce asked what percentage of people own a home now in the country and if it is declining or stabilized. Doug said it is at about 65%. The last couple reports have been within the decimal point of that number, so it seems to have stabilized. Some people have asked if you really own the home if you are underwater; so if you look at the share of people underwater and want to make the assumption that they are not owners, then it is somewhere between 60 and 62%. In terms of people who are in their house and making mortgage payments or own the house outright, then it is about 65%. Their view is that this is reasonable, although it might drop a little more to 64%. They do not really forecast this number. If you just look at common sense approach at the demographics and look at the people who are 75 and above and under 30, you knock off about 35% of the population even though some of the 75 and older are still staying in their homes. This common sense approach to the demographics will tell you that 65% is about normal.

They got up to about 69%, and they wanted everyone to own a home during that era. Bruce asked if policies will settle into where we will not make a run at 70% ownership anymore. Doug said yes and that he remembers in the mid-2000s receiving a lot of phone calls from the press. There were many famous quotes about shooting for 72-75%, and Doug gave the press people the same speech he gave Bruce about looking at the basics of demographics. He said he just does not see how their idea of going for 72-75% could work. Not everyone who is eligible actually wants to own a home. There are a lot of people who prefer renting, and this is not just low income or medium income folks, but rather high income households that simply prefer not to own the real estate. It is hard for Doug to see how you get there, and it is now broadly acknowledged that there were some public policy assumptions or policy programs put in place that were simply not effective.

Policy has made some adjustments. We would like to see credit available to those who are willing and able to own a home, but not everyone is qualified, interested, or ready at some stage in their life to be an owner. You will therefore probably see some backing off on this.

Bruce asked what the typical sentiment is of a family who lost a home three years ago through foreclosure. He asked if he had any statistics saying that they are very much wanting to re-own, or has the experience turned them off from purchasing. Doug said this was a great question and one they often sample through on their surveys. A number of years ago HUD had started some research into people who lost home and went into foreclosure and whether they ever became owners again. He never saw the results of this. In his survey he asked people if they desire to own a home, and the desire to own a home is undiminished over time throughout the cycle. People still value homeownership, but they do not have a sub-sample that tells them whether the respondents are people who actually have lost the house through foreclosure. Interestingly, the most optimistic age group about the investment value of a home is the youngest cohorts who did not participate in any of this. Now they are seeing the house prices coming back and saying this is not a bad thing.

Whether they decide to make the move today or not is a separate question. However, they have definitely seen the reset in housing, and this will work to their advantage. What is interesting is that along with statistics and charts, you have to study human nature to figure out what is next. We are pretty repetitive in what we will do, so if you think everyone is going to write off housing because it had a bad stretch, Bruce would say no. Doug said he does not see this in the survey, but what he does see adjust is people being very clear that they have to improve their credit performance. This is not just to acquire the home, although they recognized the conditions for acquiring mortgage credit would be more difficult moving forward than it was before the bust. However, they do still recognize the burden of maintaining the home, and they want to be financially prepared for this as well. There has been some healthy shift in the credit space that would indicate more stability in housing going forward.




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