Bruce Norris is joined again this week by Mark Dowling and Paul Herrera. Mark Dowling has more than 20 years of experience in real estate and community development. He serves as the Chief Executive Officer for the non-profit Inland Valleys Association of Realtors. With more than 4,000 members, IVAR is one of the largest realtor associations in California. At its core IVAR provides a variety of support services that helps its members be more competitive in a real estate marketplace. Key services include realtor education and training, government affairs advocacy, multiple listing services, and professional standards mediation. Paul Herrera serves as an advocate for realtors and their clients on local issues, helping to preserve and protect property rights and the value of homeownership. He works with colleagues at the California Association of Realtors and the National Association of Realtors. Paul helps members make a difference for their clients at the local, state, and federal levels.
In the last segment, they read a quote that sounds so reasonable. The person buying the house gets the benefit of the retrofits, so naturally he could pick up the payment. However, there is a lender in the transaction saying it is not a free and clear house now even if it should be. If he does a loan for the new purchaser, he would sit in the second position rather than the first. The primary problem is that the lender in most cases is backed by Fannie Mae, Freddie Mac, or FHA insurance. It is usually 90% of any financial transaction in the market and 70% of any sale. The vast majority of the marketplace is reliant on government-backed financing. Those government agencies have said they will not accept second position on those loans, and therefore they get jammed up. Many deals have fallen out of escrow because of this.
There have been responses made to this as well as promises that are improving it, and they are seeing a future in which this may not be an issue. However, this has been an issue and a destructive one for the past couple years. In addition to the lender having a problem for the buyer relative to doing a loan on the property, there is a common sense issue here. The buyer is looking at paying full market value for a property only to hear that in addition to paying the full purchase price they also have to finance another $30,000 in improvements against the property. Consumers are asking when they pay full market value for the property why you would be paying extra for these other items. It is like buying a car only to be told the engine is a separate bill you have to pay for on a different payment schedule.
You would almost have to force the appraisal world to acknowledge the $40 grand bump since we put in new windows and a roof. That starts dictating something we don’t really want, which could be a reduced property value. They would have to lower the value of the property to offset the lien. For this one, even though it is the same square footage it is worth $330 since it has new windows. There are unintended consequences galore for that one. It is the flavor of the month in a way. They have water issues and solar issues, but they could have a list of other issues show up that could qualify them for such a program. This is a very creative use of taxation and the definitions of community improvements.
The system is very similar to one that finances parks, sewers, street lights, and streets. These are community improvements. There has also been a clear distinction where if you finance something that benefits one home, that is not appropriate for taxation. That is why you have consumer lending individuals spending their own money. This blurred the lines and said if you save money you save electricity. This benefits the whole community and not just the one home. They could afford it the status of being a tax and levy down the one property.
Bruce asked about the loan structure and if the payments are amortized fully or always fixed. They are fully fixed payments. There is one very slight item that could change, and that is an administrative fee that is charged and can change year-by-year. However, it will only change about $10-$30 a year. That can change based on the costs administered to the programs. There was a cancellation fee initially in the program through their efforts and the efforts of other realtors associations that was essentially waived.
This is where bright idea hits the actual street and the realtor can feed back and say this is a problem since they are losing listings, loans, or sales. At the end of the day, we hit a $30 grand wall and don’t have a solution. No lender will take second position and no one is willing to write the $30 grand check. Therefore, we do not have a transaction on a sale. In general, it is a decent idea that needs some tweaking, and that is what they have just done.
IVAR has been working with Renovate America for almost a year now. Those efforts were not going very far. They were not looking to take a position, and the board of directors and other realtor associations representing the entirety of the cities in Riverside County ultimately took that same position because of the frustration that not enough was being done to address the problems in the program, which at that point was creating a roadblock to sales. It is a bit of a new program, but you may have $20,000 homes that have something that would be a problem you really don’t need. There were consumers utilizing these program 3-5 years ago, but at IVAR they were not seeing problems until the resale issue. The last 2-3 years they have been able to see them
Bruce asked about the process of non-payment. If he could not make the HERO payment, what would happen? Currently they would have the right to initiate a foreclosure at whatever it is determined they are not getting paid. In that sense, it is more like a loan than a tax. They do not wait for the tax lien since you cannot make a partial payment. It is all or nothing. They have the best of both worlds in that they have the foreclosure rule for the loan but the first position for the tax lien. Currently they have the ability to initiate that. However, at IVAR they are not aware of them having done so. In many cases you have the tax bill being a part of the mortgage payment. That is a more likely scenario where it creates a default of the entire property.
Part of it is because of the nature of the market. We have a pretty healthy market, but if you have a problem market this will not help it. It will just add one more straw to the camel’s back. One of the questions IVAR has been asked is if it is reasonable for FHA and FHFA to take this position of opposition and now allow to take precedence to their interest. What they point out is to imagine it is 2005 and not 2015, and imagine 2007-2008 is coming down the line. You have one county, Riverside County, which now has $800-$900 million worth of these out there. This will eat away entirely at Fannie Mae and Freddie Mac’s interests for whoever owns those notes down the line. If that happens, you can start ratcheting up the cost of the bailout and multiply that by the number of counties, cities, and states that take advantage of this.
If the HERO loan started foreclosure, they would notify the lender, who would then write a check. Bruce asked if anybody knows the sale process. With trustee sales it is a public sale and there are bids. However, at IVAR they do not, but they do anticipate a lot of it will be addressed very differently in the near future. It is just not sustainable that this program remains in this position given the secondary market and the taxpayer-backed enterprises will bear the blunt of these costs when there is a market downturn. It is always a matter of when. We are looking at changes coming from the government through FHA that will include most of these loans. These will not only subordinate the future loans, but the existing loans as well. This will likely change in the next couple years, but problems are also likely to remain as well as there will be a real cost to homeowners who have already taken out this money.
Bruce wondered if there are restrictions on who is explaining the wild card program to people. Are these qualified people with some acknowledgement that the people are understanding what they are being told? This goes back to the question of who is selling the product and if consumers really understand what they are signing. A number of people had come to IVAR who had utilized the program but had major concerns and truly did not understand what it meant, not the least of which was the concern of whether they could transfer the property to the buyer.
When the new buyer would come in and say their lender would not do a loan on the property, the seller who got the HERO loan is now concerned. They did not understand since they were told they could transfer. The short answer is there was not a significant amount of training and explanation to the consumer relative to how the program really works. It is a very confusing product for the general public. At IVAR they have heard all manner of misunderstandings. For example, the explanation that you pay back the tax bill. Some consumers who talked to IVAR said the way the contractor explained it made it sound like they diverted a part of their tax payment. They did not understand it would increase it.
That was probably the most extreme level of misunderstand, but they have heard many instances of just that version. There was not enough done to educate consumers. They were expected to read these contracts and understand them. They held a forum on the issue, which included the attorney who helped create this program in the first place. This question was first asked to him by the public, who asked how a consumer was to understand it. He said they should have their attorney review the documents. This usually is not the case, although in Florida this may be a more common statement. There is a reason why there are realtors, title companies, and escrow companies. It is because the consumer cannot be expected to understand the mechanics of a financial transaction that involves real estate because it is extremely complicated. You would also have to explain to them that you cannot get a refi from now on. This door was closed and they did not even realize it.
Bruce asked what size loans we are talking about here and what the typical cost of services is that ends up getting done. However, this type of information is not very forthcoming. However, what has been provided has been in the range of $20-$25,000 as a much centered number. At IVAR they have seen as high as mid-40s. On the other hand, they have seen some that were as low as $6-$7,000. However, the majority have been in the $20-$25,000 range. There is no clause necessary in the loan docs because it would be very difficult to become superior to another lien other than your tax bill.
The docs have been significantly improved. A year ago when they were working on the issue, the information about how it would affect your future interest in the property and your ability to sell refinance was essentially so paragraphed it was hard to understand. Now there is a much better disclosure document that explains the issues you should be concerned about and look into as it relates to financing in the future. Whether or not consumers understand what this means is not known, but at least there is something more reliable and more forthcoming than there used to be. IVAR is doing a great job since otherwise Bruce said he could see how this would affect somebody in a negative way through trying to sell their home and using up some of their equity.
There were people early on who were told that when the debt followed the new buyers, they were literally making the improvements getting ready to sell the property. One of the ideas was to make these improvements, get the house at a higher value, and not have to pay for it. However, this was not the case in most transactions. In Florida, where this program is available, you could have hurricane retrofits. In California, you could have earthquake retrofits that were actually introduced in a bill last year but at the moment are not utilized. The one thing it is better than is a mandatory program at the end of closing where you say you have to retrofit. It is nice that it is voluntary.
Bruce asked what changes FHA is going to make as far as the lien position. Bruce wondered if it will not take the place of a first. FHA made an announcement back in August that almost point-by-point addressed every issue raised as a matter of concern on PACE lending. The big part of this is that these loans cannot supersede the interest of the payment priority for the first money mortgage. This is for FHA, who is also working with Fannie Mae and Freddie Mac through FHFA. They intend to issue joint guidelines, which will follow along these lines. Whatever guidelines they create are not necessarily binding on anybody accept anyone who wants to borrow money. It will take some action at a state-by-state level, or some private action by the issuers of these PACE programs to subordinate their interests to Fannie Mae, Freddie Mac, and FHA.
Discussion with Renovate America as well as the other providers shows that they intend to comply with the above and find a way of getting it completed. If they do not, there will be some penalty in the marketplace. This program has these challenges if you are a consumer, and realtors will be very active in directing people to the ones that will have the least amount of problems later. There will be a penalty if they do not follow the guidelines that subordinate their interests to whoever owns a first-lien mortgage.
Now you have a very different bond and a tax bill at the top 10% of equity and not the bottom. This could be worthless, and now you have a bond failure. This was a discussion they had at IVAR with executives with Renovate America about how they intend to do this since they are bond investors. If you are an investor in the first 10% of equity, that is a no-brainer. You can forget this. This is very different, and right now we are looking at interest rates with 6 points charged and effective APRs that are 11-12% on these loans. This is with first priority and no proof of repayment possibility.
IVAR anticipates that if they make these changes, credit-worthiness will be a factor. If you are going to be the investor backing these bonds, you need a different kind of security if you are going to be comfortable and want to see your money back. It will also likely be more expensive on the loan. You are introducing risk that does not currently exist. If you are the investor on this, it may be the safest product on the planet. The other that is the most dangerous is sub-prime second, which Bruce wondered how you would fund. This would be a real tough sale to anybody with money. If you get behind 90% first with a 10% second, you would have a hard time funding very much of this.
In policy circles, especially when you have the environmental community on one side that wants it done and the consumer advocates and lending institutions on the other, this is where it is coming down to the debates where there is not much of a middle ground. We have to find a way of getting this done without damaging consumers while meeting the promises on the environmental reforms that the governor and state legislature have made. It is not going to be an easy thing to do. Bruce never thought he would see it become a first and superior to an existing lien.
Bruce asked what surprises are in store for 2015. They answered not really since if you looked at the market in the last year it is proverbial with the tortoise versus the hare, and it has been a very tortoise year. If you look at the economy, we have seen job and wage growth, but nothing significant. If you look at the housing market, we have seen good numbers on more listings coming into the market as well as higher sales volume and pending actions of sales property. Median sales prices is also up about 5-6%, but there is nothing dramatic and just slow, steady gains in almost every category. We have never had this kind of year with this set of charts. Any time we have this set of charts, this high affordability, and this low ratio of foreclosures to sales, and unemployment we are normally off to the races with a 15% gain and screaming to the top of the next peak.
This is the first time in history we have this set of charts and this result. Bruce wondered why there is such a blasé reaction. Is the buyer not showing up, or are they not capable of getting a yes answer. There are likely more restrictions in the lending side than we have seen in previous boom cycles. Likely the bigger issue is we are looking at home values that are truly tied to wage levels. When we saw prices jump up in the early and mid-2000s, there was a disconnect between home values and median income for a region. At that time there was anywhere between 15 -20% of the people with a median income who could afford to buy a house in the Inland Empire. Now depending on the county and area, it is anywhere from 40-55% of the people who work here who can afford to buy a house. This is reasonable and what you would look for in a healthy, stable market.
The idea of seeing values jumping up 10-15% in a year is not likely. We saw the last big jump in 2012 and 2013, which is 25% in a 12-month period. The last six months have been flat, and we have not seen any increase. San Francisco’s affordability rate is at 13, and they went up 25% last year. There is a disconnect if you want to see how much they make and how much the property is worth. At the peak of last time it was $900, and now it is $1,350,000. Bruce asked what the difference is here since it makes no sense that the person working there can afford what the product is. San Francisco is truly an anomaly, and there are a few areas in Orange County as well that are not a normal market. 15-20% of people who live and work there can afford to buy a house there, but that has been okay because it has been a feeder market for the Inland Empire. There are a number of people coming out of LA and Orange County that look to the Inland Empire as an affordable alternative, and this likely will not change. We are going to be the housing choice for much of those two counties. What is interesting is the builder has not responded by building anything that is normal product numbers, including sub-divisions. We are still down 85% in sub-divisions, so Bruce wondered what they are looking at that is making them afraid. A likely explanation is they are being cautious. The property Ontario Ranch was launched late last year, and sales have been picking up there. A lot of it involves pricing too and them being more competitive with existing home sales. If they are building a product for $500,000 that is a 2000 square foot house, and there are other homes in the market selling for $420 that are 6-8 years old, they are going to be at a challenge.
Where the lots are available in South Riverside County, this is where you are building 3-4,000 square foot houses. This was the tract. When you have to foreclose on all these homes, they now have to go through the filter. They may still be for sale for under $80 a foot in areas like Hemet, but you cannot build that. You can have lots there, but you cannot perform on them. You have a regulatory environment that is not friendly to any of this development, especially if you have to redo tract maps and get new approvals. They are looking to raise permits because they need the money. If builders have the opportunity for higher density products and smaller units, they would have an opportunity to sell more if they can get approval.
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