Housing Recovery Faces Serious Risk, Rentals Thrive [ANALYSIS]

The Real Estate market is more likely to take a second dip in the year to come – rather than continue its “steady recovery” – which will carry serious ramifications. On the other hand Rent/ Rental Management will be a safe bet. Housing Recovery faces risks not just from higher mortgage rates.

Housing Recovery Circumstances Leading to the Original Dip

On Feb. 4, the U.S. government filed civil charges against McGraw Hill Financial Inc (NYSE:MHFI)’s Standard & Poor’s Ratings Services, alleging that it improperly gave high ratings to mortgage debt that later plunged in value and helped fuel the 2008 financial crisis. – Wash. Post

New York Attorney General Eric Schneiderman filed a civil complaint against the Swiss bank in November, alleging it misled investors about the quality of the mortgage securities the bank sold from 2006 to 2007. – Bloomberg

In October 2012, federal prosecutors accused Bank of America of selling Fannie Mae and Freddie Mac thousands of shoddy mortgages that caused more than $1 billion in losses.

In October 2012, Manhattan federal prosecutors accused Wells Fargo & Co (NYSE:WFC) of reckless and fraudulent lending practices that cost the government hundreds of millions of dollars in insurance claims when those loans went bad.

In May 2012, Wells Fargo & Co (NYSE:WFC) agreed to pay $6.5 million to settle Securities and Exchange Commission charges that it sold troubled mortgage securities without disclosing the risks to customers.

In October, New York Attorney General Eric Schneiderman filed a civil lawsuit against JPMorgan Chase & Co (NYSE:JPM), alleging widespread fraud in the way that mortgages were packaged and sold to investors leading up to the financial crisis.

In August 2012, Citigroup Inc (NYSE:C) agreed to pay $590 million to settle a class-action lawsuit brought by investors alleging that the New York bank failed to disclose its exposure to toxic subprime mortgage debt.

Not to mention a series of cases for wrongful foreclosure and lender discrimination targeting Black and Hispanic groups.

Current Development in the Banking Industry

*Fear driven Response by Government

CFPB releases new mortgage rules in bid to reduce risky lending

The government is establishing new rules for mortgages that will make it harder for some borrowers to qualify but that are designed to prevent the kind of risky lending that nearly caused the housing market to collapse during the financial crisis. ( a response to aforementioned practices which inflated the initial real-estate bubble to critical mass )

One of the primary restrictions: To obtain a qualified mortgage, a borrower cannot have a debt burden that amounts to more than 43 percent of income. That may make it more difficult for people with lower incomes to qualify. … Certain exceptions could be key in allowing marginally qualified borrowers to meet the tighter guidelines, said David Stevens, chief executive of the Mortgage Bankers Association. … Lenders are under no obligation to issue only qualified mortgages; they just have to verify that borrowers have the ability to make their loan payments.

If the banks follow qualified-mortgage standards, banks will receive a massive benefit: They will be all but protected from many homeowner lawsuits.

Upfront fees, often used to give loan officers and brokers an incentive to make more loans, would be capped, while mortgages that allow interest-only payments or that are longer than 30 years would be excluded. Other exotic types of mortgages, where larger-than-usual payments are pushed to the end of a loan term, would also be prohibited, except in rural or underserved areas.

In other words, the government is going to force lenders to stick to rules they liked before the government forced them to stop using them.

Now the government is intervening once again, in order to prevent lenders from doing what the government pressured them to do over a ten-year period, in order to avoid another collapse. This isn’t a bad idea, conceptually, but I have a better proposal. Why not just get government out of the lending business and let the people whose capital is at risk decide how to invest it and lend it? Had we done that from the beginning, we never would have have the bubble in the first place.

President Obama is calling for private capital to take the lead role in the nation’s mortgage market with the U.S. government continuing to provide a backstop only against catastrophic risk.

“I believe that our housing system should operate where there’s a limited government role and private lending should be the backbone of the housing market”

As he has in the past, Obama blamed “recklessness” on the part of lenders and borrowers for the housing bubble and subsequent collapse of the market as the nation fell into the deepest recession since the 1930s. Now, he said, the market is healing, with prices rising and foreclosures declining.

So months later the White House policy seems to be promoting the private sector controlling the lending – sounds great right? This too is only good on paper… lets examine rising prices and foreclosures declining.

The price rise is completely artificial – the inventory is being choked at present and for the longterm the crisis resulted in a serious lack of contractors which will seriously postpone any hopes of a new boom:

skilled workers have left the industry as a result of the economic downturn, an aging workforce and an insufficient pipeline of younger workers, according to the new study released at the AIA 2012 National Convention and Design Exposition this week in Washington, DC. The study shows that 69% of architect, engineer, and contractor (AEC) professionals expect skilled workforce shortages in next three years; 32% of AEC are concerned about a shortage of specialty trade contractors by 2014; 49% of the general contractors are concerned about finding skilled craft workers by 2017, and 37% of architect and engineering firms are concerned about finding experienced workers. Skilled green workers are in even more demand; 86% of architects and engineers and 91% of contractors are finding too few green skilled employees.

In other words even as we rebound and begin to build more – we will be seriously short on expert labor – which too will drive up prices significantly making buying a new home less of a possibility for most.

Duality of the president – first he laid out for limited government intervention – now:

Data

Obama backs 30-year mortgage – More Private Funding

PHOENIX, Ariz. – Aug. 7, 2013 – President Barack Obama made a speech in Phoenix, Ariz., yesterday and outlined his vision for government-owned Fannie Mae and Freddie Mac, which collectively back about half of all U.S. mortgages. In his speech, Obama recommended an end to government ownership and a return to more private funding of mortgages.

Collectively called government-sponsored enterprises (GSEs), Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) do not directly make home loans. Instead, they buy mortgages from primary lenders and pool them into investment funds. That system makes it easier for local lenders to offer mortgages and helps keep the home finance system running smoothly.

Prices rose 7.3 percent in the year through May, according to the Federal Housing Finance Agency. The number of homes for sale fell 5 percent to 1.74 million in January from the year-earlier period, the fewest since December 1999, according to the National Association of Realtors.

Coinciding with all of these developments – the interest rates are on the rise – also slowing down borrowing.

Mortgage rates in the U.S. rose for the first time in three weeks, resuming an upward climb that has begun to affect home sales.The average rate for a 30-year fixed mortgage increased to 4.39 percent in the week ended today from 4.31 percent, McLean, Virginia-based Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) said in a statement. The

average 15-year rate rose to 3.43 from 3.39 percent. The 30-year average has climbed from a near-record low of 3.35 percent in early May. It’s still below the average of about 5.3 percent for the past 10 years, according to

data

compiled by Bloomberg.

According to Tim Ellis, an analyst at Seattle-based Redfin Corp., an online real estate brokerage, buyers competing for a small supply of homes have been pushing up prices at a pace that’s “just not sustainable” in certain markets, he said yesterday in a telephone interview. “As interest rates go up, a lot of sellers who were waiting are going to rush to put their homes on the market. So you’re going to see inventory climb and climb.”

Almost half of U.S. home sellers are concerned that interest rates will reduce demand for their properties, according to a July 19-21 survey by Redfin. That’s up from the second quarter, when 23 percent of the website’s users said they were concerned about rising rates.

D.R. Horton, Inc. (NYSE:DHI), the biggest U.S. homebuilder by revenue, said rising mortgage rates contributed to increased cancellations and a drop-off in traffic in June.

Yields at about two-year highs are failing to entice U.S. banks to add to their $1.35 trillion of government-backed mortgage securities holdings as lenders respond to changing regulations and price swings sparked by the Federal Reserve.

After soaring more than $300 billion over the previous two years, commercial banks’ investments in agency mortgage bonds have been “remarkably flat” over the past 12 months, according to JPMorgan Chase & Co. analysts.

Weaker bank demand, even with average yields up almost 1.4 percentage points from this year’s lows, is hampering the $5.5 trillion market, increasing borrowing costs for consumers seeking to buy homes or refinance.

Monthly issuance of fixed-rate mortgage bonds will fall to about $90 billion with homeowner refinancing at current levels, down from about $150 billion in the first half of 2013, according to BNP Paribas SA. Fed buying, including $40 billion of new purchases and reinvestments of proceeds from past holdings, will likely fall to $55 billion, assuming no tapering, from $69 billion, the bank estimated in an Aug. 1 report.

Mortgage real-estate investment trusts sold as much as $40 billion of the securities last quarter to reduce borrowing, and a slump in their shares is “effectively shutting new capital raising and curtailing near-term demand for agency MBS” from the firms, Barclays analysts led by Nicholas Strand wrote on Aug. 2.

Signs of Second Bubble

The interest only loan is back but in a very specific way. There are a few people with relatively high incomes that are using these to their advantage. I decided to run a quick test trial on this to see what it would cost to go with an interest only loan on a $1,000,000 home purchase. The answer might surprise many but it highlights the incredible leverage that low rates are providing to buyers. It also highlights how low rates favor large financial firms (i.e., hedge funds, etc) and those with high incomes. While the regular family might save a few hundred dollars a month they are still paying tens of thousands more on the sticker price. Combine that with the flood of big money into the market and you get the current housing market. What if I told you that you can get a $1,000,000 home for a $1,900 monthly payment? Not possible? Then we have the loan product for you.

A recent survey of potential home buyers found that many were willing to use unconventional purchasing methods. The term used was ‘aggressive’ buying tactics. Yet when we look at what was found is that people are willing to overbid and almost beg for buying a home. This has been the case for the last couple of years in California as regular home buyers compete with flippers, big investor money, and foreign buyers. The chorus of housing bulls has grown especially in the last year as flippers are now on late night television shows and flip-this home type shows are now filming on US location instead of using the hyper-Canadian housing market. What the survey found was that many were willing to overbid, borrow a down payment from loved ones, or eat up many of the seller’s costs in the process. This manic like behavior at a time when inventory is rising and some flippers are starting to see that buyers are unwilling (or unable) to pay whatever they wish may signal a turning point.

The resurgence of ARMs in the real estate market: Buyers taking on additional risk to squeeze into homes and increasing leverage in the housing market.The amount of speculation occurring in the housing market is extremely high. Not to the levels of what was seen between 2005 and 2007 but it is certainly getting close. For example, the usage of adjustable rate mortgages is reaching multi-year highs. This is an odd choice unless you have a fanatical belief that home values will continue to go up or that the Fed has god-like powers to control the mortgage markets into eternity. Yet that perception is very real and perceptions drive a good amount of energy in the housing market. The logic of people using ARMs is very similar to what was used only a few years ago during the heyday of the housing bubble. Home prices are seen as never falling, income will only rise, and if everything goes off the financial cliff then you can simply refinance. It is interesting to witness this for a second go around but the surge in ARM usage is very telling especially in such a low rate environment.

Rent Is Where the Money Is

Rental Nation: US Home ownership rate continues to decline to multi-decade lows while rental vacancies continue to decline. Record prices in a few areas. This week we had two interesting headlines converge. One had to do with home prices continuing to move up. In fact, four markets hit new record levels. These were mostly in Texas; Houston, Austin, Dallas, and Denver. Given the lower prices of Texas, this isn’t really a shock especially combining this with the record low mortgage rates courtesy of the Fed. At the same time, we find out that the home ownership rate continues to fall reaching a multi-decade low while rental vacancies slowly decline. All of this of course makes sense given a supply constrained market and a massive amount of investor buying over the last few years adding rental properties to the market (taking off market potential single-family homes for actual purchase). What is troubling about the data is the difficulty for first-time buyers to enter into this odd market. Having a larger share of our market as renters might make sense given economic constraints of household incomes yet it should be abundantly clear who the big winners were from all the Quantitative Easing that has occurred. Welcome to rental nation.

Morgan Stanley analysts predict that the buy-to-rent market will grow from $17 billion today to more than $100 billion in the next several years. They called it a “sustainable business with a long runway for growth.”

II.According to analysts, institutional investors may be able to anticipate a more than 10 percent return on investments, as rents nationwide continue to rise.

II.“Over the past three years, investor activity has removed significant amounts of distressed supply from Southern California, Phoenix and Las Vegas,” according to the report. “Consequently, select MSAs in Florida, the Midwest and the Northeast now constitute a greater proportion of the nation’s distressed properties, making them potentially more attractive to institutional buy-to-rent investors.

Source: “Morgan Stanley predicts buy-to-rent boom,” HousingWire (July 31, 2013)

Conclusion

Based on all of the information suggesting that a second dip may occur – its hard to trust the mainstream media claiming positive developments left and right – we are not out of the woods yet. It will be critical to pay attention to real estate developments and developing lender rules in the next 6-12 months. But for now, anything rent related is a safe bet.

Out of the 100 markets analyzed, 32 had declining flipping numbers, including perennial flipping hot spots like Las Vegas, Phoenix, Southern California and Atlanta. Still flipping was on the rise in more than two-thirds of the markets, including New York, Washington, D.C., Chicago and several Florida metros,” according to Blomquist.

Foreclosed, Short-sold inventory is being flipped at an increasing rate – which has been responsible for reduction of distressed properties but has not restored what was lost.