Wednesday, February 12, 2014

The Law of Diminishing Returns as Distressed Housing Becomes a Footnote in our Current Cycle

It was a perfect idea that may have run its course the way ideas often do in the real estate market. Distressed single family homes saturating the market in 2011 and 2012 proved a sure bet for private investors and larger private equity funds alike. GSEs even saw an opportunity to shed toxic assets through bulk sales to qualified private equity firms. The plan was successful. Too successful. Today, investor participation has effectively driven prices to an inflection point where finding undervalued properties is becoming harder. Distressed housing no longer yields strong enough returns to remain top on the list of options for the investor community.

“Buy and Hold” was the prevailing strategy of the previous cycle with investor participation shoring up the market. Investors firmly positioned themselves to benefit when prices would eventually appreciate, and in the meantime enjoyed revenue generated by a growing single family rental market. Meanwhile, larger institutional investors garnered much of the attention resulting from government partnerships involving bulk distressed real estate sales in California, Las Vegas, and other areas hard-hit by foreclosures. Independent investors found room to participate as well. It’s estimated that investors have injected up to $15 billion in capital into the housing sector since 2011 in pursuit of distressed properties. Peak has also participated in accumulating a pool of these rental homes in the Las Vegas and Los Angeles areas.

Fast forward to 2014. More than Federal programs, monetary policy, and an improving jobs market – all cash investor activity in the housing market has arguably had the most impact on bolstering home values and boosting the economy. As private capital returned to the financial ecosystem, homeowners saw equity return and distressed borrowers displaced through foreclosure or other actions had the opportunity to regain their footing through the availability of single family rentals. The market has now reached a point where “Buy and Hold” is generating diminishing returns resulting from:

  • Rising home prices. Investor purchases provided a much-needed floor for home prices that halted plummeting home values and provided the groundwork for equity to return.  Unfortunately, as prices rise on existing inventory, investor returns fall.
  • Reduced inventory. An improving economy, government programs, and more proactive lender workout programs have resulted in the lowest numbers of foreclosure filings since 2007. In addition to rising home values deterring investors, the supply of available distressed opportunities are simply drying up as the cycle shifts.
  • The “own versus rent” choice for households. Strong rental revenue for investors simply translates to higher monthly rents for dwellers. Despite higher interest rates, higher home prices and new underwriting criteria, current renters are exploring options to trade in their rent check for a mortgage check. Moreover, “boomerang buyers” – homeowners displaced by short sales and foreclosures during the last decade have regained their economic footing and are looking to buy again. Investors are encountering a plateau on rising rental revenue. Additionally, the cost of turnover, repairs, and down time for rentals is eating into the return as the properties and the investment sits.

Patterns are emerging signaling an end of this cycle as major players who acquired thousands of properties early in the game are now cashing in the chips. First, investors are scaling back pursuit of foreclosed properties. Second, investors have taken notice that home appreciation is slowing, and see this as the perfect opportunity to “hold” no longer and to sell. In Las Vegas, once dubbed the “Foreclosure Capital of the U.S” where prices at one time appreciated as much as 25% in one year, private equity firms are exiting the market.   

We’re currently evaluating our portfolio, and see merit in pursuing disposition of the residential side, while pursuing other acquisition opportunities on the commercial level. While there will always be a distressed sector and opportunities, it’s time for investors to evaluate if the cycle is winding down an acquisition strategy for their own long term goals. 

Wednesday, October 30, 2013

The Qualified Mortgage Rule - Who Truly Wins?

As Washington continues to find ways of scuttling our economic recovery, the real estate recovery has fallen out of the spotlight for a moment. Delinquencies continue to fall, home equity is on the rise, and investors continue to find a more stable haven in real estate than traditional investment vehicles. What’s proven to be real estate’s missing piece has been credit -- a meticulous balancing act of making it available to sustain housing growth at an affordable price while at the same time maintaining fail-safe protocols to deter abuses rampant in the last cycle.

January 10, 2014 looms as yet another housing industry witching hour with implementation of the Qualified Mortgage Rule (QM). QM carries with it the potential to restrict consumers as well as traditional sources of capital for the market, which will inevitably impact growth in our sector. However, QM aspires to bring stability and additional credibility to a mortgage industry often cited as a key factor in the recession of the last cycle. Restrictions versus credibility --- that’s the question to ponder today.

Broadly defined, QM sets specific criteria for a home loan that meets certain standards set forth by the federal government as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010. Interpretation and implementation of QM is overseen by Consumer Financial Protection Bureau (CFPB), the agency created as part of that legislation for enforcement purposes. After more than two years of discussion and debate, the following provisions stand out as key concepts of QM for lenders to follow.  These in turn will provide legal protection against borrower lawsuits as well as increased confidence that GSEs won’t require “buybacks” of defaulted loans that have been guaranteed by Fannie or Freddie:

  • Elimination of "low doc" or "no doc" loan programs
  • Adherence to "ability-to-pay" provisions, inclusive of tighter underwriting based on borrower's ability to pay over the long term
  • Elimination of interest-only, negative amortization, teaser-rate, or other loan programs deemed "exotic"
  • Loan term not exceeding 30 years
  • Debt-to-income ratios not exceeding 43%
  • Total disclosed fees not exceeding 3%

While QM hopes to rid the mortgage industry of risky loan products and ensure that borrowers have the ability to meet their mortgage obligations, it poses three very clear and present dangers that can’t be ignored. First, QM excludes a huge segment of borrowers who have difficulty meeting stricter underwriting standards, but aren’t necessarily credit risks. Second, while more risky products will be eliminated as a result of QM, so are the choices borrowers have in choosing loans that fit their budget and lifestyle. Remember, our current culture of tight credit has made “exotic” loans harder to qualify for as well, so our current environment has actually generated a strong class of qualified borrowers with less likelihood of defaulting on a mortgage. Third, and potentially crippling to the industry, is the 3% fee cap. Mortgage brokers stand to suffer the most from this cap. Already operating under tight margins as well as a host of regulations limiting what they can charge, broker fees may not be able to exceed 1% of the proposed 3% total disclosed fee rule on conforming loans. Today’s mortgage broker fills an invaluable niche for borrowers who don’t fit the standard underwriting mold. We could lose yet another borrower financing avenue if there is a new shakeout in the mortgage broker industry, and this could eventually impact demand with fewer borrowers in the mix.

It appears, then, that QM is more about choice --- from the borrower perspective --- than it is about restrictions or credibility. While GSEs and lenders win by only writing loans for a predefined criteria, borrowers that don’t fit the criteria lose. Peak has been exploring a number of opportunities for 2014 to create more options for borrowers that find themselves even more disenfranchised by lender and government standards. A healthy housing sector requires a strong mix of investors, inventory, credit, and buyers. More choices of credit for buyers equates to long-term stability for the housing sector.

Monday, August 12, 2013

Rising Prices and Rising Rates - And the Recovery Continues

If there's one thing about cycles - what goes down eventually comes up. We are enthused to be involved with a number of residential projects as a capital partner in Southern California during this "Conservative Renaissance" of real estate. The great response from the market to these single family offerings clearly affirms our sentiments that a recovery is in full swing. This in addition to our commercial holdings, clearly supports the conclusion that the recovery is across the real estate product types. But as always, smart investors practice cautious optimism even during a positive period. The road ahead looks promising for continued growth in real estate, but a few trends are worth keeping our eye on that could impact the cycle down the road.

We all recall too well the dark days of the housing crisis characterized by plunging property values and growing shadow inventories before disparate forces in real estate actually converged to create opportunities investors are currently enjoying today. First, strong government initiatives in the form of legislation, regulatory reform, and programs benefitting distressed homeowners mitigated the flow of foreclosed properties ending on the auction block or as REO. Second, monetary policies and other market conditions maintained a low ceiling for interest rates, allowing investors and consumers (that could meet strict underwriting guidelines) to borrow at cheap rates. Third, the economy following its own cycle of growth finally showed sustained month-after-month improvement, with the much welcomed inverse relationship of falling unemployment and rising GDP. The result has created a market of increased demand caused by the lack of distressed properties available at a discount, affordable mortgage payments due to low interest rates, and more consumer confidence that they will have an employment base to support a mortgage.

Vista Urbana, an affordable home project in the Ventura area is one of our success stories.  Peak served as the capital source for the endeavor. Construction commenced in October 2011. The affordable housing development consists of 156 condominium units, recently completing phase I and II of construction with all units reserved or sold. Units in phase III, currently in the final phases of construction, have all been pre-sold. Oak Terrace, a mixed townhouse / single-family residence project in Thousand Oaks catering to a more upscale audience is another Peak capital project that boasts 84 units upon completion. With almost 50% of units built and occupied, the remaining units have also been pre-sold. In both of these ventures, favorable market conditions have contributed to their success.

Rising interest rates is the one factor posing a potential threat to the current momentum. So far, the market has been able to operate smoothly in light of tight inventories. The upward pressure this is applying to home values is starting to entice more homeowners to sell, and some analysts anticipate home values to appreciate more than six percent in 2013. However, rates have incrementally increased over 100 basis points in a year, and some fear the combination of higher rates with higher valued homes could price many consumers out of the market. Moreover, investors could begin looking for better returns in other investment vehicles. 

As affordability decreases, urgency increases. Rising home values, along with rising rates,can continue the momentum by spurring ambivalent buyers that can afford to participate into the market while they perceive they can still afford to buy. That, coupled with increased inventory generated by new sellers benefitting from rising equity in their homes, should prove to modulate the increased cost of homeownership in line with continuing improvements in the economy. In light of appreciating home values and interest rates, we’re confident we are still at the beginning of a great cycle for real estate, and are anticipating great returns from additional residential projects we are involved in as financing partners that should complete construction in the next twelve months. Investors and consumers alike can both benefit from today’s market. Appreciating values and rates reflect the fortitude of a market and economy that can support it.

Monday, June 17, 2013

What Could Be Looming in the Rear View Mirror as Housing Recovers

What a difference two years makes. While the media and other pundits proclaimed loudly and often the end of our industry as we know back in 2011, the smart money should have been on the analysts and economists that recognized real estate was in the throes of a downward cycle that would eventually correct itself.  Granted, this was no ordinary cycle and there is still blood on the streets. A recession initiated by an over-inflated real estate market imploding almost proved the media and pundits right. But a full court press comprised of a combination of monetary policy actions, government programs, and the “X” factor of cash rich private investor participation gave housing the foundation it needed to rebound.  Today we enjoy a much more stable market. To sustain the industry’s current prosperity, we should take note that the issues that haunted us during the darkest moments of the housing crisis, while mitigated, are still factors that require action. 

One example is the recent extension of the Obama administration’s Home Affordable Mortgage Program (HAMP). Originally set to expire at the end of 2013, the program was extended for two years through 2015. To date, over a million homeowners have received permanent modifications under HAMP since the program’s inception in 2007, with over 42,000 modifications granted this year. While at first glance, the program appears to have justified extension by helping huge numbers of homeowners afford their mortgage, approximately 1/3rd of loan modifications executed under the program have re-defaulted according to a recent government report. This implies that significant cross-numbers of distressed homeowners are still on the threshold of foreclosure. 

In addition to a less-than-perfect long term track record on loan modifications, ongoing lender foreclosures that comprised the dreaded “shadow inventory” should not be taken for granted in light of our current recovery either. Granted, an improving economy combined with proprietary and successful government loan modifications has put a virtual ceiling on mortgage delinquencies and Notices of Default filings; 2013 has seen the largest drop in foreclosures and 30 and 60 day late mortgage payments in six years. However, while small and getting smaller in comparison to past years, there remains a steady stream of homeowners going into default. In reaction to heightened regulatory scrutiny to ensure that proper protocols are being followed in dealing with distressed homeowners, major banks have put their thumb on the foreclosure “pause” button to ensure procedures are being followed to avoid running afoul of any potential processing errors. At some point once these institutions are confident they are meeting regulatory guidelines, foreclosure filings will resume. 

As the current recovery cycle continues thanks to heavy investor participation, a potential exit of this group could be on the horizon as real estate values continue to rise.  Clearly, smaller independent and larger institutional investors stopped housing’s downward spiral by buying up billions distressed and undervalued assets. The good news --- investor activity sustained housing while government modification and refinancing programs, lender settlements with regulatory agencies, and an improving economy kicked in to help cure the crisis. The not-so-good news:  bulk investor purchases have also contributed to shortages, which in turn are driving prices up to a point where investors won’t enjoy the strong returns they once did and could start looking elsewhere for higher yields. The steady injection of private capital has been a key ingredient to the success of our current cycle. We’re nearing a critical inflection point where the mass acquisition of property by investors that proved such a boon to the industry is now creating so much appreciation that those same investors could leave. At the end of the day there needs to be real homeowners that acquire a property with the intention of staying. I have clearly seen large samples of homes being sold by investors to a new group of investors. As the price is increased, the affordability factor has declined to the ultimate user.

In some circles, there’s an impending air of euphoria concerning the upward trajectory of this new phase of the real estate cycle with appreciating values in both residential and commercial sectors, increased purchase activity, increased construction to meet demand, and an overall new respect for the contribution housing has made to the economy. Let’s not forget a similar time ten years ago where a different type of euphoria permeated the industry leading to the now infamous “bubble and bust” phase that played a role in one of the most devastating recessions of our age.  We as an industry have learned some hard lessons. And as a result, this current period of growth has great potential to be more sustainable and fundamentally sound.  But it’s important to keep one eye on the mirror and an ear to the pavement. The issues that led to the housing collapse have not been eliminated, only contained. There are still prescriptive solutions that must be applied to truly put the housing crisis behind us for good.

Thursday, May 2, 2013

The Impact of Inventory on Both Ends of the Housing Spectrum

Inventory, Inventory, Inventory. The return of housing to better days has mainly been attributed to lower interest rates, fewer defaults and a gradually healing economy. But what has brought the biggest smile to the face of analysts and homeowners alike is steady appreciation in home values as part of this new cycle. Since the end of 2011, home values have risen over 5% nationally, and are forecast to rise at least 6% over the next five years. The increases have been much higher in many major cities. It all has to do with supply, or the lack thereof, that’s driving home values north. While everyone is encouraged to see the return of equity of home values, a protracted period of tight inventories could have a negative impact on the current cycle. Simply put, if buyers can’t afford to buy, the process stalls.

Attaining the right balance of all the ingredients that have led to the current recovery phase can be tricky. The combined result of fewer foreclosures and mortgage delinquencies combined with brisk all-cash investor activity is effectively containing the specter of a looming shadow inventory of distressed homes that had once been seen as one of the major headwinds preventing a full housing recovery. The downside of this is, of course, an overall reduction in available, affordable homes on the market.

Fortunately, those developers and investors wise enough to understand the nature of the real estate cycle foresaw the scarcity in inventory and the resulting opportunity as they brought more units online. Investors in new multifamily housing flourished in 2011 with units becoming available now, and overall construction in housing for both apartments and single family dwellings actually helped to boost the economy out of recession. We have been involved in a number of new projects in Southern California aimed at bringing affordable units to the market. Case in point: we served as a major capital partner for a 156 unit condo development in the Ventura County area that broke ground in the 3rd quarter of 2011, and the developer is currently in the second phase of development to meet demand with most of these units already pre-sold. Another project we’re involved in is a 10 unit townhome subdivision in the Tujunga community that will be bringing 10 new homeowners into that market shortly. We are also online and committed to begin a residential gated development and a Thousand Oaks home development in the area.

What’s often ignored in the inventory equation is the participation of the “move-up” buyer and having available product to meet demand. For a fully functioning housing cycle to occur there has to be an upward migration of current homeowners to larger homes to allow first-time home buyers and growing family households an opportunity to purchase at affordable prices. Of course, as the last period saw home values depreciate, the cycle stalled as homeowners found themselves held hostage by falling equity and the inability to leverage it toward a larger purchase. Today paints a different picture, as homeowners are starting to test the waters with rising home values and multiple offers on listings. Inventory now becomes a welcome problem to have at the affluent end of the housing scale. In March, homes sales over of $800,000 are up over 33% from last year in Southern California. The current housing cycle requires adequate supply for move-up buyers to continue its progress. We have positions in the affluent market as well as the primary partner in a 20 acre, 15-estate equestrian development project in the Sunland community.

Home values for entry level as well as larger homes are skyrocketing, to the delight of homeowners, potential sellers, real estate professionals affirming that for the long term, real estate is and always has been, a sound investment choice. Additional housing units coming to market to balance the supply/demand equation won’t dampen appreciating values, but should modulate increasing values just enough to allow more new buyers into the market and persuade more owners that they can locate replacement properties if they list their current home.

Tuesday, March 12, 2013

The Online Auction Process: The New Frontier for Real Estate Investors

It's a simple concept found everywhere --- volume purchases equal volume discounts.  And, during the last recessionary cycle, both GSEs and investors learned to leverage the concept to their advantage. Fannie and Freddie's pilot "REO to Rentals" program that moved thousands of distressed assets off their books through bulk sales to investors captured industry headlines in 2012. Other examples include savvy private equity firms with deep pockets sweeping up multiple foreclosures at bargain prices at courthouse auctions, as well as the FHA employing the same strategy to shed underperforming notes in bulk deals. We’re seeing that a previously underpublicized conduit for disposing of distressed assets is gaining traction among both lenders and private investors as a way of moving distressed assets in volume --- the online auction process. It comes along at a great time to continue housing’s forward momentum.

Along with other industry watchers over the past few years, I’ve been following the progress of the “shadow inventory” comprised of increasing delinquencies, rising foreclosures, and REO. Today, year- over-year mortgage delinquencies have fallen. Short sales, loan workouts, and new state laws are slowing the flow of distressed assets into the foreclosure pipeline.  The all-cash investor has emerged as the white knight rescuing lenders and servicers from their toxic REO problem. The online auction process currently serves to connect volume REO sellers and qualified volume buyers in an efficient manner to dispose of distressed assets. The auction process has shown itself indispensable in removing huge blocks of extremely nonperforming REO from lender and servicer balance sheets at steep discounts, and the online auctioneer is carving out a special niche as a new type of servicing agent to the housing industry.  As a result, sellers win by disposing of assets, and a new type of servicer solidifies its presence in the industry. But most of all, private investors have found a new way to participate in the market. Government -run bulk sales programs carried with them the expected baggage and inefficient red tape that is ultimately less-profitable to investors. Acquiring bulk assets through the auction process allows investors a faster return on their money as they can get property to market more quickly to either generate rental revenue, or flip faster for sale to take advantage of our current environment of rising equity and tight supply.

Some real estate analysts and professionals have argued investor participation at the bulk level could be counterproductive to nurturing a fully-balanced and healthy housing climate. It’s no secret that the current rise in home values is directly related to low supply of available homes for sale. The REO inventory currently moving through the online auction conduit could possibly modulate appreciation in select markets by preventing abnormal price spikes and keeping values at more affordable levels if sold on the open market. This argument doesn’t take into consideration three important factors. First, scarce inventory is mainly the result of existing homeowners still sitting on the sidelines waiting for the right moment to sell.  Second, much of the REO inventory sold via the auction channel requires substantial work to get it to market standards, and investors can leverage the capital necessary to do so. Third, many investors are following a “rent and hold” strategy with acquired properties, which fills a very important gap in housing by creating affordable single family homes rentals.

Recently, through our escrow services, we have been actively involved in the auction process by facilitating some of the back-office administration and closings for hundreds of bulk transactions. We are optimistic that the quiet yet positive impact it is having on the industry will continue to mate investors with opportunities, continue to deplete distressed inventory, and ultimately facilitate new sources of affordable housing.

Friday, February 15, 2013

The Balancing Act between Affordability and Inventory

What a difference one year makes in virtually changing the course of real estate. The specter of the shadow inventory and its predicted drag on the industry has been dispatched in a flurry of workout solutions, bulk REO to Rental strategies employed by GSEs, and the influence of all-cash investors snapping up bargains at a rapid pace. When combined with cautiously optimistic reports on the economy’s performance and improved consumer sentiment, the average American homeowner is enjoying the return of rising equity. What has not seen improvement at the same pace is the availability of affordable housing for rank and file consumers.

In today’s market, affordability is an elusive target due to the number of factors that define it. What homeowners applaud as “increasing equity” as the price of homes in their neighborhoods rise, potential buyers perceive as homes pricing themselves out of reach requiring a larger mortgage. The 30-year fixed rate mortgage benchmark is inching its way north of 3.5% as the economy improves, becoming another barrier to affordability for potential homeowners. Affordability is equally a concern for rank-and-file renters who face the never-ending cycle of rising rents, as demonstrated by the greater Los Angeles market where rents have increased by nearly 30% since 1993 while renter incomes have decreased by 6% over the same time period.

The real culprit here is not affordability, but available inventory, or rather, the lack thereof.  One of the consequences of the last cycle was a contraction in single-family and multifamily construction as developers felt the crunch of a debilitating housing downturn. Moreover, the growing numbers of foreclosures and REO created the new “shadow” inventory class that gave the perception of surplus housing units available to the market. But that same downturn created opportunities for cash investors to snap up those distressed bargains in bulk from lenders and government entities. Additionally, foreclosure prevention activity initiated on both the state and government level capped the flow of new distressed assets into the available inventory. Now with a perceived end to the housing crisis and a return to stability, the industry finds there are simply not enough housing units at reasonable prices for renters and entry-level homeowners to comfortably afford. We are currently partnering in an affordable housing condo project in Oxnard, California and can attest to the overwhelming demand we have experienced from qualified buyers unable to find any housing.

If affordability is tied to available inventory, investor participation is absolutely critical to restore equilibrium. During the darkest moments of the housing crisis, multifamily property activity was the one bright spot in a lackluster housing market providing housing for those displaced as a result of foreclosure or other relevant lifestyle shocks. Developers in the single-family sector have already begun to seize the moment of a post housing crisis with new projects. New projects require fresh sources of capital. While the “thawing” of traditional capital channels via commercial lenders is continuing, lenders should bring more to the table in terms of flexible credit conditions to support more development in both multifamily and single-family arena.

Bringing more new units to market overall should also coax more existing single-family units into the housing supply. Many potential sellers are still waiting on the sidelines waiting for prices to appreciate even further before listing their property with an agent. As prices stabilize with new inventory, sellers should be motivated to put their property on the market before values begin to level off. The principles of supply / demand economics should modulate appreciating home values in such a way to allow more buyers into the market with more homes for sale.

This market is on the verge of a breakout year, but only if more buyers gain access to the market with available inventory to meet demand. The market must create favorable conditions not only for sellers with fair home values, but also for buyers whose purchase power can afford the homes on the market.