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.
The panel continued the discussion on the large amounts of debt people acquired. Sean O’Toole said one important point that gets lost in all this is the people who borrow. The whole conversation becomes about the qualification of the borrower and if we are making loans to the right people. Sean does not think it has anything to do with the people who borrow. It has more to do with the price at which they borrowed. An example would be if we tied loan limits to 7% return on rents and never loaned above that. Sean said they made pulse loans when there was a 1 ½% return on loans. Anybody with a whole suite would be lent money. This was clearly a problem. However, at the bottom a year and a half ago when prices had increased a lot, they could have made loans to homeless folks with no income or anything else. There would be zero losses today because we could have taken them over sooner. There would be no losses since the losses were a part of unsupportable base incomes.
Leslie Appleton-Young believes price appreciation trumps solid underwriting every time. Now she says that price aggression is what trumps solid underwriting. Everybody makes out okay regardless of what happens. Debra asked how, as a lender, you would make a loan and know you are going to get price appreciation endlessly from now until doomsday. Christopher said it was pretty clear from a historical standpoint that there are some basic fundamentals. Sean said unless you get into a period of time where rents are declining dramatically, you wonder where this has really happened besides Detroit.
Christopher said the argument for continued price appreciation is made best by looking at the rent-to-price costs in the area. Rents are still incredibly high relative to homeownership, and that says that there is a demand to be here one way or the other. This is going to translate into higher home costs, so it will probably be another 20% year. Leslie said what did not make sense to her was that in 2005 you could get a loan with no pulse. They would lend to anyone at the top of the market. At the bottom of the market, nobody could get a loan. Bruce said even the investors in the room have a hard time getting loans to this day, even with good balance sheets.
He remembered somebody there in the audience went to a lender he had been using. He took a couple years off, sold his portfolio, made lots of money. The area he majored in crashed really hard, and things that were $300 grand were now $60 grand. He went back to the lender, who told him that he did not have any income for two years. He has seven figures times a whole lot of multiples, and he has to fix his monthly income before anyone can loan to him. He went and bought 30 free and clear houses, came back, and the lender told him he did not have it on his two years of tax returns. Therefore, this person has been made loans at 9.9%. This is frustrating in a sense because it is not sometimes about who to loan. He said the room does not fit whatever they think is safe, and this is really not true.
Debra said the pendulum has clearly swung too far, and we would all agree that credit is overly tight. She thinks we will probably find the right balance again. It is taking probably a lot longer than we might suspect. One of the things lenders will ask for is clear reps and warrants from the investors to whom they sell their loans. Whether it is the GSEs or FHA, they need to say the definition of materiality and duration and how long the borrower will have to pay before it is a good loan. For her, clear reps and warrants is one of the most important things we can do in the short term to get lenders lending again. Reps and warrants refer to when you sell a loan to the GSEs. You rep and warrant certain things that meet Fannie and Freddie’s underwriting guidelines.
Over the past five years lenders have been in a position where they have had lenders defending the definition of a guideline versus a technical default. It has been a bit of an environment where lenders have learned what they are never going to do again, so credit has gotten tighter. We are almost through the legacy book of business. FHFA has suggested that we all be through the legacy books, so anything prior to conservatorship needs to be cleaned up and done by the end of this year. FHFA has also given a little bit of definition around reps and warrants. What lenders want is to be told the definition of materiality and when it is material versus a technical footfall.
Bruce asked John Burns what his biggest concern for his industry is in the next year. He said the biggest concern for him is the economy. He said it seems to be going along okay. The biggest concern his clients have is the price they are paying for land right now. He said one thing the audience does not do a good enough job of is putting their lender hats on and really understanding what it is like to be a lender. Another issue for them is dealing with put backs of loans they made to very good people where you dotted every I and crossed every T, but you still lost $200,000. There’s also the lawsuits all while they are being told to loosen their credit. He also understands that with Dodd-Frank if the loan is underwritten improperly and sold, the buyer of the loan will be liable. There is no appetite to buy your security from the bank because Black Rock and Pimco are not going to take that risk. As soon as they get rid of that, there is a huge appetite for 4 ½-5% interest rates backed by assets that are rising. This is really the only thing they need to fix to get credit flowing again.
Leslie said her biggest concern is really in regards to jobs. She thinks a sustained improvement in housing is going to take a lot stronger job growth than we have right now. You have structural and cyclical issues as well as there are a lot of people on disability that are not getting counted in unemployment. When you look at African-American teenagers and white males over the age of 55 in these niches, the unemployment rate is very high. It really circles back to the whole thing about where the first-time homebuyers is going to come. They are not going to come from anywhere if they are not able to move out from their parents’ house since they cannot find a job with decent income. Leslie said she really worries about the fundamentals as well as income distribution and how skewed it is becoming. She also worries about social unrest; and there are so many things to worry about it is hard to pick just one.
Christopher Thornberg said his worry for the nation is the ability for Congress to do a lot of harm to our economy. He worries that the uncertainty they began is going to carry over into another big mess in February. Too many people would be pursuing illogical agendas and not paying attention to the pragmatic realities on the ground. It scares him to death that we have these kind of folks leading us. We live in a two-party/one-party state. On a state level, his biggest concern is the high housing costs. This is a state that desperately needs to increase the housing relative to its population growth. There are a lot of social and economic issues because of this particular problem. For those who can afford the expensive homes, it is good. However, the overall health of the economy is dependent on having an appropriate amount of housing, and this goes back to Sequa. The so-called Sequa “reform” almost made the situation worse.
Sequa is the California environmental quality act. It is the tool by which unions and lawyers get to hold up every homebuilder in the state and take off the 20% at the top. On top of the environmental issues, at the last minute when they were doing the Sequa reform they tried to slip in another provision to the bill. On top of the environmental impact report, you would have had to do a social justice impact report. Thankfully, it was a midnight thing and whoever slipped it in did it at the last minute. It was one of those things where every chamber in the state went crazy. The ones who support Sequa are the same people who want to put affordable housing mandates on all new construction. People want to build here because candidly if you want to get the permit it is hugely profitable. The big builders may not want to change it because the margins they get in the businesses actually increases the results. The margins then go to the landowners in the cities that collect the billing.
Sean O’Toole said his biggest concern is regulations swinging too far as well as a lack of political leadership. The thought that we can increase affordable housing by adding taxes to housing seems so nonsensical. We think we can add fees to housing to fund it and make it affordable. This is the political environment we are in right now where we think we can tighten credit to improve lending. Nothing makes sense anymore. Forty years ago we had all the affordable housing we wanted and did not have to do anything. We thought it was a problem that needed fixing. Sean jokingly said the people thought they should just withhold all the inventory and keep people from buying it. This will then push prices back up again. Affordable housing in our political environment is not about people being able to afford homes, but rather about helping a handful of folks who build affordable housing or benefit from running affordable housing programs. This is almost a cynical view, but Sean thinks we are really at that point.
Debra said there are three intersecting things that worry her. For one, she worries about broad access to credit for qualified consumers. She also worries about a competitive marketplace. If you think competition is good for consumers, then how many lenders with this complexity of the regulatory environment are going to throw in the towel and be done. The notion that housing is critical to our economy and if we will derail is another question. Mark Palim said jobs is clearly the number one worry. The number two worry is what goes on in the rest of the world. In the early stage of this recovery, exports were a big part of rebuilding employment in the U.S. There are still a lot of problems in the Europe with the Euro and in the Middle East as China is slowing. We are becoming a much more trade dependent economy with very low domestic innate growth. Mark said he worries about the negative shock from outside the U.S.
Bruce said there are a couple things that we are used to having that we think are always going to be there. These are the 30-year fixed mortgage rates and deductible interest on taxes. Bruce was curious about everybody’s opinion on these “holy grails” and if they are going to stick around for the duration. Christopher Thornberg said the one thing many economists, both left wing and right wing, will tell you is that the interest deduction is a travesty and a ridiculous subsidy to housing. It destroys capital markets in every way, and the only people who benefited from it were the people who own homes when they were put into place. Ever since then we are all paying higher prices because, more or less, we have subsidized interest rates. It is a crazy thing to put into place and should be gotten rid of but never will. Even though you cannot justify it and there is no logical model out there on how it works, it is still in place.
John Burns had a little different spin on it. He did a white paper on it, and people forget that the standard itemized deduction for a couple is $12,000. This means 70% of the people who buy homes today do not even use the mortgage interest deduction since it does not add up to the $12,000. All of the benefit accrues to five states, California being one of them. There are has already been some movement in North Carolina to drop the dollar, so he thinks we may see the dollar amount decrease. It is not a budget saver since it is costing $55 billion a year. Everyone in this room uses it, but we are really the minority.
Leslie Appleton-Young said you could see second homes hit a certain level or the $1 million cap go down. The more interesting issue philosophically is what we believe about the government’s role in housing. Do we believe that it should be subsidized in some way? She said she clearly can never disagree with Christopher Thornberg because from an economist’s point of view, there are more efficient ways to subsidize homeownership than the mortgage interest deduction. With all of this said, it has been around for an awfully long time, and changing it when the housing sector is one of the strongest parts of the economy right now is probably not a good thing. There are so many reasons why you should not touch it, but theoretically you can do it better other ways. The question is what the role of government should be. With respect to the GSEs, it really does boil down to this. Private capital is waiting on the sidelines to come in at a huge spread, so the issue is really the price at which this would happen.
John said people want a 30-year fixed-rate mortgage. The appetite of bond funds to buy 30-year fixed-rate mortgages is huge. This is why this is not going to go away either. It is huge, and people want to buy 30-year fixed mortgages. Pimco manages $2 trillion in bonds themselves, and people are looking for more things to buy. If you are running a bond fund and can get a 4 ½% coupon, that is a pretty nice return right now. The banks should not hold it on their balance sheet, but they could offload it into the bond market.
Debra said his comment on private capital waiting on the sidelines is interesting. Debra said if they are returning, then they are coming back with a big spread and a bigger yield. The GSEs and FHFA have been raising the guarantee fees. Some lenders have had 7-8 g-fee increases in the last 18 months. If you look at the g-fees that ultimately are consumers are paying for the credit quality we are doing right now, it is way outsized. The purpose was to crowd in private capital, which is not back yet. It is not working. The rate on the jumbo loans dropped below 30-year, which explains why there are a lot of gap holes. You can get a jumbo at a lower rate than a Fannie or Freddie loan. Debra said if you look at what private capital is lending, you see that they are lending 15-20% down with a 70-80 credit score. It is for the wealthiest borrowers, not for middle class America.
John Burns said g-fees and increased interest are now a risk since people now know that increased risk will increase the spread over treasuries. Even if we had a 5% interest rate, that is still a great rate. You include it in the rate, and you move on. Bruce said this makes housing even more unaffordable in California. Affordability tells you where you are historically. We are at 36%, and it has been in the 90s since the downturn when we had 39-40 max. We get down to 17 normally, so we are nowhere close to where we were. There is a lot of head room for price to go up, although Bruce thought Christopher said everyone was leaving because it is not affordable. He reiterated by saying there is a segment in the middle. In the end, Bruce thanked the entire panel for their time and said he really enjoyed being on it with them. We look forward to next year’s I Survived Real Estate 2014.
This is the final segment for the I Survived Real Estate 2013 radio show. Thank you so much to all who came and participated. 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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