On Friday, September 27, the Norris Group proudly presented its 12th annual award-winning black tie event I Survived Real Estate. An incredible lineup of industry experts joined Bruce and Aaron Norris to discuss perplexing industry trends, head-scratching legislation, massive tech disruption, and opportunities emerging for real estate professionals. All proceeds from the event benefit Make A Wish and St. Jude Children’s Research Hospital. This event is not possible without the generous help of the following platinum partners: the San Diego Creative Real Estate Investors Association, InvestClub, ThinkRealty, Coach Fullerton, Keller Williams Corona, PropertyRadar, the Apartment Owners Association, MVT Productions, and Realty411. Visit isurvivedrealestate.com for event information.
This week’s radio show is Part 2 of our six-part series that will cover our recent event I Survived Real Estate. Today’s show will cover Dyches Boddiford and his advice on the best way to learn, and you will hear Doug Duncan, John Burns, and Jim Park discuss the market, including why bond deals are so low, interest rates and whether they could be affected by outside influences, people’s motivation to buy a home, and people’s main reason for wanting to buy one.
Dyches Boddiford thanked everyone for the award and attending the event. He was reminded of Socrates when he went to get a haircut. His barber asked him, “How would you like your hair cut?” Socrates said, “in silence.” He decided to keep it short, but he said if you ever want to learn something, teach it. You’ll get enough questions that it will force you to learn all the nuances of whatever you’re teaching. He learned that early on, fortunately, and he has enjoyed teaching ever since. It’s not only been an income stream, which obviously people understand, but it’s also been a source of education for him. He was able to learn what was happening in everybody else’s marketplaces, take that, and use that not only to improve his teaching but improve his investing. So thank you all for this. Thank you. He then reminded everyone how the event was about the children. Bruce saw his wife Debbie tear up and thanked Dyches again.
Bruce Norris headed what was known as the economic panel, which featured three in the industry. Aaron was in charge of the tech panel, which Bruce could not be a part of because he didn’t have a clue. They would later end the evening with all six panelists. There were a lot of very smart investors in the audience, and when he spoke in front he realized there was some concern. A lot of the questions that he thought of to ask came from the audience and what they had been concerned about.
Jim Park is the CEO and founder of the Mortgage Collaborative. Jim provides day to day oversight of the Mortgage Collaborative business initiatives and works closely with TMC’s board of directors to ensure that the company achieves its annual and long term goals. With nearly 30 years in the housing and mortgage banking field, Park has held various positions in the corporate sector, starting several businesses, worked in Federal and local governments, and helped to launch a number of prominent nonprofit organizations. Second on the panel will be Doug Duncan, Chief Economist of Fannie Mae.
Doug is Fannie Mae’s Vice President Chief Economist. He’s responsible for managing Fannie Mae’s Strategy Division and economics and mortgage market analysis groups. He is a frequent speaker on national and state, economic, housing, and mortgage market conditions. He’s been named to the Business Week 50 most powerful people in real estate.
John Burns is CEO of John Burns Real Estate Consulting. John founded John Burns Real Estate Consulting in 2001 to help executives make informed investment decisions. The company research subscribers received the most accurate analysis possible to inform their micro-investment decisions, and the company’s consulting clients received specific property and portfolio investment advice designed to maximize profits. John co-authored Big Shifts Ahead: Demographic Clarity for Businesses, a book written to help make demographic trends easier to understand.
Bruce began by asking Doug Duncan a question that was open to anyone on the panel. Today, the U.S. economy has about a 2 percent GDP growth, a 50-year low unemployment rate, inflation under control. Bruce asked why bond deals are so low? Doug said if knew the answer completely to that, he would tell the Fed because they would like to know too. He gave an illustration of being the best looking horse outside the glue factory. He was raised on a farm, so he gave that visual. But, if you look at the tenure, it’s about one point seven. Most of the developed countries in the world actually have negative rates at tenure. So we’re growing. Two percent growth is pretty good. Typically, economists think about the growth, the rate at which the economy can grow without inflationary pressures as being the sum of the growth in your workforce on an annual basis plus productivity gains. So we’re not too far from that. We think that’s about two and a quarter percent going forward, so we’re pretty close to that. So the U.S., relative to other countries around the world, is a pretty good place to be. The question of why inflation hasn’t come is an issue that the Fed would like an answer to.
Bruce asked about the influence outside of our own borders and if their economies are likely to worsen and put more downward pressure on interest rates? Doug said it is certainly a possibility. China is clearly slowing. That is one of the effects of the trade discussion that’s going on. They’re actually about twice as sensitive to trade as a share of their GDP as the U.S. is. You’ve seen recently some easing of credit conditions, and some of that will flow into their shadow banking system, which is a real concern for them today. There’s no question that people are worried about whether the U.S. is actually isolated from those effects of slowing in other countries. We’re still the biggest economy in the world. China is the second biggest. So as China slows, it does have an impact, but not as much on the U.S. as it does other trading partners of theirs around the world.
Bruce asked if, based on the Fed’s actions, whether the interest rate reductions in the U.S. are preemptive rather than necessary. Doug said for those of you whose lives are so exciting that you watch the press conference of the Federal Reserve chairman, press conferences which they form cocktail parties around, there are some clues. In the rate cut that they issued in July, they call it a midcourse correction, which suggests that the economy is actually doing okay. However, the risks are on the downside, so we’ll just temper it a little bit and be a little bit easier on the money. They are listening in September and listening for the words”mid-course correction” and insurance. He actually did use the word insurance, which suggests their view is that the risks are greater to the downside than they were. They actually have another rate cut in the forecast in December on the insurance idea.
Bruce said if we go back a year ago at the last meeting, the anticipation was we were going to have three rate hikes going forward. Now we’re probably going to have three rate cuts. That’s a big difference, and real estate’s feeling the effects of that. Doug said they saw the run-up in rates to that expectation late last year, which bled over into the market in the first half of this year.
Bruce next went on to talk with John about his business, which only started in 2001. It’s an amazing accomplishment because when he got started he had a nice run for builders. When he and John really got to know each other, John invited him to debate with some very smart people in 2005 and 2006. At the time that went on, John’s clientele was basically builders. John Burns said he had to pivot, which is an astonishing word because almost all the builders that survived had to do exactly the same. Thanks to Bruce, a number of his builders sold their company and got out before things got worse. Nobody can time what’s going to happen, but you can figure out when the risks are higher than usual. He thinks there is a parallel with what’s going on right now. He doesn’t know what’s going to happen next year, but he is confident the risks are higher than usual. With this in mind, that’s how his clients are running their business again.
Bruce told him as he has expanded his client base, he also added to his life the input from very smart people across the board. He has 250 the smartest clients out there who pay every month to make him smart. That’s a good deal and business model. Bruce asked if the urgency or animal spirit to own a home changed from what it was? John said the animal spirit to own anything has changed. In a demographic research book he did, it was very clear to him. They nicknamed those born in the 1980s the “sharers” because they basically invented the sharing economy. They asked themselves why they would need to own anything when there’s an efficient way to rent something. It starts with prom dresses, and it goes to houses and Airbnb. They want to borrow, whether it’s a bike or a car. It’s the same thing with a house. They don’t like rent hikes and would like to own their own things. Most of them are going to become homeowners, but the question is whether they are going to achieve the homeownership rate as their parents did. He thinks the odds of that are less than 1 percent. They’re just not going to get there. The GDP growth in the last 20 years has been a full point lower than the 20 years prior to that. So they just haven’t had the same economic tailwinds.
Bruce said when you look at the numbers for people that retire with their home free and clear and they retire as a renter, that’s not a pretty sight. Bruce asked if they are going to be making their money a different way. John looked at it through their lens. It’s not a pretty sight, in their lens, to see their parents get thrown out in a foreclosure. If you were born in the 1990s, the word “recession” means foreclosure. That’s the same thing. They want to be homeowners, but his clients have done some really interesting research on that. A lot of them are not stretching as much as you would think. They’ll stretch on the downpayment, and they’re putting nothing down. He doesn’t want to go up to his eyeballs, particularly in California and with the college-educated people in California. His data showed this group has the smallest share out of any of the last three generations, contributing more than 30 percent of their annual income to buy a house. This is much more conservative. He doesn’t mean to say a lot of people aren’t stretching, but according to his data, a lot of people are stretching.
Bruce asked what the main reason is to buy a house today. John said it’s because people are ready to settle down and have a family, and they’re stable. It used to be you would take a job and be someplace for 30 years. Now it’s not like that and you don’t have much of a choice, even if you want to stay there for 30 years. Even in big markets like Phoenix, if you buy a home on the west side of Phoenix and then decide to take a job on the east side of Phoenix, you have to move. Traffic is an issue, and everybody is a dual-income household too. Both of you have to have a job on the west side of Phoenix, and this just creates a lot of psychological barriers.
Bruce Norris next went on to ask Jim Park what year the Mortgage Collaborative got started. He said it started about six and a half years ago with the concept that lenders could learn from each other and support each other’s growth. They now have 170 lenders throughout the country that are members of the organization. They benchmark their performance against each other and help raise and elevate their performance level in terms of operation and efficiency. It’s an important issue in this environment. Right now, the average cost to produce the loan is ten thousand dollars. It was about eight thousand about a year ago, and it was much lower if you go back five years. There were some issues around regulatory costs that were embedded into that, and it added to the cost of producing a loan. There are higher loan officer comp and other things that played out, which makes it very hard for lenders to survive in this market. A lot of their members were struggling at the beginning of the year before the rate started to drop. Everyone’s feeling really good again; but this business is a very cyclical business, which they expect to last for a little while. The balloon will come back down again or the bubble will come back down again, and they expect to run the business more efficiently yet again.
Bruce asked if the Mortgage Collaborative ultimately relies more on purchases or if there are other avenues of loans. If somebody gets aggressive with loans to investors and stops at four or 10, maybe 30, would that have an impact on his clients being able to make money? Jim said the bulk of the business today is very safe and sound lending, something Doug Duncan also knows very well. Some of these aggressive lending products that are in the marketplace are still a small piece of the business. Generally, business today is better than ever. That’s why a lot of people are concerned about the bubble and what the market will potentially hold for years down the line. Jim created some of the manufactured loans that have been seen in history, which Bruce didn’t have as big a concern about the potential for a mortgage downturn in that same way. There are other issues at play in terms of the broad economics; but in terms of the mortgage side actually bringing the economy down, he doesn’t think we have that issue ahead of us.
Doug said one of the things he tracks is early payment defaults. When a loan is new, you have to ask how many of those loans go into delinquency, 30, 60, or 90 days, and how soon. Those numbers are the lowest they’ve been in over 20 years. To Jim’s and John’s points, the quality of the loans that are on the books, and a lot of those are younger people that are being much more conservative. Partly, it’s the tightening of underwriting criteria that has supported that, but it is factual that it’s unlikely that the mortgage space will be the problem next time around.
Bruce asked about current lending laws that are still in place and whether they indicate that we’re still going after safety first or trying to get the percentage of owner-occupants up again to people that own their own home? Jim said the low level of delinquency that we are experiencing in the market historically low, according to Doug’s point. It does tell you that maybe it could loosen up a little bit. Obviously, that has a direct correlation to how wide the door is to let people into getting financing. Jim said on the builder’s side, supply is the bigger issue, even less so than the kind of credit available in the market. That’s a bigger issue. You have plenty of people looking for housing. They have financing behind them, but they can’t buy the house that they want or can’t afford it. It is particularly at the mid-level or start-up mid-level where he thinks people are struggling the most. We can try to create more buyers, but we have to find places for them to buy. That’s the challenge ahead for us.
John Burns clarified that the mortgage underwriting isn’t tight in every aspect. The documentation is as tight as ever, so if you don’t have great documentation, it’s tough. If you don’t have a FICO score of 640 or above, it’s also tough. It’s a lot tougher than it was 10 years ago, but it’s pretty comparable. About 10 percent of mortgages are going to those people, and that was similar to the 1990s. They could loosen on documentation, and they could loosen more loans to the sub 640. We have 57 percent of mortgages putting 10 percent down or less, which is the highest ever. The down payment is as loose as ever, and Dodd-Frank came up with an arbitrary number, 42 or 43%. We should not be above somebody’s gross debt to income ratio except for Fannie, Freddie, and FHA. 43 percent of all mortgages are above 43 percent debt to income ratio. So, we’re not tight on the down payment, and we are not tight on debt-to-income either.
Jim said part of the reason why you see the trending down of the down payment amount is because home prices have moved up. You’re talking about an average teacher or fireman and how long it takes them to get 10 percent or 20 percent down. It’s quite substantial. People want to jump into the market, and the only option they have is to go towards more than a low down payment product. With Fannie, Freddie, and FHA, you have a vehicle for making that happen.
Doug said the point is that the product is there. The thing that was different than in the 2004-2006 time frame is that the underwriting process now is diligent about what they call layered risks. If you have a spotty employment record today, it might be okay as long as you have good savings and a good record on repaying your debt. But, if you have a spotty employment record and a weak record on repaying your debts along with no savings, you’re unlikely to get that low down payment loan. The underwriting has removed those layered risks.
Doug went on to say how they survey a thousand households a month, which they have been doing since June of 2010. Each quarter, they survey the universe of mortgage lenders, and they have watched the parallel recognition of both households and lenders of the pace of slowdown in credit easing. Starting at the post-crisis period in the 2010 period, credit was very tight. It’s gradually been easy, and both consumers and lenders have recognized that. Part of it is the rules, and Fannie Mae is part of what’s driving that. Over the last year it’s flattened out; and in the most recent quarterly survey of lenders, there was actually marginal tightening in every group except in the private label issuance. This is less than 5 percent of the total market. FHA also tightened a few rules, including the debt to income ratio that John discussed. This was another area they saw some layered risks emerging. Fannie Mae also tightened some rules that were translated into the industry very quickly.
Bruce next went on to talk about repo markets since they had been in the news every night. It’s not a repo like we’re used to because it’s not a repossession but rather a real repurchase. Doug Duncan said the Fed only wishes it was the kind of repo Bruce had in mind. Bruce said there’s been billions of dollars that have had to be added to shore up something. What basically happens is you have lenders that have money, and you have lenders that need money. What occurs is the lender that needs money actually gives up ownership of something. They have to rebuy it within a certain tight timeframe. He asked why there was a shortage of 75 billion dollars in that exchange? It’s not going to October 2nd and could add up to $2 trillion. Doug said there was a press conference on this, and in the conference the chairman asked if this was a surprise. Doug said no because it happened in December, although at a much lower level. But, what did surprise him was the magnitude. When asked the cause, the chairman said they did not fully know.
That’s a troubling statement, but, it’s also an honest statement. It’s an honest statement, but we don’t want this to happen. It’s true that the whole capital markets community is attempting to understand this, and there’s not a good solid answer to it. If you really want to get into this, there is a guy named Zoltan Poznar that is an analyst for UBS. He’s been warning about this for about a year. Doug wanted to change his name as Zoltan is a much better name than Doug. Fannie Mae had him come to the company the week before because they wanted to talk to him about this since they put a lot of money in as a result of the mortgage payments that come through their business. They put a lot of money into the cash component of that repo market, and where they were concerned was the huge volume of issuance of Treasuries that are having to be done because of the deficits that they are running. There are 24 companies that have been granted access to the Treasury called primary dealers. You can look it up on the web, and you can see who they are. They are made up of 24 global banks and are the ones that actually execute the sale of treasuries into the market. That’s where the reserves either shrink in the banking system or increase, depending on whether they’re selling or buying.
The magnitude of the issuance of Treasuries and those institutions all have capital rules that say on a daily basis what their liquidity has to be. They will go into the market, and if they need more liquidity, they will be dedicating some of those treasuries to the trading partner who will then give them cash to meet their regulatory growth. Then, the next day they sell those treasuries back at an incremental nightly interest rate. That’s a piece of it. It’s also the case that on a quarterly basis there are corporations that have to meet tax issuances. Some of them typically access cash through the money market funds, which also has to do with the reserves on bank balances.
Bruce asked what their collateral is, whether it was bonds or something else. Doug said it’s typically treasuries or agency securities. Those are a couple of other things, but that’s not all of it. He didn’t pretend to understand everything that Poznar had written about it since he has been trying to make his way through it himself. He doesn’t fully understand all the elements, but he’s been the one person who’s been really accurate that this is going to be a problem. He suggests it will ultimately drive the Fed to expand its balance sheet and drive the funds rate to zero.
Bruce asked if the very act of what they’re doing is actually already doing that and adding to the balance. Doug said there is liquidity and you would need to let the Fed balance sheet grow organically. A New York Times reporter asked if you can give consideration to actually increasing it today to a higher level because of those reserve requirements and then let it grow organically. He said no, that’s not what they are going to do. There was another follow-up question where someone asked if you should stand up a permanent repurchase facility, which he also said no. They’re still trying to understand the dimensions of the issue, and it does have some global components to it because some of those primary dealers are global bank components.
The Norris Group originates and services loans in California and Florida under California DRE License 01219911, Florida Mortgage Lender License 1577, and NMLS License 1623669. For more information on hard money lending, go www.thenorrisgroup.com and click the Hard Money tab.
The Norris Group would like to thank its gold sponsors for supporting I Survived Real Estate: Coldwell Banker Town and Country, In A Day Development, Inland Valley Association of Realtors, Keystone CPA, Las Brisas Escrow, LA South REIA, Michael Ryan and Associates, NorcalREIA, NSDREI, Orange County Investment Club, Pacific Premier Bank, Pasadena FIBI, Shenbaum Group, SJREI, Spinnaker Loans, South Orange County Real Estate Investment Club, uDirect IRA Services, White House Catering, Wilson Investment Properties. See isurvivedrealestate.com for event information.