Friday, December 17, 2010

The Pit and the Economic Pendulum

The whole world knows, by now, that the United States real estate market is in a pit, and the pendulum of its cyclical market has swung to tight money, with corresponding low asset prices.   Mixed economic signals abound, but the smart money is still placing bets that today’s prices. 

The secondary market for mortgage loans is fully consolidated between three government-owned or sponsored agencies.  New valuation models have emerged in the residential housing markets, based on financing and market to sales times, which are not uniformly factored into bank’s lending calculus before the boom or today.

The twin issues of valuation ambiguity and regulatory mayhem have conspired to cause a sharp consolidation of the national mortgage lending market into the hands of 5 money center banks who control nearly 65% of new originations, and limit competition through their oligarchy.   

  The barely-existent finance market is in the peak of the bust, while residential lending has been regulated to its knees

Investors have scoured the market for rock bottom deals in South Florida real estate during 2009 and 2010 with many pulling the trigger.   This bear market rush virtually exhausted the supply of new construction condominiums in Downtown Miami within a couple of years, rather than the 5-10 year horizon gloomier souls predicted. 

The bear market buying frenzy was helped by a combination of low prices, government assisted lending and many individual cash buyers from foreign lands.   There is a new bifurcation of real estate values caused by the predominance of cash transactions by the great majority of individual buyers. 

Two main investor’s pricing models have emerged for residential housing: Cash Basis and Financing Basis. 

The Cash Basis pricing model from lowest price to highest is the foreclosure auction price, the “short sale” price and the REO or repossessed home price. Cash basis pricing is typically based on the market capitalization rate, or the percentage return an investment yields on a real estate investment proportionate to an interest rate on the equity invested.   These prices assume anywhere from an immediate to 15 day closing, in cash. 

In the middle, real estate pros refer to the “Cash Price” which is the price at which a cash buyer would buy a property without any obvious distress or for a bank owned property in reasonable state of repair.  This is also a price where buyers will invest into a lender blacklisted, fractured or distressed condominium.  In condos, this price is typically 50% of the comparable apartment’s Government Supported Housing price.

The Financing Basis price starts at the price a financed buyer would accept with a 20-25% down payments and bank or GSE agency financing.   The final pricing nuance is: Government Supported Housing.  The highest priced residential real estate, are homes that are eligible for 3.5% to 5% down payments.  These are select condominiums and all single-family homes with sellers accepting financed contracts and up to 60-day closings.    

Banks order real estate appraisals that currently only evaluate “Financing Basis” pricing of home sales.  There’s no model of integrating the Cash Basis sales, unless there are only “Cash Basis” sales inside the sub-market.   The resulting confusion is hurting banks’ ability to lend responsibly and borrower’s ability to leverage real estate.   However, investors are using these pricing variations to buy up bank inventories below end user prices and turn around and flip these properties to end users paying a premium.

Just as national money center banks have become too large to fail, their lending units have taken virtual complete control of the primary mortgage market as supplied through mortgage bankers, brokers and retail originations through their banking franchises.   The Freddy Mac rate survey indicates that even as underlying Treasuries rates have been getting lower, origination fees are rising.  Furthermore, from July 2010 through October 2010 there was a 50 basis point (0.5%) drop in  Treasuries that yielded only a 23 basis point drop in average lending rates.

Bank of America simply painted new colors onto the Countrywide Home Loans lending and servicing operations, and handed them the keys.  Their disastrous robo-signer issues, and newly discovered possible securitization process flaws point to the inherent danger of consolidating too much financial control into a single institution.    However, that didn’t stop the Octopus of Charlotte from dropping their mortgage broker channel in November.   This means the largest lender in the country now has zero transparency regarding yield spread premiums issued to consumers through their entire origination channel.  

The bull of a financed real estate market has been neutered by heavy-handed government regulation.  The mandate that all loans have documented sources of income for repayment is excellent for wage earners, but completely locks self-employed persons out of the home finance markets.  These entrepreneurs are risk takers, who traditionally were able to get a (safe for a generation) loan by simply showing their good credit behavior, cash in the bank and equity in the home.   Traditional standards were 25% down payment for one of these loans. 

Self-Employed people, as well as foreign persons, US Citizens who work abroad and wish to repatriate, permanent residents with legitimate foreign sources of income are forced to seek higher interest rate loans with 50% down payments.  These high rate loans are also the only resource for borrowers whose FICO credit score falls below 640 for any reason.  Non-Traditional and lower income documentation loans are only available for investment properties. 

New regulations require a 3-business day waiting period on ordering appraisals.  Federal disclosures have been transformed from simple, transparent documents that include all pertinent information on a page to a veritable paper mache’.  The new Good Faith Estimate has triple the information, but obscures entirely lender loan profit margins and the total cost of home ownership.  

The bear market cash buying frenzy is showing signs of acceleration even as new lending guidelines further depress available housing demand for end users. 

Certainly, there’s a glut of available properties on the market and in the “shadow market”.  However, these new regulations have created shadow demand as most end users are locked out of the finance market for their own protection.  Ultimately, lenders pricing models need a complete, national overhaul to reflect current realities.     

Until the real estate market shifts from an Investor’s market to an End User Buyer’s market, we won’t see the normal price appreciation that signals a healthy housing market.   It will take years of momentum to chip away the worst of the new regulations, and revive the economically crucial mortgage markets on a national level.  In due time, the pendulum will swing back again. . . 

Thursday, December 9, 2010

FHA Gives Condo Lending Market Reprieve

As reported by and  Mortgage News Daily this morning at 9 am, FHA announced a Condo Project Approval extension after the article Condominium Financing Markets Lose Government Insured Lending Supports was published to this blog and set for 7:30am release.  HUD held an "industry call with Gary Long and his partner in the condominium policy department in Washington DC and revealed numerous facts about FHA's condo program through the years, as well as the implications of the new project approval changes.  

Condo Projects will have a staggered expiration based on when they were approved starting at year end and proceeding through September 30th, 2011.    
FHA condos extensions are by year approved.  Projects approved with number of affected projects in parenthesis:

1972-1980 (403) and 1981-1985 (1800) expire 12/31/2010
1986-1990 (7800) expire 5/31/2011
1991-1995 (5700) expire 7/31/2011
1996-2000 (3800) expire 8/31/2011
2001-2005 (2000) expire 9/30/2011
2006 - Sept. 2008 (1700) expires 3/31/2011

HUD clarified that it will accept loans with an FHA Case Number issued up to and including the expiration dates, which clarified a point of lender concern that approval expiration was date based, not case based.

HUD's new FHA condo lending homepage contains current condo guideline resources including recertification processes which will be handled by a contractor with HUD supervision for the "HRAP" process.  Once a condo has expired, it has 6 months to re-certify.  Afterwards it will have to re-apply from scratch.  Florida condos must use the HRAP process to re-apply directly through HUD.  HUD's goal is to have a 30 day recertification process.

During the call, HUD also announced that the temporary guidance guidelines issued last year is also administratively in the extension approval process.  These guidelines require all Florida condos to go through HUD review and allow certain leniencies as well.  However, re-certifications can be handled by lenders using the DELRAP process if the original review was completed by HUD.

Condominium Financing Markets Lose Government Insured Lending Supports

At the stroke of midnight last night, December 7th, the FHA officially invalidated the condominium approval list that it spent the last 30 years to create.  With this last salvo against the condominium financing market, FHA is signaling the bottom in Condominium lending has just officially begun.  The evolution of condo lending standards has devolved into a cacophony of competing standards.  Clearly, lenders are unable to properly evaluate counter-party risk, building management practices and capital structure using any of the competing standards in Condo evaluation.    The lack of end user Condominium financing amounts to the erection of an Ivory Tower to guard new condominium towers from commoners and homeowners.

The condominium market upon which most of the pre-2007 standards were built, reflected realities for fairly small apartment housing projects with shared ownership starting in the 1970s.  Nobody at the time realized how much more complex and active the market would become when untethered from oppressive Co-Operative Housing Corporation rules and restrictions, when coupled with it's exposure to the mortgage interest tax deduction.

Condominium lending started slowly with the FHA in the early 1970s and by the early 1980s had an organized process to approve condominium projects directly through HUD.   Over the decades, HUD amassed thousands of project approvals covering the 50 states, and available through the "FHA CondoLook" database.  (link: ***  

  The HERA Act of 2008 wiped out the old statute authorizing condo lending, and shifted funding authorization to the Single Family housing statute.  This law caused expiration hard project approval rules, which FHA replaced with administrative guidelines.   The FHA set out a complete refresh of their condominium project approval rules, and these went into effect 1 year ago.  

Notably, the FHA guidelines are used to enable end user borrowers to place 3.5% down payments.  After deducting the 1% financed FHA insurance premium, these buyers are borrowing 39 times their down payment.

The new guidelines discarded a 30 year old legal guidelines agreement between Fannie Mae, Freddy Mac, VA, FHA and HUD.  In addition, FHA the approval process, due diligence practices and eliminated on site inspections.  It placed new emphasis on budget reserves and site insurance analysis, while eliminating on site inspections and the bulk of new construction projects.  As a result, both Fannie Mae and the VA cancelled their approval reciprocity with the FHA earlier this year.   

Meanwhile, Fannie Mae spent 2008 implementing tough new "PERS" Condo Project Approval standards and mandatory national reviews.   By the start of 2009, their failed "get tough on the market" approach yielded to a new "Special Approval Designation" list known as the "Spade" list by industry insiders.  "Spade" approvals are so special that it has taken 9 months for initial lender adoption, mainly because this list included nearly every highly distressed project imaginable.  In fact, it was virtually a case of creating an approved black list by Fannie Mae, since entry on the list virtually guaranteed that local banks and portfolio lenders shunned included projects.  

As of today, Fannie accepts loans through it's PERS process, Special Approval Designation, "Full" Review and "Limited Review" (25% down payment by borrower minimum for no review) or absolutely no review at all for "Refi-Plus" loans.  Got that?  Complicating matters are state by state guidelines for Private Mortgage Insurers who exclude some of the largest condo markets entirely, such as Florida, leaving "Conventional" borrowers with a minimum 20% down payment on all condominiums.

The onslaught of exotic lending products pushed our multi-family single unit financing market is at it's nadir today.  No single project standard is accepted across the secondary market for mortgage lending.  Today's mass expiration of government insured lending eligible condominiums is a blow to every potential owner occupant looking for a starter home in condominium communities.  Until project approval standards are re-evaluated altogether, from today forward, the Condominium finance market will be stuck in neutral until further notice.

(SEE UPDATE at 4:30pm today)