Bruce Norris is joined again this week by Sean O’Toole. Sean is the founder and president of ForeclosureRadar.com, one of the finest websites a real estate investor can get involved with on a regular basis. Sean has done an excellent job on the website and put his computer genius to work in the industry, saving a lot of people a lot of money. He has also created competition that did not exist prior to his website by making it easier for people to become very proficient.
What is interesting is that people do not even know how to appreciate it. Bruce remembers watching a blog discussion where somebody was surprised by the mention of $50. Bruce thought to himself, “You have no idea what this business was like prior to this site.” You can absorb $50 in a half hour of time and never even check out 1/100th of the trustee sales since you are on hold. Sean had a customer early on who said they are now in double the number of counties that they were before and laid off two people, saving him $4,000 a month. Sean did not know whether to feel good about saving the money or bad about folks who lost their jobs, creating unemployment in California. This is the dilemma.
Sean’s site is not just a foreclosure website, but it has grown into the short sale referral network also. This will be a big thing for the next couple years as far a lot of properties going this route, even for investors. Short sales continue to be very important as lenders are on board with them pretty much across the board. So finding those opportunities certainly has been a key part of their business to help realtors do this and be a partner with the California Association of Realtors with their business products division. To help realtors with this has definitely been an important part of the business.
Bruce asked if there was anything new on the horizon for the website. Sean said there is, and they have been hard at work for two years. Those who have been regular customers know they really have not released much new in quite a while since they have been hard at work with something big. It is coming now very soon and will be out to their existing customers. They will receive the first peak at it, and hopefully later this month they will start dribbling it out. By spring, everybody should be able to have access.
The California real estate market usually improves when it gets employment to improve. This comeback has been orchestrated by policies that really have not included anything significant in the improvement of unemployment. One of the things Bruce feels pretty comfortable with is when you start having price increases to the extent that you will end up with building starting to pencil again, this is the most important domino. Once this tips over, you actually have a legitimate reason to be optimistic because those dominoes are the traditional ones that cause the comeback. Even if we force feed it to go there, once it goes there it is a big piece of the puzzle for California’s budget problems and migration. There are a lot of good things that happen if we have to build something.
California’s budget problems are primarily driven by unions, but that is a whole different segment. Sean thinks it is possible that we will see some more building. It is like what happened after autos when they got so low and we received all this straight news that they were up 5-10%. However, they were up from nothing to nothing; which is still nothing. We really have nowhere to go but up. In Riverside there was the announcement that construction is up 17%. Bruce looked at the chart, and it actually meant 8 houses. If you have one month of inventory and you have price aggression that starts to pencil, Bruce said he does not know where else inventory will materialize if every other policy is sending it to the sidelines as a rental. Sean said he was really surprised by the 2010 Census because he really expected it was going to show that we had overbuilt throughout California. It really didn’t show that; but it really showed that housing units for most of the state were really on pace with population growth. Certainly in a downturn you get some negative household growth, whether it’s kids moving in with parents or parents moving in with kids, or families, brothers and sisters moving in together to save money. However, Sean thinks we do not have a fundamental overbuilding in California, Merced and a couple other spots being an exception. We are going to need more housing units, and we should absolutely have some construction crew.
One of the things that happens when you have a recession as bad as we have had is you have delayed household growth. You have the 29-year old with the Master’s degree still living in the Irvine third bedroom, making $120 grand a year and still paying off his college loans. Aaron Norris, Bruce’s son, graduated from Irvine with a Master’s degree and was in the group that was single and wanted to be mobile. Last year, 20% of them got married. All of a sudden, the maturity level for that group who had really been delaying all those things joined what was typical, only they did it seven years late. This is another factor in that you do have the echo boom generation wanting to be a household much later in life, but it is actually about to be now that they want to do it. The multi-generational housing is probably not what everybody wants, it’s just what everybody needed to do. You want to say that a lot of these will be reemerging as households, and they don’t have to move anywhere since they are already here.
Bruce looks at a lot of pieces of the puzzle. He knows job creation will kick off after construction, but because of a pent-up pile of buyers coming out of foreclosure and credit damage from three years ago. Bruce said he does not even know if we need an employment increase to have such demand for houses, especially when it is paired with a one to month supply of inventory. This is really the kicker. Bruce said if you gave him six months of inventory, then he would be pretty benign on price increases. You have six months of demand on top of a month’s supply.
Sean is really in the cat-bird seat for information since he is predominantly dealing with people in the buy/sell business. What ends up happening is you get a property when you finally get the eviction done; you start to fix it or put it into the MLS with the phrases that you will fix things, and you receive offers as is that exceed your asking price. A few months later, they exceed any possibility of an appraisal being equal to the offer as is. You then realize some dynamic is going on that hasn’t really existed. This is largely in markets where payments are well below rents. Sean is not really seeing this type of thing except in these very employable areas. It’s a little different in Silicon Valley, but Sean thinks in most other areas where you are seeing a hot demand is where ROIs are above where they should be and payments are below.
Sean also has a service where it extends to Phoenix. Bruce mentioned the hedge funds that showed up in droves, and he wondered if they left the building. Sean said they have, most of them last year. Sean started hearing a lot of people, some of them based in Phoenix, saying they were done there and it no longer fit their profile. One of the predictions Sean has for California in 2013 is we may see the hedge funds move on from certain markets like Sacramento and possibly San Bernardino and Riverside. This will depend on how quickly prices come up compared to rents. Sean thinks they will leave; and when they leave that will certainly dampen the demand. What is interesting about that is one of the things happening when you are a buyer with financing is you can’t get in. It’s not like your needs are being met and you’re done. Rather your needs are not being met and you wait. Sean does not think the players in the market are large enough to be market makers where they are all that matters. If they go away, it would not spell doom for the market.
Bruce asked what percentage of the market is made up of hedge funds since cash sales are about 30%. Bruce wondered if the big people are 3 or 4% and if they would be equivalent to the foreign investor buying things in California. Sean said this is something they have been trying to get a handle on and figure out if they can get a more accurate number. The only thing Sean has currently is anecdotal where you talk to some people who bought 1,000 homes last month, and you think there is ten of this. This is nationwide, so we are still talking single-digit percentages of the market. It sounds like a tremendous impact, and it is a comp. If they are willing to pay something more than everybody else, then it presents a comp that the appraisal world can pay attention to and raises the boat for the other purchasers. These people have also been a market maker for aggression in Phoenix, where they are also market maker’s in the level where the rents decided to stay.
The question is what impact they will have on rents. Sean has heard a couple people say these people are really going to push rents down and be super aggressive. At the end of the day, their job is to push the yield up. They are pretty motivated to push rents up, not the other way. Sean does not think seeing these guys coming in and buying a lot of units means lower rental prices for sure, especially when the position the last market maker can take is exiting all at the same time. Some of these guys have different models. Where we run the biggest risk is that some have a longer term buy/hold than an exit model. They are going to sell back to individuals and single-family buyers. Others plan to package the properties up as a REIT and take public investment in them. As they go to float those REITs, as we should see fairly shortly, if there is not a market for them and they cannot finance them, then they need to exit. This could put a few homes back on the market very quickly in some specific areas they have been focused on. They will need to exit; they will not trickle them out over a long period of time.
A lot of these people are using leverage to acquire these properties to then float as a REIT. That leverage is short-term leverage since they are planning to exit through taking the portfolio public. Bruce was not really sure how long the commitments were that they had, so Bruce wondered how long Sean means by short-term, whether it’s a year or five years. Sean said it’s actually one to two, which is a pretty brief period, especially if anything significant changes to interest rates. In some of these markets, you could go in and buy houses at a ten percent yield. This means given your investment you get 10% of your money back a year. If rent is $2,000 a month and you have expenses of $4,000 a year, that is a $20,000 a year income stream. This is what they are buying; and at 10% you would value that asset at $200,000. If you are willing to take a 10% yield, the house is worth $200.
These people, these market-makers, are coming and saying in these markets where things are selling at a 10, they are only willing to pay a 7. This pushes prices to $285,000, which is pretty big increase. Sean said this is really what they have been seeing. People are coming into the market and have really pushed prices up quickly and are buying cash. Where they create comps, it pushes prices up. At least for some of the people who plan to take the portfolios public, they are hoping to do it more like a 5% return, which values that same asset, that house, at $400,000. When they do this and take this public, it will not actually create a comp in the market. Sean said this is where he thinks if you are buying into this REIT and paying $400,000 for a house that a year ago was worth $200,000 and only got pushed up to $285, it will be interesting to see if these REITS fly and what the repercussions will be.
Affordability is probably still close to all-time highs. In California we have come from $245 grand to $340. We have moved almost $95,000, close to 38%. Yet, the affordability number is the highest Bruce has ever charted. Even though we have had this pretty aggressive price movement, we still have to dole out monthly the least percentage compared to our income. Regarding payment sensitivity, you may feel like there is only so much room for the person to qualify. Bruce wondered where this line is for the lender. Sean said it looks like FHA is going back to a more conservative stance. Even though we are at an all-time affordability, Bruce wondered if the brakes will be applied by the lender on a monthly cost basis. Sean said he does not know, although he does know that Bernanke recently expressed dismay over the fact that they pledged to buy all these mortgage-backed securities, and it has not pushed interest rates further on housing.
Sean definitely thinks we are hitting the bottom end there and that folks realize these rates are probably not sustainable. You look at the $250 to $350 increase, and $250,000 was the median back in 2000 when interest rates were more like 7. Now they are half of this, and we are only at $350. If you were just to look at that in a vacuum, it would say we were underpriced as well as it is a ridiculously low rate. Sean thinks we are seeing now concern about rates in the future and that rates going up in the future are actually holding prices back. If we knew interest rates were going to stay at 3 ½ for thirty years, it might help prices. On the other hand, if we knew rates were going up, in the short term it might help prices since people who rush out get aggressive and purchase something.
Being the investor, Bruce is looking at a window of opportunity and saying that his bet would be we will relive 2004 and 2005 in the next several years. This is because the payment is so ridiculous and interest rates are half of what they were the last time we were at these prices. Bruce is completely concerned about the day that they stop having those interest rates if they do it too late. If we get to a $600 grand median price at a 3% interest rate, that is a problem. If you take a regular 30-year loan and look at $250,000 and 6%, that is a payment of $16.63. Today, if you can get 3.75, that is a payment of $1620 on $350,000. If you think about the payments being flat and incomes being up from 2000, it makes sense that affordability is low. However, it does not necessarily say that the housing market is still strong compared to 2000. Bruce thinks the lenders are going to say yes to people long enough to have a substantial price increase because it does not change the monthly payment to an unbearable number for either the lender or the borrower.
What Bruce is wondering is if someone will break loose with the new policies that always seem to follow price aggression. This was a subprime issue. They were making junk loans, but prices were accelerating and no one was defaulting. Everything looked like an A-paper loan, so when you start having good paper written it seems you will have policies that get somewhat lax and continue this thing. They say history repeats itself, but Sean hopes we are not that stupid to go play this out over again. The Fed seems intent on doing it, so if the Fed is any indication then we’re probably going to blow another big bubble and do this all over again. What is interesting about if we do it this time is we are going to have a $600 grand mortgage with a 6% interest rate. If they go to a 6% mortgage rate and your price goes to $400, you wonder if you will default on your $600 grand mortgage since your payment will be less at $600 than it will be at $400. You may have negative equity, but you have a positive payment.
The folks who want to stay put will probably stay put since there is probably also a low payment versus rent. You will probably stay put and make your payment until you have to move. The one thing that does not change is that life events happen. This could include divorce, job transfers, death. The people who go through these are going to have to move. If 5% of the population moves in a year for these reasons, but they are stuck underwater and with reasonable payments, this could be a problem. This is one of Sean’s problems with the whole loan modification where you leave all the principles outstanding and reduce the payment, the non-principle reduction loan mods. It flies into the face of reality, which is that people have to move. You are kicking the can down the road and spreading out the problem over years and years. However, it does not mean the problem is solved.
Sean thinks some of the policies right now around loan modifications and low interest rates are insuring that we are going to continue to have housing problems and issues, artificial government involvement, and an unhealthy overall market. Hopefully we can land on the right side of it and exit before it is a problem and make some money in the meantime.
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