"Are we there yet? Real estate's wild ride"

This op-ed piece was originally published on Sunday, December 20th, 2009 in the Miami Herald but has since magically vanished from their website.  I think it's a great work as people are suddenly interested in deciphering the current situation in the South Florida real estate market.

"Are we there yet?  Real estate's wild ride"


BY GRANT STERN

Since I think that most participants in the real estate market would rather be somewhere else right now, I'd like to compare our local housing downturn and recovery to a family road trip to Disney World on the Florida's Turnpike. Back in late 2005, we left home and after four long years on the road, we've only made it to Yeehaw Junction.

``Sure, it's the middle of nowhere,'' we tell the kids in back, ``but it's also an important crossroads.'' In two years, we'd like to be frolicking in the Magic Kingdom, but sadly, all we see right now is more signs to buy advance tickets, and an exit in not-quite-there-yet St. Cloud.

In the rear-view mirror, we can see obvious displeasure and barely contained impatience brewing in the back seat. But a quick check of the map shows that the Magic Kingdom is only a couple more years away -- and the scenery is definitely improving.

The residential real estate market is showing progress in the most urbanized locales. However, signs indicate that a second stage to the housing crash is underway. Middle class people all over are slowly being squeezed out of their homes by unending furloughs and pay cuts.

PENT-UP SUPPLY

Compounding matters, there is a pent-up supply of homes of unheard-of proportions.
This means that while the housing market's fundamentals are shoring up -- appraisal valuations falling in line with sales prices and lending activity increases -- there's no double-digit percentage price improvements within sight.

Strong markets like the Miami Beach barrier island won't experience tremendous moves in any direction for the coming two years. And there is likely going to be mild price erosion in the suburban as well as high-end homes markets through the next two years.

As for condominiums, the boom is slowly transforming downtown Miami and Brickell neighborhoods into a realization of Walt Disney's original plans for EPCOT. In Walt's 1966 vision, urbanity would be constructed to the Nth degree. Everyone would work and contribute to the community -- the People Mover renders automobiles unnecessary -- and all dwellings are corporately owned, everyone is a renter. Surely, Mr. Disney never envisioned the landlords being from Colombia, Canada and Western Europe -- but the all-cash buying today will ensure that two years from now, absentee landlords will own a vast chunk of our central city district.

Recently, the FHA made a prudent move to modernize its condo finance program and expand the availability of its loans through brokerage outlets for all properties in 2010.

This should allow local buyers to jump into select projects with stable underpinnings in the district. By 2011, we should see a few of today's stalled high-rise projects become owner-occupied properties, promoting a more sustainable and local urban core.

However, FHA and Fannie Mae have both weighed in that, ``Any man that falls behind is left behind.''

CONDO SHAKEOUT

Some condo projects have deferred maintenance too long, cannot afford insurance coverage. Others have less stakeholder equity than a Scott Rothstein investor. In the coming two years, many associations will take advantage of Florida's revised Condominium Termination laws to conduct mass short sales. This should rid the condo market of its weakest players, although it won't weed out all of the properties scrambling to keep their wooden eye in place.

Two years from now, the real estate market still won't be all the way to the Magic Kingdom. But assuming that we complete the return to the modern business cycle -- with limited interference from hurricanes, politics and external factors -- our journey through the swamps of this market should be reaching civilization. In some markets, there will be great fundamentals. Others will be worse in 2011 than they were even in 2008 when all bets came off the table.

No matter what happens, we'll be paying the toll for our current dilemma for years to come. But in a couple of years, signs will appear more frequently and as a market we should feel like there's some positive direction. When involuntary unemployment declines, we'll all be back in line to buy tickets, with the Magic Kingdom in sight on the horizon.

Condo Market Fractures Lending Standards

The deterioration of Condominium lending's standards between housing agencies has ruined the market for homeowners seeking financing.   Agency lending standards for Condos had been settled for nearly 30 years, with the four main housing finance authorities accepting each other's certifications for most projects. Recently, the two lead agencies in Condo financing - Fannie Mae and the FHA - updated their guidelines to achieve divergent risk management goals.  The end result is decreased access to credit, lower Condominium prices in comparison to surrounding single family homes and enhanced losses to mortgage holders.  The Condominium market needs a unifying set of approval standards and reciprocal agreements between housing agencies to revive normal lending activity.


A little historical context and legislative history illuminates the speedy evolution of Condominium Property rights and financing over the last 50 years.  Condominium real property exists as a purely legal construct, first recognized formally in modern law under France's Napoleonic Code of 1804.  The Condominium form of ownership began formally in the United States in Puerto Rico in 1951.

After ten years of lobbying, the National Housing Act of 1961's Section 234 allowed the FHA to insure condo mortgage loans.  Section 234 loans were wiped out  by the HERA Act of 2008.   HERA converted long used rules into flexible guidelines which HUD is open to interpret and change.  The FHA issued the first new Condominium approval guidelines since 1974 in 2009, with the intent of improving risk management.

Thirty years ago, attorneys from the (now) government agencies of Fannie Mae, Freddy Mac, FHA and the VA gathered to create a common standard for the needs of lenders to finance condo mortgages.   That document still provides some of the basic hoops every modern condo agreement should jump, such as minimum rental periods, recordation of documents with proper surveys etc.

Proceeding from those guidelines, there was a thirty year period of reciprocal acceptance of FHA Condo Approval by all parties, and over time, Fannie and Freddie virtually merged their standards with Fannie leading the way.  The former private market-makers also created condominium approval review exemptions (aka "limited reviews") based on the loan to value and occupancy of the borrower which exist today.

  Fannie Mae began changing their Condominium Approval process in 2007 by dropping direct reviews in favor of 100% lender delegated reviews.  After the real estate market calamity in December of 2008 Fannie issued harsh new lending rules for properties in Florida and nationally for new construction projects.   The agency has spent the last 24 months backpedaling from those tough guidelines, and spread fear throughout the market regarding condominiums.

Sadly, the fear spread by Fannie Mae's abrupt pullback sparked the consequences it sought to avoid, namely a collapse in condo prices throughout the market.   In a Minsky Moment, Fannie began quietly advertising to industry sources that even it's toughest PERS approvals would be flexible.  Eventually, they created a whole new approval category called "Special Approval Designation List".  This "SPAD" list is so special, no lender or correspondent wants to issue loans into those projects.

 The FHA was required by HERA to draft new Condominium Guidelines which they issued in late 2009.  The implementation is still being phased in today, after 20,000 expiring projects were given a reprieve from expiration this past December.  Unfortunately, during the break from past practice, Fannie Mae used the opportunity to cancel their reciprocity agreement.

The FHA's new guidelines have heavy emphasis on large cash reserve accounts, and restricting developers from renting unsold inventory while holding the units for sale or lease option sale.  Fannie's new guidelines aim to take a blood sample of each building and analyze the physical plant for flaws, this in addition to the usual financial checkups.

The two largest standard setters have gone in opposite directions.  As a result, the list of approved buildings for both agencies is shrinking.  Mortgage lenders who entered the market after 2005 have suffered losses even with loan to value ratios of 50/50 after some condo prices declined 90% or greater.    Condo owner/directors are rarely informed of the implications of sweeping changes affecting the marketability and price of their homes.   All of this has been happening without stakeholder input in Washington, D.C. aside from the  money center banks who now control vast swaths of the market for new mortgage loan originations.

 The privatization of Fannie Mae and Freddy Mac casts a long shadow at their standards departments during the interregnum.   It seems logical that new standards should be set in the private sector for Condos and the private non-profit corporations governing Condo property.

The fact that two large standard setters cannot agree, clearly indicates that there's no consensus on how to heal the wounded standards for what really separates a functional Condominium from a failed project.  The prolonged existence of the rift is eroding investors' trust in the legal form of Condo ownership's ability to withstand shock.  Ultimately, the condominium financing market needs new defining standards to resume normal functioning.

National Mortgage Licensing System Goes Live Today

The National Association of Mortgage Professionals (aka NAMB) fought in favor of a national licensing system for many years.  

 The NAMB had twin goals of allowing better access to multi-state markets for loan originators while simultaneously looking to end the practice of company licensing for non-depository mortgage originators (ie. a "Mortgage Lender" could employ as many unlicensed originators as they wished, while Mortgage Brokers could only use licensees to originate).    A tertiary goal was to stop abusers from state hopping since there was no sharing of data on abusive loan professionals, and in many cases (Florida inclusive) the state licensing systems only checked for state legal action and not Federal crimes (see Florida once again).

 During the boom, unlicensed individuals committed some of the worst abuses.   Countrywide Home loans, for example, was one of the top abusers of the system.  The only sad omission from the new system is employees of nationally chartered banks.  This means that another Countrywide could spring up, and send out legions of unlicensed people, to sell loans on a wholesale basis to non-depository lenders and brokers that are as a class, predatory.  In addition, it was these types of bank reps who encouraged brokers to find loopholes in underwriting guidelines, present and obtain unwarranted lending exceptions or worse.

  Ultimately, I agree with the perspective that it is counter-productive to asses the credit risks of a group of professionals disproportionately stung by the credit bust.   Mortgage brokers are the only real estate lenders who must disclose all of their fees and loan pricing on the Good Faith Estimates today.  The mortgage broker is the only check on bank and non-bank lenders' loan pricing and profit margins.  In addition, a mortgage broker is one of the few outlets remaining for borrowers who need access to private capital (the "hard equity loan") when they do not qualify for a traditional bank loan.   

 As the agents of the banks, mortgage brokers have gotten hit pretty hard in the PR war, being that we're the front lines, the people that the public is acquainted with.  The additional costs of new national licensing are a serious burden on Loan Originators and Brokers like myself, but needed to restore credibility to our profession.  But make no mistakes, if every mortgage broker in the country is sidelined for personal credit issues, it will simply complete the process of tilting the tables completely in favor of the too big to fail banks who caused this mess in the first place.

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. . . 

FHA Gives Condo Lending Market Reprieve

As reported by Realtor.org 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: https://entp.hud.gov/idapp/html/condlook.cfm) ***  

  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)

Condo Terminations May Be Next Phase Of Real Estate Crash

Condo Vultures® Opinion Column

BY GRANT STERN

Nearly 18 months after beginning the lengthy and uncommon process, Condo Terminators has successfully unwound a 44-unit association in South Florida. 

Think of it as a administrative do-over of a troubled condo complex that probably never should have ever been converted.

By our estimates, as many as 15 percent of the existing condos in Florida are legitimate targets for termination due to plummeting values caused by high foreclosure rates, unpaid maintenance fees, expired insurance, and serious code violations that jeopardize a project.   

In terminating the Sunset Lake Villas condominium in suburban Fort Lauderdale, we are providing a much needed relief for a project where prices of individual units have plummeted to 10 cents on the dollar from the original boom time values.   

Our plan of termination was recorded in the Broward County Public Records on June 11, clearing the way for the failed Sunset Lake Villas to revert back into a single-title apartment building. 

The idea of terminating a failed condominium started with a hunch: while condo conversions had been the boom transaction, the mass short sale of a condo project had to be the child of the real estate bust.

Corporations are often viewed as entities with unlimited life. I knew that each and every building is required to have a clause allowing the dissolution, having drawn my own condo documents in my own projects. 

At the time, I speculated that the same market forces, which so mispriced multifamily dwelling assets in the boom, would reverse themselves horribly during the bust.

This month, the idea became reality when my consulting group, Condo Terminators, announced we had successfully turned back the clock, offering another way for faster resolution of the foreclosure crisis.

Developer Anthony Galeotafiore of AJG Capital LLC in Bethpage, N.Y., assisted in bringing the transaction to fruition along with his counsel Sree Reddy of Roth Reddy & Associates in Miami Beach, who drafted the instrument of termination.

Pursuant to this plan of termination, a special purpose trust company managed by Condo Terminators took possession of the apartments. 

This trust company is instructed to proceed with the orderly wind-down of affairs for the Homeowner’s Association by the plan.

The main purpose is to prepare the project for sale to AJG Capital, which intends to operate it as a rental apartment building.

Once the plan of termination was approved and filed, the building's title was transferred to the Termination Trust. 

This transfer stripped the existing mortgage liens - all currently in foreclosure - from the individual units.

The mortgages are still valid and attach to each unit owner’s share of the proceeds of sale of the property - even if these proceeds are insufficient to cover the whole amount owed.

A real estate appraiser visited the property to determine market value for all units, as per the plan.

The Sunset Lake Villas project is being liquidated for its current fair market value estimated at around $18,000 to $22,000 per unit. The condo units had depreciated 91 percent from the sales prices in 2008.  

Based on mortgage documents in the public records, the terminated units had a present loan-to-value in the 700 percent to 1,000 percent range.

In 2007, the Florida condo statute’s termination section was revised to provide an orderly process to wind down and terminate failed condos. 

It allows these properties’ legal agreements to be dissolved, and for the properties to be reconfigured or sold to investors as multifamily commercial property.

Condo termination could potentially produce positive outcomes for local governments, banks, and the market as a whole in addition to savvy investors looking to profit from the bust.

Ultimately, I estimate that up to 15 percent of the post 2003 condominiums developed statewide in Florida could be legitimate targets for condo terminations in the course of the next five years.

Grant Stern is the owner of Morningside Mortgage Corp. in Miami. He can be reached at 786-220-0117.