Bruce Norris is joined again this week by John Karevoll. John was born in Minneapolis in 1951. His family moved to Norway where he was raised, educated, and married. He worked as a journalist in Oslo for ten years and joined a Scandinavian business publication in New York in 1983. In 1987 he was pulled into the world of data, mining large databases for trends. He has worked for TRW, CDB Infotek, Axiom, and others. His relationship with San Diego-based DataQuick Information Systems goes back to 1989. The statistics he generates are used by public agencies, lending institutions, title companies, and others.
If you are in the business of selling properties, one of the things that has been obvious in the last twelve months, it is becoming increasingly obvious that there is less to compete against. There are also several buyers beating each other up to get something when before there was plenty for all. One of the problems is a lack of inventory, and the other is a competitor who will probably pay cash. John said right now we have the highest level of cash buying. In the Inland Empire, roughly 40% of the buyers are paying cash. As a whole, it is about 30%. It is really hard to get in and compete with this, even if you go in with a pre-approved offer from your lender. It still takes an appraisal and other things, and they are just losing out here.
John goes to a conference at the Department of Finance about once a year where a lot of the number crunchers look at various things. John said he thinks the last time around one of the biggest issues everybody thinks is going to emerge is this pent-up demand. There is an awful lot of buying activity, which has been put on hold. We have to remember that demand is generated by just the most mundane of things. It could be because people move to an area, graduate from college, get divorced, have kids, or anything that could generate demand. The demand that has been met the past six years has really just been a fraction of the demand that is being generated out there. No matter how you do the numbers, it appears that there is an incredible amount of pent-up demand out there. It is not just the boomerang kids who have gone back to live with their parents after they finish college, it is also retirees and people who want to move closer to work. What we are seeing now with prices off-bottom, people understand that property values are just going to continue to go up for a while. This was a psychological turn. It is hard to buy something if you think it is going to go down in value; but rather it is a lot easier if you think it is going up in value.
John said he has been hearing about open houses in North San Diego County and Southern Riverside as well as a lot of LA. You literally cannot get in the door. People are lined up outside waiting to walk through the living room and kitchen. All of a sudden it just hit; so it will be interesting to see just how much that demand pushes prices up between now and summer. One of the things that was unprecedented is the number of foreclosures that happened in 2007 and 2008. When you can qualify for a loan three years later, you created unprecedented demand on top of normal demand. This is where a lot of it has been coming from, but they have not been able to buy because 40% of the market is cash-buyers beating them out. They are still in the hunt, but they have not been satisfied.
We have to remember that there is a lag between the agreed upon purchase price and when it is agreed upon, and when the appraisal comes in. When we go back 2 ½ years, John was at a conference. The CER representative here said that half of the escrows were dying because half of the appraisals were not coming in anywhere near where they needed to be. John’s understanding now is that the appraisals are a bit better, but it is still very bad out there. If you go out there, make a bid, and are even pre-qualified for your financing, then there is a good chance that the appraisal will be based on the last 3-4 months of sales activity. It is not going to come in where you want it.
Bruce said the appraisal world is lagging the real world by at least 45 days. The time it takes for those transactions to close, especially in FHA areas where a buyer cannot arbitrarily say they want it anyway and give you $20 grand, is different. If you are in a conventional market, you will have people pay a 5-10% premium just to get one, and this becomes a comp. The market proves the appraiser is behind because they wanted it bad enough to close it anyway. John said this will probably self-balance itself at some point. John and Bruce both remember in the late 80s and early 90s when one of the ways the pressure was eased was by carrying a second. This would mean if you were selling a piece of property, you sell it for $350,000 while the bank says it is only worth $300,000 because of the appraisal and are only going to lend 20% on it. The person may have a $50,000 down payment, and suddenly there is money that just is not there. Therefore, you carry a second. This was about 1/3 of all the sales from 1989-1991. We are facilitated by the seller carrying a second and the lender being willing to let that occur.
A lot of the lenders said they did not want the aforementioned to happen, and people did. If you bought a property, it was financed, and everything was recorded, the lender cannot go up to you after the fact and say you cannot use the property security for a loan even if it was on top of the one put out there. People did that, and seconds were big. Bruce wondered if when you have price increases lenders will look at it and say they can become a little more aggressive with their policies? John said the answer is they did and he expects them to continue. This was Ditek in 1997. It is somebody going out there and saying they will make loans based on what they think is happening out there. It cannot happen now, but if an aggressive lender comes in and says they won’t give you a 4%, 3o-year fixed but rather a 6% and let the agreed upon sales price constitute the actual sales price, then they could go forward with it. This is where you have the little 2% margin and what you have as a differentiated, good, healthy mortgage market where you everybody making all kinds of different loans for different purposes. Although it’s pretty absent right now, John thinks it will come back.
If you pile stated income on top of a low down payment and on top of an ARM as well as a negative AM, that is a recipe for disaster. Being self-employed, John has to go out and show all kinds of documentation, so stated income loans are appropriate for this. John’s wife is a physician, and a lot of her colleagues are self-employed as well. They do not have an employment history since they are self-employed, so a stated income loan is absolutely perfect for them. They would simply go out there and get the stated income loan. All of these loans, whether they are a negative amortization or interest-only, they are all appropriate for their specific circumstances. We have the loans gone wild crazy period where these people were unfettered, went loose on the market, and nobody reined them in and they are causing us all problems.
John said there was one person at a conference he was at who brought up one of the most controversial types of loans. She said the most controversial new loan characteristic out there for home loans was when they decided to let spousal income become part of the qualifying process. Before then it was strictly the bread-winner’s income, nothing on the side. It was basically, “Wives’ incomes count,” and when this came in this was much more controversial and there were more naysayers. John grew up in Norway where ARMs are what people use there. The fixed rate loans are just not used. Here the down payments are around 25-30%. Bruce thought things would change and wondered how other countries finance things, and he saw that a 30-year fixed is not normal. However, John said in Norway you can get a 10-20% down loan, although they are more expensive and harder to qualify. Their rules and laws are also different.
Bruce asked if you had a lender finally break the ice and say something was perfectly safe, it would seem to him that as soon as they have a track record for being paid somebody else will say, “Here we go.” After that we will be off and running with something of a program. John said where things get really interesting is when you go and talk to the lenders, you will see that most of the loans made by them are still bought by investors. Now there is just no stomach for risk, although John does not think this is the case. He thinks they may think that’s the case, but John said he has heard in other context that there is a lot of money, especially foreign money, just stacked up and waiting to jump into the market. They are looking for ARMs. The one John heard about was tens of billions of dollars waiting to be invested in ARMS, and none of the lenders were willing to bundle a lot of ARMs for them so they could invest in it.
However, the returns are going to be good. If you have a pension fund and are looking out there to park $10 billion a month, whether in a teacher’s fund or public employee fund, the question is what you are going to do with the money. You cannot put it into a savings account since you only make about 2.25% interest in it. This is the flip-side of having great rates to borrow, and then you have people with money saying they do not want to do it. This is especially the case with a 30-year term. John thinks this is going to cascade at some point and become more available. John does not want it to get to the way it became back in 2006 and 2007.
John said he remembered going to a meeting with Wachovia, and he listed to the people talking about how they were originating mortgages out there. John was not aware of this mirror in front of the mouth qualification where you fog the mirror and get your loan. They were using this exact analogy and laughing about it, which confused John. It was after the fact for Bruce as well since he did not know what a collateralized debt obligation was or a mortgage-backed security until about mid-2007 when he really studied it and was surprised. There were other people on the other side betting against it with credit default swaps, and you find out that they sometimes have on the same hat. One of the things interesting in California and possibly Nevada and Phoenix is the hedge fund world has really played havoc with the private buyer trying to get inventory they would not have to finance since people are coming in with all cash offers and buying everything in sight.
John said growing up in Scandinavia, he is wildly at the other end of the political spectrum, but he does believe in a good strong market. He just thinks the people need to be reined in and that it should be a level playing field for everybody. Unfortunately, if you go back to the 2006-2007 period, it was not a level playing field. It took John a long time to understand what one of the debt obligations actually was. If you go and look at all the derivatives, it is astonishing what happened and how little regulation there was. The deregulation was not a good thing for the economy or the world. The thought that they would rein them in themselves turned out to be not true. What we had was a chain of participants, all of whom had made their money on commission. There were no grownups telling them to stop. Everybody in the chain from the local originator all the way up the chain to the person packaging things on Wall Street were all making their money basically on commission. You have a lot of sales people out there, but these sales people need managers or at least connected to the real world in order to know what the rules are.
However, at the end of the day it really did not help anybody. They made a lot of money, and that was the only thing they know how to do. They have basically been out of business for five years. Money should reflect an underlying value, whether it is productivity or some kind of tangible; and this money was just funny money. When you go look at the derivatives, it was like a synthetic CDO. It would be like John and Bruce investing money in somebody’s life insurance policy, and then they start selling what they invested in it.
Bruce said inventory right now in some areas is about a month to a month and a half, although in other areas it is literally days. Bruce wondered how this reverses and gets back to a normal inventory level if lenders are not going to come up with the REOs. Short sales have also been consistent, so the only place it can really come from is equity has it. In Sacramento, for example, half of them don’t have it. According to Economics 101, the solution to this is prices have to increase. Bruce said for 2013 he does not see how the inventory would grow to months and months of supply since it will have to have more demand than it has supply for the entire year or two. However, John said this would happen if we kept the six-week lag between the when sales occur and the appraisal can come in properly. This will have to shrink down a bit.
Additionally, we are bouncing off the bottom right now, and the velocity of the bounce is the fastest. Once the bounce gets further up off the bottom, a little more gravity will exert itself and pull back a little bit. With the low interest rates, a rise in prices is just in the cards. This will keep going until there is equilibrium of some kind. This will probably go up fairly strongly, at least between now and summer. Bruce said what is interesting about equilibrium is it is hard to get if you only have two months’ supply of inventory. You then still have a huge push. However, it seems like once people start making a lot of money on their real estate, it does not end until it is numerically possible to qualify. Usually this regains momentum instead of slacks.
Right now we are probably going to have a period of time where we dipped up into the pent-up demand, so things will be going very well. However, at some point it is going to level off a bit and the regular things will exert themselves. This includes household income, how much money you saved, self-directed IRAs. Here we also have demographics, which is the baby boomer generation of which John was a part. It was a big bump on the curve that is now past us. A lot of the force that was built into that will probably dissipate and go back to the basics. There has also not been much building going on the past six years. No matter how you do the numbers there are too few houses, especially here in California. How this plays out will be interesting.
Cal Poly produces a report about this, and they are the only place that actually counts sub-divisions. Sub-divisions are down by 95% in Riverside County, which is where building would obviously take place. You cannot catch up with sub-divisions or finished lots tomorrow if you decide it is finally okay to do a sub-division. There was some consolidation out there, but the builders were pretty good about keeping the pipelines active. There are a lot of projects that were being incrementally pushed through the pipeline, and you can crank it up just a little. John said he has watched a few; and they will be able to crank it up, but like nothing compared to what the demand is going to be. During the last boom in 1989 when people were building like crazy, they were building a lot of really crummy things. There were then an awfully lot of boxes being put up and long lines on asphalt roads. The things we are looking at now and the things built back in 2004-2006 were well-thought through projects. If you go drive down in Murrieta or Temecula, there are a lot of homes that are 4,000 square feet. The neighborhoods and homes are nice, they have planned for schools, parks, and commercial development. It is not like driving around in Palmdale where everything was built back in 1988.
This all takes time. If you start breaking ground tomorrow on the next one, you are going to have to go through all the approvals. These don’t come out of the ground for a while. John said he flies ultra-light airplanes out of Paris, and they fly about 20-30 miles. There are a lot of building projects they fly over in these planes and oversee, and they see how they brought the development as far as they could before they pulled the plug on it. There are 400-500 lots built in these half-circles, and they kept them active. There were always 2 or 3 houses being built right at the end of some street, so there was always something occurring. During the past 3 months, you are all of a sudden going around and there are no longer only 2 or 3 but 12-25. They still have plenty of other lots there, and the lots never degraded that badly. They are still rebuilding, and things are now starting to come online.
Bruce asked John’s opinion of interest rates starting to go up and what the reaction of the buying public will be. John said initially there will be a rush to go out there and buy before it goes up even farther. Not only did they miss out on the bottom of the price, but now they don’t want to miss out on the interest rate too. A lot of people think the opposite will happen, but that is not true. Even back in 1983 when John moved, people were still talking about their 17% mortgages. Bruce refied back in 1981 to become an investor at 17 ½, and he was shocked when he was able to pay it off with a 12. John remembered when it went below 10 and everyone was saying it was only temporary and would go right back up to 18 again. However, it never did, but in the future we could see in the future is the other end of the chart.
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