On Friday, October 24, the Norris Group proudly presented its 7th annual award-winning black-tie event I Survived Real Estate. An incredible lineup of industry experts joined Bruce Norris to discuss perplexing industry trends, head-scratching legislation, and opportunities emerging for real estate professionals. Proceeds for the event benefit Make a Wish and St. Jude Children’s Research Hospital. This event could not have been possible without the generous help of the following platinum partners: Auction.com, HousingWire, PropertyRadar, the Apartment Owners Association, the San Diego Creative Real Estate Investors Association and President Bill Tan, The North San Diego Real Estate Investors Association, InvestClub for Women and Iris Veneracion, Wholesale Capital Corp, New Western Acquisition, MVT Productions, and White House Catering. For event video and information, visit isurvivedrealestate.com.
Bruce began this segment talking about the budget for the country. We have had a lot of diversions, but it would seem like real estate would be a prime target to take away some goodies. If we are trying to balance the national budget, you would have to think real estate is being looked at and people asking what they can take away from the industry. Bruce asked Doug if he was concerned about any other pieces that we consider valuable, such as interest rate deductions or debt forgiveness. Bruce wondered if we will continue with what we have, or is it going to change. Doug said politics is a whole different ballgame.
Doug said the first thing that needs to be considered seriously is the degree to which we have lost our fiscal and financial flexibility as a country. It is a serious matter, and the social security, Medicare, and Medicaid will be bankrupt in the sense there is any reserve fund off of which the payments to recipients comes. Those will be exhausted and will come out of general revenue within a decade. This is something with which we will have to deal.
Doug said there are various ways of dealing with this, social security being the easiest. This could make things solvent for 50-75 years by moving the retirement age back gradually a couple of years. It does not have to go a huge distance. However, even with that Washington cannot get the traction on getting serious about it. The question then is where housing is vulnerable. Mortgage interest deductions are things people discuss, although he does not actually think you would get much revenue if you eliminated. This would affect house prices, and people would alter their behavior and change the amount of debt and equity they use to affect that. One of the things not well known about this is that the low income households do not itemize and therefore do not actually use it. Therefore there are some things to think about here. The deductibility of debt forgiveness will probably get renewed in the meeting after the election. Congress will convene, and that will be part of a package that is likely to be renewed, but maybe not.
Other things such as the deductibility of state taxes at the federal level will be looked at also. Doug thinks if they were really going to go after something in real estate, they would eliminate the deductibility of second mortgages and possibly lower their limit. Gary agreed they have looked at it many different ways, including lowering the cap, taking away second home deductions or second mortgage deductions. They have looked at a lot of different things and made different proposals, but nothing has really been voted upon yet by either body. The outgoing chairman has put together a tax proposal, but it is not going any place since he is going out of office.
Washington calls it a tax break for the rich according to Bill Cosgrove, so the question is when it comes into play. The answer is when there is a debt ceiling on prices as well as when there are budget fights. MBA advocates for everything remaining the same, but when there is a spark of fire this is where is starts. It seems to always die down and they move onto something else. There also seems to be agreement that debt forgiveness will be approved during the late Dodd session. Bruce wondered if this will be the mood at some point since you will not have enough people upside down to worry about. Doug said things tend to never go away in Washington. At some point the market will normalize, supply and demand will go back in balance, and house prices will move at their long-term national average. Right now it is 4%, but adjusted for inflation it is about ½-3/4%. You will have very low levels of delinquency and foreclosures, so the number of households that would be impacted by that will not be politically important and they may let it expire.
Bill Cosgrove said it has another two years to be relevant, so it may get passed now but we will deal with it again this same time next year. Sean O’Toole said we still have a million homeowners in California underwater, which is about 12%. We are only selling 400,000 homes a year. Even if we went to sell all those homes and sold nothing else, it would take 2 ½ years. This is why we cannot build new homes.
What confounds Bruce is the $500,000 free sale if you are a married couple. This was a coup he could not believe happened and had to make a phone call to someone smarter than him asking if he was reading it correctly. This seemed overly generous at the time, and he had just taken advantage of it. Bruce asked if this is up for grabs or if they are just going to ignore this too. Bruce thinks real estate is a target to say they will take some of your goodies, although no one else seemed to agree. However, Gary said it is a target if they get really serious about changing their entire tax code. When they get really serious about it, then everything is on the table. With the Republicans taking the Senate, there is a real possibility of a real tax code overhaul.
A few years ago a group of investors were invited to speak with Fannie Mae, and Bruce left the meeting with the room feeling convinced they would not have a job in a certain period of time. This sentiment has changed, so Bruce wondered what the financing in the future will look like. He wondered if Fannie and Freddie will exist the way they do, will they be downsized or changed, or will it be business as usual after a little bit more time. Doug said the questions you have to ask when you think about reforming the secondary market is if you want there to be a 30-year fixed rate, level payment, pre-payable mortgage. If you do, this requires certain structures in the market. These structures exist largely because legislation has created boundaries that allow institutions to earn returns sufficient to deploy capital. This does not mean institutions like Fannie Mae and Freddie Mac have to exist.
Part of the infrastructure of those two companies is what makes a 30-year fixed mortgage rate exist through what is called the tba market. This allows lenders to sell forward and the commitment to deliver mortgages with fixed payment. If they decided they want a 30-year fixed-rate mortgage, the likely consensus in Washington is 90-100% yes. This presupposes a tba market. Then when you ask the question what makes this function, the answer is there are certain types of plumbing. You can argue about who owns this plumbing, move it around, and see how the pieces connect to one another. You can take the companies apart, but a lot of what they do has to exist in order for that 30-year fixed rate to exist. The other piece is whether or not the government wants to be involved explicitly or implicitly. Doug thinks there is a fairly close consensus in Washington that there should be an explicit insurance premium on the tail risks. In a great cataclysm, the government will step in anyway. We need to have an insurance fund in place against that eventuality, and maybe it will reduce the likelihood that would happen.
Bruce asked what percentage of loans right now are funded with some government program, which Doug said is in the range from 85-90%. You have the three rules of forecasting. The first is if you give a number don’t give a date. Second, if you give a date don’t give a number. Lastly, if you get it right don’t look surprised. Next, Bruce asked what holes in the mortgage market they would like to see filled. Bill said it is the private label market, which in nonexistent today as long as lenders are being fined billions of dollars almost by the week. With the number of investors who were in the room, the question is who will put their money into the system where you could be fined billions of dollars at any moment by any government entity. You cannot measure the risk, so in order for the markets to recover the penalty phase must end.
Bruce asked what percentage of the market the private label had at its peak. There should be a certain type of product that it can responsibly handle. Bruce asked what is missing and if stated income is one of the pieces. Bill said he does not see in any viable fashion the private label market coming back for another three years. Bruce asked Sean his opinion on crowd funding and its impact, which he said the answer is to get the government out of the way. Bruce wondered if it is mostly going toward investor type deals or if it is reaching into the occupant-owner world. Sean said on the owner-occupant side he really does not see it. The return that people are looking for is nowhere near the interest rates you receive from Fannie and Freddie. We are going to have to divorce ourselves from the idea of 3-4% mortgage before we can get any private money back into the market.
There are two issues. One is a regulatory issue, and the other is an interest rate issue. At the current rates, you need some kind of Federal backing behind it and a solid guarantee of security that you are willing to take that low of a rate. If there is actual risk and it is not government-backed, then you will demand a higher rate. There is no market for this higher rate right now. If you add the regulatory piece on top of that, then the question is why you would make the loan to the consumer. Sean would have backed up the truck and raised every penny he could to make a loan to anybody who wanted a home in 2009 if they had just come off foreclosure. At the end of the day, if they did not make that payment he knew he would be glad to take the product back since it was underpriced.
Bruce said one of the things that happened to the market in California in 2014 was the reduction of FHA’s loan limits. In Riverside, they went from 500 to 350. Bruce asked their feelings about this on a national basis and if this is an indication of a gradual slide on that number. It is still relatively high percentage-wise in relationship to Fannie Mae, so Bruce wondered if their intention was to lower it some more. Gary Thomas does not think they are going to lower it any more. What happened was we had too big of a footprint for the FHA loan program. The regulators decided they needed to shrink that footprint, so they made a lot of changes to FHA. Lowering the loan limit was only one of the items they did amongst many other things that shrunk the FHA footprint.
Bruce asked how this impacted builders in California. Dave Cogdill said it was this along with the tick up in interest rates that really put the brakes on what they felt was going to be a much stronger recovery. They have been bouncing around ever since then. This lends itself to the affordability question. What is interesting about affordability is as it declines, it is always accompanied by volume increases in real estate sales. This happens until you hit a magic number and the market does something very ugly. California is at about 30% affordability, which is not low. There was an affordability decline, and this time the volume in sales did not expand. Instead, it slowed. Bruce wanted to know if there was a reason better than affordability decline since this is not the right answer unless we are permanently saying no to a lot of people to whom we used to say yes. This is a whole different calculation and ball of wax since we now may be saying we are at a price peak. Monthly we cannot afford anymore since we will not get a yes answer.
Gary said what is interesting to him is if you drive around many parts of Orange County, especially the southern part, the amount of huge apartment projects going up tells you where we are going in this county. They are saying we have to build more rentals, not more properties for people to buy. Those decisions were probably made two years ago since a building permit takes a while. Bruce said if he looked at the foreclosure chart, he would have said it was a rational decision. He had a lot of people who were going to be leaving an occupancy home and having the availability of a rental. The construction had to hit a game plan a couple years ago, so the question is if this is the new habit being formed and there will be a better preference for not owning something.
Gary said we have seen that coming out of this crisis there are a lot of people asking if they really need to own a home again or own one at all. If we are pushing out people from forming families, that leads to renting as well. People like to live closer to entertainment and things to do as well as close to work. A lot of this is a driving factor as well. When they might have gone to the Inland Empire and bought something that was very affordable, they are now deciding to stay in the appointed areas.
Bruce asked how different the household makeup is now. A household used to be considered a married couple with 2.3 kids. Bruce wondered how different this is now and if it affects the ability to buy something. It’s possible the would-be owner is single. Doug said the triggers to buying a house are completing school, getting a job, getting married, and having a baby. The share of our children who are getting college degrees has risen, so that means you are moving at the margin and the time to buy a house out. This means they are not in the job market for the time period, so this moves the time they get a job out. There has been a secular decline in the rate of marriage by age. The age at which people are getting married has been pushed out for reasons other than education and employment. This then pushes out the age at which you have your first baby and then buy your house.
They recently took a look at the American Community Survey, and in the 2012 one they pulled out the households that were between the ages of 30 and 32 that were married, had a four-year college degree, a child, and income above $95,000. Anywhere in the country this gets you into first-time territory. If you compare that to the same cohort of people from 2000, the share of them who purchased a house is 10 percentage points lower. This is a big number. Today, demand weakness trumps credit tightness. This does not mean credit is not tight, but there is this move to apartments for flexibility. If one is going to be changing jobs in three years, the question is if you get a payback on buying a houses given all the fees you have to pay up front, house prices possibly going against you, or the possibility of being mobile. There are a lot of things going on in the younger segments of the population. GenX, which followed the boomers, are the ones who took the biggest losses in foreclosures. They are a smaller age group, but this was the group who took the biggest losses in homeownership during the crisis. We will just have to see if they make a comeback.
Bruce asked how big a deal college debt is for people and if it is blocking their ability to get a yes answer. Bill Cosgrove said at the MBA they absolutely believe it is a big deal. Statistically he believes a four-year college graduate is coming up with about $36,000 of student debt. This is three times the amount it was back in 2005. If you take the QM numbers, look over the last decade, and factor in inflation, a 30-year old’s income is less today than it was a decade ago. You have a tight credit bucket, and median income is down for that 30-year old over the last decade. Their student debt has also skyrocketed. If you take this combination and talk to loan officers who meet with customers every day face-to-face, they will tell you student debt is an issue.
The Norris Group would like to thank its gold sponsors for supporting I Survived Real Estate: Adrenaline Athletics, Coachella Valley Real Estate Investors Association, Coldwell Banker Town and Country, Costa Mesa Marriot, Council of Multiple Listing Services, Elite Auctions, In A Day Development, Inland Valley Association of Realtors, Investor Experts, IRA Services Trust Company, Jennifer Buys Houses, Keystone CPA, Las Brisas Escrow, LA South REIA, Leivas Tax Wealth Management, Personal Real Estate Magazine, Pilot Limousine, Primary Residential Mortgage, Northern California Real Estate Investors Association, Real Wealth Network, Realty 411 Magazine, Resonant Lens Photography, Rick and LeAnne Rossiter, SJREI, SONOCA Corporation, Southpointe Companies, Spinnaker Loans, Tony Alvarez, uDirect IRA Services. See isurvivedrealestate.com for video of the live event and more on our sponsors.
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