This week The Norris Group Real Estate Radio Show and Podcast presents Part 9 of I Survived Real Estate 2009. This is the final installation of the audio for this event.
Bruce begins by discussing the declining housing inventory. A declining inventory typically means that the market is doing well because you have multiple offers being placed on homes. We currently have the highest affordability rates in the history of California. The volume of sales has gone up to normal, but we have high unemployment.
Delinquencies have exploded. From July 08 to July 09, we have gone from 5.3 percent to 9.7 percent delinquencies. The inventory of REOs has gone down because banks have not taken back as many as they should. Some people have not made payments in 14 months. Trustee sales have also declined during this same time period. We had 28,795 trustee sales in July 08 and then we progressed to the 9.7 percent delinquency rate. We are currently 306,000 trustee sales short of where we should be. That averages 25,000 homes going out per month in the future. We have not peaked at delinquencies, and according to reports, we will soon be at 13 percent delinquencies. At 13 percent, we will be releasing 70,000 homes per month. Bruce does not believe that we can have a positive market if these statistics are true.
FHA is going to have a large number of defaults next year. They once had a 203K loan for investors in which investors could buy a property and include the repair bill in the loan. A lot of people would use this kind of loan and they would buy up to 7 homes and use them as rentals. Bruce thinks this would help clear up a lot of inventory.
Bruce thinks that Fannie and Freddie programs should be expanded so that qualified buyers can get unlimited loans. We are currently stuck at 10, and many investors are capped out because they exchanged their homes out of California and moved their investments to another state. Those investors cannot sell their property and come back to California.
We are currently giving away homes for 8,000 dollars. That money is coming from taxpayers. Bruce thinks that we should just let people take these homes for no down payment. We will have people walk away, but the next buyer will be able to easily take it. Under this kind of proposed program, it would not matter if the buyer qualified or not because this loan can be continually passed down. These houses could go to investors with a 5 percent interest rate. This program would not have foreclosure, because the problems would be solved by the next buyer. The people who have recently foreclosed on their homes will not be able to qualify for homes, which may keep them out of the market for the next few years. We could just reintroduce these people as buyers if they did not have to qualify. This is not a program that we have never seen before. We are trying to solve this problem by selling the next house to the owner occupant who was shoved into home buying by the nonsense financing of 05 and 06.
We are already doing zero down deals. When Bruce sells a property, he usually pays part of the closing cost. The person getting 3.5 percent down on a 100 grand purchase is getting an 8,000 dollar check; that is better than nothing down. If you just had nothing down and these people qualified, we would get rid of a lot of homes.
Bruce and many other investors believe that we need to get rid of the FHA 90 day flip rule. When an investor fixes a property, which may only take 3 to 4 weeks, and they sell it within 90 days, the investor is believed to be guilty of fraud. The lender has to pay the cost for this, because the investor will subtract the amount that he or she must pay the lender for the property. We need to start looking at investors as people who can help this problem. At some point, we must either choose to not foreclose, or we must pay catch-up in a painful market.
Bruce asks Christopher Thornberg if he expects the dollar to lose value, and how the value of the dollar impacts interest rates. As the trade deficit gets wider, the dollar goes up. Now the trade deficit is going to close, so the dollar will get weaker. There is very little doubt that the dollar will weaken. Interest rates are undoubtedly going to go up. The federal reserve has increased the money substantially and that money is going to cause inflation. The Federal Reserve is either going to let inflation happen, which will raise interest rates, or they will fight inflation by selling the long range securities they bought, which will also raise interest rates. One way or another, interest rates are going to go up. In the shorter run, it will be faster to allow inflation to occur, because that would bail out the asset markets. In 1982, the mortgage rate was 18 percent, because of the fear of inflation.
Bruce thinks that we can absorb a higher interest rate and still have a good real estate market, because the combination with the cheap price could absorb a double digit interest rate, just like in the 70s. Thornberg says that a 1 percent increase in the mortgage rate means a 10 percent decline in prices. Bruce disagrees with this, because between 1974 and 1980 we had a tripling in real estate prices and interest rates doubled. Thornberg tells Bruce that he is talking about the real mortgage rate, which is the mortgage rate minus the rate of inflation.
Bruce asks Thornberg what the statement Unemployment is a lagging indicator means. Thornberg says that means that the labor markets are the last to go into the toilet and the last to dry off. Bruce asks if that means when labor improves, every other category of real estate should have already started to improve. Thornberg says that residential real estate leads commercial. Now, we keep waiting to hear about the collapse in the commercial market, but we are not seeing this at all. Thornberg says that this sort of lead and lag mentality can be exaggerated.
This is why Bruce brought this up, because in the last cycle, employment improved in California from 1994-96 but we did not have a price increase until 1997. If we do not have price increases, builders will not build anything. Bruce asks if you can have an improved labor market if builders do not have any work to do. Thornberg says that these two factors do kind of work together. The prices started to go up after the labor increases from 1994-96. Thornberg reminds Bruce that in the early 90s we lost zero space, defense, and migration. In that market, the real estate was hampered by the excess supply. Thornberg takes issue with the idea that we should subsidize the building of new homes, because he believes that we have too many homes. Thornberg believes it would be a bad idea to subsidize the construction of homes when there is already too much inventory. Bruce says that some builders have been fixing existing inventory, and Thornberg believes that is all the builders can really do.
Robert Toll made 700 million dollars between 2000 and 2007 because he was selling too many houses at too high of a price, and now he wants tax payers to bail him out.
Bruce Norris asks Rick Sharga if people foreclosed for different reasons in 2008 versus 2009. Rick says that the reasons are not as different as the press would lead you to believe. The media has jumped ahead to the next wave of foreclosures. We are looking at a 3 wave foreclosure tsunami. The first wave began in the first quarter of 2006, because of the subprime meltdown and ARMs. The MBA numbers suggest that 33 percent of the new foreclosures are unemployment. That means that 2/3 of the foreclosure activity is not employment related.
What we are really seeing is increasing levels of foreclosure activity from the first wave, which is being made worse from the second wave. The second wave is about to pick up steam. If unemployment peaks around the first quarter of next year, we will see the foreclosures related to that peak around the 3rd or 4th quarter next year. That will be just in time for them to be augmented by the next wave. This next wave will be caused by the option ARMs. Many loans are going to reset, and people will owe more on their reset loans than their original loans.
Strategic defaults are going to be a problem. In the past American culture, people honored their contracts and chose to make their payments. Now people are realizing that the house they bought is worth half of what they owe, and they are wondering if it is in their familys best interest to keep paying. If someone is only 10 percent upside-down on a loan then they will probably stick with the loan, but if they are upside-down by 50 percent then they will probably default.
Thornberg asks people if their credit or their equity will hear quicker. Thornberg says that most of these people will have their credit heal faster. Sharga responded to Thornberg with a story about a Coldwell Bankerk agent that was fired. This agent counseled her customers to default on their current loan after qualifying and buying a second house. Bruce feels that there is still a lot of character being shown in California; a state with a 9.7 default rate that has had a 50 percent value drop.
An economist from the building industry claimed that California needed to build 230,000 homes, but John was only able to build 70 homes this year. Economists who say things like this ruin the credibility of the people in their industry. Bruce feels that people owe more to their industry than they give.
Bruce thinks that now is a good time to buy property even though he thinks property values will go down. There is a combination of good interest rates and prices that make paying for properties an easy thing to do. Bruce thinks that the price declines that are coming will mostly affect the “as is” inventory, because loans will not be available to homes without kitchens.
Right now, investors are not being rewarded for the $35,000 they spend on repairs. The appraisal business is using a broken model which does not allow for proper adjustments on repaired properties. Every sale we have is an anomaly. The neighborhoods that Bruce is buying and selling in contain homes that are worth $60,000, but buyers want Bruce’s property at $130,000 because it has a kitchen and financing. If investors are going to make these improvements in the real estate market then they need to be rewarded for their efforts. The appraisal model being used right now is telling buyers that their decision to buy a repaired property is unwise. This hurts the market because fixed homes make neighborhoods more valuable. If these homes are left unfixed then more foreclosures will occur.
Joseph agrees with Bruce’s opinion that the appraisal process is broken. There is no magic number in appraising that makes it impossible to make a line item adjustment impossible. If an appraiser is going to make an adjustment worth more than 10 percent of the sales price, then they need to give an explanation for that. When there are multiple offers on a property, then an appraiser should consider those offers in their property evaluation. Unfortunately, the underwriters are not allowing these adjustments to take place.
For the final segment of the show, Bruce asks each speaker what they feel the biggest problem in real estate is.
Joseph believes that real estate’s biggest problem is appraisal management companies that hire incompetent people who are not qualified and do not have enough experience. Those people make bad decisions and they ruin deals.
Patt says that it is hard to tell what the biggest problem is. The biggest problem for Patt and many other realtors is getting inventory out of the market place. There are too many short sales that no one knows how to sell. When someone performs a search on the MLS and finds that 75 percent of the properties are being labeled as “subject to short sale”, you have a problem. 90 percent of the time, those sales will not close. The foreclosed homes are easy to get rid of, because a bank owns them, and they have answers for someone who wants the property.
Tommy thinks that the biggest problem is the tremendous volume of deteriorating, empty homes. These homes need to be put into the hands of investors or home owners as quickly as possible, and Tommy thinks that auctions do that very well.
John Young agrees that we need to get through this inventory as quickly as possible. Previously in the show, Bruce proposed multiple solutions to the inventory problem such as zero down deals. He believes that this problem will not be solved by just one helping factor.
David Kittle believes that the biggest problem in real estate is the people who are making laws who do not understand the business, and have never run a business.
Rick Sharga believes that the entire real estate “ecosystem” is imbalanced. Valuations are imbalanced because we have less professional and competent appraisers who are under valuing properties. There is a freeze in the capital market, because lenders are afraid to risk lending money on homes that may not have proper valuations. Hundreds of thousands of homeowners are under water on their loans, and there is too much inventory for the market to buy. He does not believe that there is one central problem that has caused this real estate mess.
Real estate is a boom-bust phenomenon. When times are good, it is very good, but when times are bad, it is very bad. 2001 to 2006 was a phenomenal time for people in the industry, but because of that boom, they are suffering from a terrible crash. From a long run perspective, we are dealing with a mess of rules, regulations, subsidies and taxes. Local governments are constantly pushing all sorts of taxes on builders. Those taxes drive up prices on homes, and as a result, a constituency cannot afford those homes. Then they try to subsidize the price of a home by having an FHA mortgage. You do not want a loan on a house to be a normal loan, so you make it a no recourse loan, but then third party appraisers are more important than what someone is trying to buy a home for. We keep creating problems by trying to fix problems. Christopher believes that we need a massive deregulation of the market. We need to clear these regulations so the market can work efficiently.
Bruce hopes that the investor will have the chance to influence congress. Right now, investors are a very important solution to this problem, but they are currently having trouble. If investors are able to get financing, they will be able to fix homes and prevent them from returning as “for sale” inventory. If investors cannot get financing, then they must either leave these homes alone or they must pay for these homes with cash. Unfortunately, investors have a limited amount of cash to spend.
For more information about The Norris Group’s California hard money loans or our California Trust Deed investments, visit the website or call our office at 951-780-5856 for more information. For upcoming California real estate investor training and events, visit The Norris Group website and our California investor calendar. You’ll also find our award-winning real estate radio show on KTIE 590am at 6pm on Saturdays or you can listen to over 170 podcasts in our free investor radio archive.
