On October 18, 2013, The Norris Group proudly presented I Survived Real Estate 2013. An expert line-up of industry experts joined Bruce Norris to discuss perplexing industry trends, head-scratching legislation, and the outlook for real estate in the coming year. Over $90,000 was raised to benefit Make a Wish and St. Jude Children’s Research Hospital. This event would not have been possible without the generous help of the following platinum partners: This event would not be possible without the generous help of the following platinum partners: PropertyRadar and Sean O’Toole, HousingWire, the Apartment Owners Association, the San Diego Creative Real Estate Investors Association and President Bill Tan, Investors Workshops, InvestClub for Women and Iris Veneracion and Bobi Alexander, San Jose Real Estate Investors Association and Geraldine Barry, MVT Productions, Wilson Investment Properties, RODA Construction, and White House Catering. For event video and information, visit isurvivedrealestate.com.
In this segment, Bruce spoke with the entire panel of experts, acting as the mediator to protect both sides from each other. He began by asking what most surprised everyone about the last year. He asked John Burns about looking back a year ago, what he thought was going to occur and what did occur, and what the biggest surprise for him was. John said he and Bruce had a discussion in December when he said home prices were going to go up 20% in the Inland Empire, and John told him this was not going to happen. Bruce was right, and John said this was his biggest surprise when he got it right once again. Price aggression was a surprise to him.
When Bruce asked Leslie Appleton-Young, she began by saying she had never heard it called price aggression but rather price appreciation. Bruce said when it goes 20% or more, it is price aggression. She said the lesson she keeps relearning over and over is that markets really do change on a dime. When you forecast forward, it is typically a gradual trend. The big changes that happen are really hard to forecast. When she looks backwards at the market, in February 2012 it changed. When you look at the data starting in March, that is when the home price appreciation really started to take off. Inventory was below where it was a year ago, and this is really the best leading indicator of what is going to happen in the single-family housing market. It always surprises her how quickly markets can change, sometimes for no apparent reason. Bruce said this is a very important factor that is a little hard to quantify. This is why Bruce likes charts since they prevent him from acting on how he feels.
Christopher Thornberg was the next person up on the panel, who said that a couple things surprised him. He said to Leslie’s point, inventories are the leading indicator. What is amazing is how we manage to forget this constantly. The currents were there for them to see. Inventory was drastically dropping, so when you get below a certain level you are going to have bidding wars. He was not surprised by the last year, although he said the year before was when you really started to see it. It really caught everyone by surprise when you started getting wind of these bidding wars occurring. Bruce said one of the advantages they have is they are selling properties, so his oldest son Greg is buying 120 properties a year. Gradually through 2012 they noticed a transition of having all the time in the world for having a property fixed and bought to not having to fix anything. They could sell it at multiple offers, and they even had a clause in the listing saying the appraisal will no longer determine the sale price. You have aggressively bid up the property beyond its capacity to appraise, and people still bought it. This is what forces you to go backwards and say what you thought mattered didn’t happen, so you see what trumps this. The answer is that there is nothing for sale.
The second thing that surprised Christopher is we are all celebrating the fact that prices are going up; but if you want to talk about California’s economy overall the single largest problem we have is that housing is too expensive. If you look at all the people leaving the state, it is middle income folks who cannot afford a house here. This is emptying things out, and we wonder why our factories cannot get qualified workers. We just came off of 50% affordability, and that number had never been broached in California since the 1970s. It has also never been broached in Texas in the other direction, but price aggression there is 0 and always will be. The rules are not always the same. You can go to Texas and see if you have migration of businesses and people. If you put this same formula in California, you have price increases. In Texas, you have nothing except another 100 acres somebody can drive.
If you look at the history over the last decade of population growth and migration, what is amazing is we had a complete reverse pattern of flows. You go back into the 90s when everything went bad and unemployment went up, people left the state because the unemployment was lousy and everywhere else was better. However, you still saw that on migration. This time around, the out migration peaked around 2005 when our economy was on fire because home prices were so high. They were leaving at a very rapid pace, and of course when prices dropped down it reversed. A few people started coming back in despite our bad economy. The pressures of housing costs in California are enormous, and you are going to see on the other side of the equation new people pushing for regulations on affordable housing mandates and other new social programs.
John Burns said he believes the affordability index is based on the median income household. Last year’s price appreciation was not driven by the median-income household, but rather affluent households who live in California and foreigners. The entry-level buyer was not present. They do a lot of this kind of work all over the country, Debra as well. When they go to Texas, people ask why they are sending them here. They see all the California license plates and see that there is a big out migration occurring. At $70,000 you cannot afford a $400,000 home, you just can’t.
Sean O’Toole taught Bruce something years ago that he had trouble agreeing with at first. Sometimes two charts can look like they work together just because you may have people migrating out because they cannot afford it. However, maybe they just cashed a $400 grand check and can buy two Texas houses. This may be why they left, not because they could not afford it. Nobody wants to move to Texas, and this is probably why they will come back.
Sean O’Toole said the thing he is still struggling with is the inventory as a predictor. Inventory bottomed at the end of 2005 when he and Bruce were getting out of the market. The big surprise for him that year was the whole interest rate bump. He really did not think we would see any big move in interest rates until 2015. Bruce asked Sean if he thinks we have had a big move in interest rates, to which he said they are clearly still historically low. If you look at the median income buyer, they can now afford 10% less than they could 60 days ago. If you take the median income in the state in 2000, qualify them by using the calculators over at Fannie Mae, and they got a median price of $250. You go to the peak in 2007 using the pay option ARM, take the median income household, and they can now pay $550,000.
Today, you take the median income of $62,000, put it into the thing, and they have $350-$360,000 they can afford. This is where they pegged the median. Buyers have always bought what lenders will lend to them. This is how they buy houses. With the median price they show based on public records, we are now at around $355,000. Sean does not think it’s over, it just really comes down to what happens with lending. Bruce asked Sean if a repeat buyer usually brings in a large percentage of their equity to the next purchase where the loan just does not change. This is part of the statistic. We keep on moving that equity around. Sean said we are doing things right now with lending that we have never done in the past. We talk about finally getting rid of the pay option ARM and how it is a terrible loan program. However, it has been around since the 70s. It was a great loan program because if you got in trouble you could make a lower payment. The difference between the 70s and what happened in 2005 at the peak is that you used to get qualified based on the worst payment. Now they are qualifying you based on this teaser rate pay-option ARM payment. There is nothing wrong with the loan product; the only thing wrong was how people were qualified for it. However, we are throwing it out the window and are doing it across the board with looking at what happened historically and without putting it in any frame of reference. What happens next year is anybody’s guess. We are doing all kinds of things in which we have no idea what the implications are.
Leslie said the other difference is twenty years ago you were not cash-out refis. This is one of the things people never talk about, so she thinks the financial crisis would have been 1/3 to ½ less severe if you had not had the “home as a piggy bank” thing going on for three or four years. The subprime share in California at the peak was 12% of the market. This involved all the CDOs and everything going on in the financial markets. The whole phenomena with cashing out and taking money out of your home put so many people in harm’s way when prices started decreasing. You did not have the same domino effect in earlier cycles because people had a nest egg.
Christopher Thornberg disagreed with this and thinks you should not pull money out of your home if you cannot pay it back. It goes back to the idea that there was a lack of credit standings. Leslie said a lot of it was semantics and that there was a time when the equity in your home was not a flexible part of your financial portfolio. Rather, it was the money that was in your home. What happened was it became easy to get at, and that is what people did.
Bruce asked if this helped our economy, and there were some differing opinions. Christopher said when all of this was happening, the nation opened up the 6% GDP trade deficit. The fiscal value of that did not accrue to our nation. Bruce Norris said it did help his household since it was a cheap interest rate and he did not have to give a payment until he had a use for it. If he found a deal on a house he could write a check, fix it up, sell it, and pay the money back. Bruce said he would not want the whole industry to restrict his access because somebody abuses it. Christopher said you can take money out of your home, and as long as you can pay it back it is fine. The problem was they were giving people home equity lines of credit that were larger than the ability they had to pay them back.
Leslie said the point is that things ought to be priced differently in the market, and it is not. Debra Still said that originally the loan programs were morally innocent if used for the right buyer. If you think about the CFPB and Dodd-Frank, the ultimate change in dynamics is that Congress and the CFPB do not believe consumers will behave rationally in an irrational environment. This is the case whether it is affordability or price appreciation. Consumers need to be protected. It used to be as long as they disclosed properly, Debra would give the borrower a loan. Now there are obligations that the lending community will own to make sure things go right. Debra said it is also about layered risk. Pay-option ARMs are fine with maybe a down payment and high credit score. However, with a 0-down, low credit score, high-backed ratios, and a program that gives maybe too many options in a moment, there is a right way to underwrite everything.
Debra said there have been a couple studies she has seen. The Research Institute for Housing in America, Harvard, the Joint Center, and Fannie Mae all did surveys that suggest that 85-90% of America still wants to buy or own. The fact that we have that appetite for homeownership after what we have been through is still a pleasant surprise.
Mark Palim said there was an aspect to everything that was a change in the institutional structure of mortgage originations. If you go back to the SNL age, people held things in portfolios. This does make you behave a little differently. You had to originate to sell, and people were originating FHA loans. At some point in the 90s you had commercial banks start to buy, and the behavior of sub-prime lenders started to change.
By the time you got to the mid-2000s, you had the layering of risk that is clearly an important part of why loans failed. Sub-prime is an old product. If you are doing sub-prime with a 60 LTV in a state where you can foreclose in six months, the lender will not take a lot of risk. If you are doing low doc for someone who made $1 million last year, and they own a business where the paperwork around that is not great you can just imagine the tax situation. If they have a 50 LTV, then that is one kind of loan. If you are doing a low doc for somebody who clearly has a very middle income job and the broker is adding a 0 or moving a decimal place on their income on a stated loan, this is something completely different. Mark thinks it was a gradual thing and that cash-out refis were a part of it as well as layering risk. Lending institutions were focused on making quarterly earnings and fee income rather than holding the loan for a long time.
Bruce remembered a time in 2005 when he was not sure what all was happening with the loan programs amidst the chaos. He would call up a lender to borrow money, and they would tell him yes and he did not have to send in anything. Bruce did not know this was happening at the time, and he even barely knew what a mortgage-backed security was. When everything hit the fan, he wrote in some of his reports that prices were going to decrease. However, he did not even know what a collateralized debt obligation was. It was not until later when he read everything that he was shocked by how things worked. Bruce’s question was whether the buyers of that type of product were ever going to show up again in sufficient quantity. Bruce asked if we have burned that bridge where this is not coming back, and this is partly what he is concerned about in going forward.
Christopher Thornberg said he has not seen many numbers, but he has heard much talk that there are collateralized debt obligations coming back into commercial space a little bit. However, they are much more transparent. There is a value to these things from a liquidity standpoint. If you have one big loan with one big building, then you have no flexibility. You cannot get rid of some of that debt when you need to, such as when you need cash. If you have these tradable securities, then it makes sense. The problem here was that there was a whole other second issue with the fact that nobody was watching anybody. The regulators were falling asleep, the rating agencies were a joke. All of these things need to be brought back into some form. If the ones in charge make sure things are going right, then this should not be a part of the equation.
Debra said the key word here was transparency. She thinks investors will protect themselves in the future, and there will be standards for transparencies so you know what you are buying. Mark said if you look back at that pure complexity and opacity, you see that we are not the friend of the investor, borrower, or half the people involved in the middle. You can look at the corporate market for an interesting analogy. In the 1980s we had the junk bond boom. When that crashed, corporate America took on a huge amount of debt. Since then, corporate balance sheets have actually been in great shape. You have piles of cash, low debt levels, and what you would still call junk bonds. It is just nothing like the volume there was. Although, covenants are actually getting worse, so you may see some of the same mistakes creeping back into the market. Mark said what was interesting to him about this last cycle was you saw it was in the 2000s where household debt got out of hand. There was a massive run-up that ended except for student loans. This is the one area that is actually growing. Now there is a shift with the economy being dependent on a large increase in government debt.
Christopher said if you look at the Federal Reserve’s financial obligation ratio, which is an estimated percentage of household income being used to service financial obligations, you see that there was not a big problem with this in the 2000s. It was not because the financial obligation ratio, which was well over 12% in the 1980s, got up to about 14%. You are talking a percentage point and a half higher. This is nothing because of the big decline in interest rates, which goes back to what has already been said about the problem in all the loan portfolios being not how much people were borrowing, but who was being able to borrow it. This is the primary problem, no doubt about it.
Mark said the monthly payment capacity, which this measures, and low interest rates disguise how much debt there was. If you look at the amount of equity people had in their homes, it diminished drastically during this time period. This occurred when prices were decreasing. When they were increasing, things remained steady. People were just loading up on large amounts of debt.
To find out more, tune in next week for the final segment of I Survived Real Estate 2013. The Norris Group would like to thank their gold sponsors for supporting the event: Adrenaline Athletics, REIExpo.com, Coldwell Banker Town and Country, Claudia Buys Houses, Elite Auctions, FIBI (For Investors By Investors), In a Day Development, Inland Empire Investors Forum, Inland Valley Association of Realtors, Investor Experts Inc, Keystone CPA, Las Brisas Escrow, Leivas Associates, Homevestors, Bottomfeeders, Northern California Real Estate Investors Association, Northern San Diego Real Estate Investors Association, Orange County Real Estate Investors Association, Orange County Investment Club FIBI, Personal Real Estate Magazine, Pilot Limo, Primary Residential Mortgage, Realty 411 Magazine, Rick and LeaAnne Rossiter, Southwest Riverside County Association of Realtors, Sonoca Corporation, Spinnaker Loans, uDirect IRA, Tony Alvarez, and Westin South Coast Plaza. See isurvivedrealestate.com for the video from the live event.
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