Moving Past the Election to Keep the Momentum in the Real Estate Recovery

With the election now behind us, the country and the economy now has a clearer idea of where they're headed for the next four years. Notably absent from most of the rhetoric from this fall's campaign was a sense of what the real estate industry could look forward to. The signs of improvement in the sector emerging at the beginning of the year have now been validated as a full recovery, but the significant drop in foreclosure starts, rising equity in American households with appreciating home values, and the return of a seller’s market were seldom mentioned. Now that the dust has settled, it’s time to turn our attention back to pressing issues put on the back burner that could make or break our housing recovery.

Some of the best news for housing in 2012 is the ongoing “undistressing” of the American homeowner. Higher employment numbers, the effects of a flurry of Obama Administration housing programs initiated in 2009, a landmark $26 billion settlement between lenders and states addressing past foreclosure improprieties, and a more aggressive mortgage workout strategy executed by banks has resulted in a 6 year low in foreclosures and more borrowers staying current on mortgage payments. Short sales emerged as one of the most popular solutions to foreclosure, and made arguably the most noticeable contribution to helping distressed homeowners. Lenders lose less on a short sale than a foreclosure, and more borrowers can take advantage of short sales now with an expansion of programs that include borrowers who are current on payments. What threatens to scuttle the gains short sales have achieved is a crucial tax benefit for borrowers currently on hold. The Mortgage Debt Relief Act, which addresses the difference between the original loan amount and the actual selling price of a property in a short sale transaction being treated as taxable income, is set to expire on December 31st. The Senate passed an extension of the bill, but no further movement has occurred to keep this important benefit to borrowers intact as the nation focused on selecting its next president. This is a huge concern for the continued recovery and short-sale acceptance by lenders. Recent indications are that the “REO rental” program has not been allowed to gain momentum because lenders are realizing that the short-sale is in fact a more profitable solution and they are holding off on selling at steep discounts to institutional private buyers with the rental restriction in place.

The Responsible Homeowners Refinancing Act (RHFA) is another example of pending legislation in Congress with great potential to solidify the recovery, but finds itself stuck in a holding pattern. Approximately 12 million homeowners could benefit from the bill that would extend refinancing opportunities to Fannie and Freddie-backed mortgagees current on payments but facing negative equity or other hardships. Introduced in September, the bill has languished in Committee with no further consideration. The RHFA could be the final component needed to power a sustained cycle to stabilize the current borrower base. Congressional movement on the future of the RHFA is crucial for us to move on in the development of the cycle.

The election- season freeze impacts arguably the most sought-after player in the current cycle --- the private investor. The future increase of capital gains taxes and the extension of Bush-era tax cuts is still undecided and could have a long term effect on investor participation on sustaining a fully-rounded recovery past 2012. Two investor camps have formed – one camp which was responsible for a short- term flurry of commercial real estate investment activity in the third quarter leveraging advantages of the current tax environment, and the other camp that assumed a more conservative “wait and see” approach and backed out of the market. The future of how taxation treats investor real estate profits is a major factor that keeps investors in the commercial real estate game through this cycle, or keeps them on the sidelines. Real estate needs private capital in the game to sustain the recovery from the commercial perspective. There is also the need for a post election relaxation of lending standards and compliance allowing the pendulum to swing back towards easier access to capital.

Given the growth in the nation’s GDP recently attributed to housing, and recent findings that real estate could continue to fuel the economy’s growth regardless of the election outcome, very little priority has been given to continuing the momentum. The industry’s progress could face new headwinds impacting homeowners and investors alike without fast action from the government now that November 6th has come and gone. It’s time to move forward.

Extending the Flow of Capital to the Small Commercial Investor

Just a little over year ago, gains on the commercial real estate ("CRE") front bolstered the recovery as home prices floundered.   Industry pundits touted CRE as the white knight to lead the real estate sector out of its economic purgatory. Fast forward to the fourth quarter of 2012 and it does seem that CRE advancement may be slowing– at least for rank and file investors seeking opportunities in smaller markets or asset classes.

In 2011, Institutional investors, large private equity funds, and deep-pocket investors possessed the capital to take advantage of the higher return on commercial backed securities and acquisition of trophy properties in Class A markets.  At the time, returns on CRE deals for selected transactions could average as high as 10-12%  when compared to much lower yields from equities, treasury notes, or other traditional investment vehicles.   Lenders, extremely risk-wary of interest revenue from the residential sector, felt more comfortable in a commercial sector that enjoyed solid price appreciation and had stronger underwriting procedures in place than its residential counterpart. Lender purse strings particularly favored institutional and large investors because of the size of the prime asset class and prime location.

This “love affair” between big lenders and big investors has barred small investors from the rally. Assets with great growth potential have been cherry picked from top markets,  forcing investors to scour smaller markets for riskier assets. The upside is that investors with a higher risk tolerance are finding some tremendous opportunities off the beaten path.  Unfortunately, lenders don’t see the same potential nor share the same risk tolerance as these investors. And this represents the current dysfunction in the CRE sector and is preventing it from moving forward at a healthier pace:  lack of available capital for commercial acquisitions in new markets as well as stringent credit requirements and guarantees by borrowers.  Without available capital, the once robust expansion of CRE is beginning  to cool down and exclude a significant sector of investors from finding the  financing it needs.

Compounding the issue is the billions of dollars in commercial debt maturing in 2012 for loans originated in 2007 and bundled into securities.  Major lenders, faced with the potential of future losses on old debt and gun-shy of financing assets in riskier markets, have constrained the flow of capital necessary for new acquisitions and thus contributed to the tepid CRE performance in 2012.

There cannot be a balanced recovery in real estate unless the imbalance in CRE capital availability that disfavors small investors is corrected.  In light of current lender sentiment, small investors would be wise to explore alternative debt structuring solutions. The real cure, however, is for traditional capital sources to extend the same underwriting latitude and trust to small investors as it does to their larger siblings. Recent trends indicate a thaw could be in the works for commercial lenders to do just that:

one of the unexpected by-products of the most recent round of Federal Reserve Quantitative Easing has created a new demand  for commercial – backed mortgage securities. To bring more CMBS product to market, lenders will need a supply of new commercial mortgages to collateralize.  This means less- expensive loans, less-restrictive underwriting guidelines and a willingness to lend on commercial properties in new geographic regions.

Real Estate’s current growth will be guaranteed a more sustained upward cycle with a stronger contribution from the commercial real estate sector. That can only happen by increasing the flow of capital to a larger cross-section of investors and product type.

Emerging Inflection Points as Real Estate Continues Down the Road to Recovery

As results continue to roll in on the state of real estate, there’s good news on all fronts.   Few now doubt the return of stability to housing.  Here’s a short list of notable gains in the past twelve month period:

• A dramatic drop in foreclosure starts
• Lower REO inventories and a shrinking "shadow inventory"
• The exodus of the all-cash buyer having been replaced by the return of the average consumer
• Increased demand (and revenue) for multi-family and single family rental units

 The most promising news is that the appreciation in home values is so solid that even the S&P / Case Shiller Home Price Index has now officially acknowledged it in its recent reports.

 

These are all encouraging developments that, barring significant setbacks in other areas of the economy (job growth, GDP) should sustain the recovery. It’s important, however, to watch for upcoming inflection points in isolated parts of the industry where progress in one sector has direct impact on another sector.  The recent trend of rising home prices is a good case in point.  

Multiple factors contribute to the current low supply of housing product, including reduced inventories of distressed properties as a result of bulk purchases, lower REO inventories, and sellers sitting on the sidelines.  As prices to continue to rise, watch for the inflection point when more sellers list properties.  Potential sellers are not just playing a wait-and-see game for a better return on their investment. Despite the current wave of loan modifications and refinancing opportunities, a significant cross-section of homeowners still owes more than their homes are worth.  Appreciating home values combined with principal reductions, loan modifications, refinancing, and other borrower relief programs should bring about a tipping point that will introduce more homes into the sales pipeline.  The perception that prices are rising could be enough to coax homeowners with entry-level homes to bring them to market to fill that important affordable niche of homes.

Short sales present another interesting scenario of an upcoming inflection point for the disposition of distressed assets.   After our many years of experience as well as lobbying with local politicians, short sales have come of age in 2012, finally gaining full support of lenders and servicers. With increased lender incentives, additional regulatory guidelines streamlining the process, limits on junior lien indebtedness and allowing even more borrowers to qualify, short sales are helping thousands to avoid foreclosure and reduce the flow of properties back onto bank and GSE balance sheets.   The inflection point: when the discount to lenders for selling off a bank-owned property matches or exceeds the discount for short selling the property before it’s foreclosed.  Recent data shows a margin of 3% between losses lenders incurred for foreclosures (25%) and short sales (22%), and the gap is narrowing.   However, when all is said and done, if REO enables lenders to start recouping losses faster than do short sales, the cycle could turn again.

Renting versus buying in today’s environment is probably the best-known example as an inflection point in today’s market.  Given the strong demand for housing generated by displaced families (a result of foreclosure or short sales) and new households that didn’t meet lenders’ strict underwriting standards to qualify for a mortgage, the rental market boomed.  Owning a home seemed improbable, if not impossible.  But rents have increased at such a pace that now, buying a home for many consumers pays off only after three years of ownership.

The recurring impact of home prices on all of these scenarios creates potential inflection points. 

 

If all factors come to play to nurture an environment that allows for the measured, consistent, and healthyappreciationof home values, the real estate secor should enjoy a long cycle of positive growth. It's clear that the dircion of home values has a powerful impact on affecting change in number of critical sectors in the real estate industry.

Let the Housing Cycle Run its Course - Without the Training Wheels

The housing recovery is in an interesting stage. Even as more reports affirm a positive direction for the real estate recovery cycle, the push for additional government support is gaining momentum. Granted, intentions are noble, however, additional activity to assist the cycle could, in reality, bring headwinds to slow its progress.

What we’ve seen so far in 2012 is a dramatic reduction in mortgage delinquencies and foreclosures compared to 2011, due in part to a host of government programs and legislation already implemented throughout the mortgage crisis. Government influence began with the Obama Administration’s “Home Affordable” program suite of cures providing short sale incentives, loan modification help, and refinancing relief for homeowners in negative equity -- known as HAFA, HAMP, and HARP, respectively, and culminated with a landmark $25 billion settlement between individual states and big lenders providing relief on the state level.

Additionally, states have enacted their own strategies to slow the progression of distressed homeowners into the foreclosure pipeline. California being a case in point with the recent passage of its “Homeowners’ Bill of Rights” which affords homeowners increased protection from foreclosure above and beyond actions taken on a national scale. These steps have not only prevented more borrowers from reaching the foreclosure stage, they’ve also served to shrink the flow of distressed homes into the “shadow inventory” of residential housing, resulting in less distressed properties depressing overall home values. These are great developments. Not only are fewer people losing their homes, existing homeowners are seeing the value in their homes begin to rise and buyers are returning to a market now struggling to keep up with demand. Not all markets have seen this phenomenon but it is clearly becoming more frequent in most major markets.

Bottom line: existing programs to help borrowers, combined with small gains in the overall economy, are proving sufficient to support a healthy recovery. Additional intervention at this point could prove costly. Case in point: more widespread application of principal reductions at the GSE level striking a resonant chord with consumers, politicians, and the media, comes at a taxpayer cost and could drive private investors out of the market. Recent analysis from the FHFA, the conservator for Fannie Mae and Freddie Mac estimates principal reductions would prevent $1.7 billion in defaults, but cost taxpayers $2.1 billion in implementation and incentive payouts.

At the local level, recent Eminent Domain proposals allow municipalities to purchase loans at “fair market value” and pass on the savings in the terms of principal reductions. Championed by the newly- bankrupt California city of San Bernardino as a way to protect its distressed homeowner base and stop the hemorrhaging of tax revenue, if implemented; these plans could ultimately incur significant losses for private investors in securities collateralized by any of these mortgages. Moreover, principal reductions through Eminent Domain or at the GSE level provide little backstop for losses on homeowners who simply cannot make their mortgage payments.

Future prescriptive actions by the government could only serve to continue taxpayer participation in the recovery, prolong the recovery, or both. Where the housing sector can benefit, however, is by lenders playing a larger role. Borrowers in 2012 understand the responsibilities (and consequences) of a mortgage payment better than their predecessors of the previous housing cycle, and as such represent a better credit risk. It’s time for lenders to relax underwriting guidelines and qualify more borrowers for loans. In addition, while lenders have made significant strides in working with delinquent borrowers, they can do more to streamline the short sale process to dispose of properties before they come up for auction or end up contributing to an REO inventory.

Government has proven itself a strong ally in breathing life into the housing cycle. It’s now time for the cycle to run its natural course. The fundamentals are in place for it to succeed.

The Short Tunnel for Real Estate's Recovery

The overused "light at the end of the tunnel" symbolizing the arrival of the real estate recovery may just have gained some credibility as we enter the last half of 2012.  Or at the very least, the tunnel's gotten much shorter.  The guarded optimism that the downward cycle is over is being supported by some very encouraging news on a number of different fronts. While it’s still premature to proclaim the official demise of the housing crisis, encouraging trends developing over the first six months of the year may portend overall good news for the real estate industry for the last six months of the year.

A housing market described so often as distressed for the past four years is currently getting relief that is constant, sustained, and showing measurable signs it’s providing a cure.  Predictions that lenders would ramp up foreclosures at a rapid scale in 2012 as a result of a landmark settlement with states simply haven’t materialized.  Aggregate foreclosure starts, especially in non-judicial states, dropped over 18% on an annual basis.  The widespread acceptance of short sales by both lenders and borrowers have served a dual purpose in keeping borrowers off the foreclosure rolls and preventing properties from ending up as REO on lenders’ balance sheets.  Moreover, the distressed borrower of 2012 is more qualified, educated and proactive than in years’ past to take advantage of lender solicitations and government programs to modify their loans.  As a result, mortgage delinquencies are at all-time lows, and more borrowers are avoiding Notices of Default.

The non-distressed sector provides some of the best signs of a sustained recovery as well.  In short, buyers have returned.  When bargain-price homes weren’t enough to jumpstart sales, record-low interest rates enticed buyers back to the market.  In fact, selected markets have even seen the return of multiple offers on properties, and the scarcity of housing product is contributing to modest appreciation of home values in selected areas.  We are certainly experiencing this market improvement in our immediate area in the western San Fernando Valley and the Westside of Los Angeles.  In a direct parallel to the distressed borrower of 2012, the prospective homebuyer of 2012 is better prepared for the responsibility of a long-term mortgage commitment and making more prudent choices regarding what they can afford and the right type of loan program to finance the purchase.

Investors have reason to smile as well as they furnish housing for a specific niche of the market not able to take advantage of the aforementioned buying market.  Today’s rental market is booming, generating strong returns for both multi-family and single-family property investors.  The forward-thinking all-cash buyer of SFR bargains in 2010 and 2011 foresaw the environment would be more conducive to generating revenue through renting as opposed to flipping. This strategy has been extremely popular in 2012.  Moreover, the slowdown in new apartment construction during the height of the housing crisis paved the way for a shortage of available units now that has brought back demand.  Low vacancy rates and higher rents prevail.  As a welcome footnote, new building starts and permits for new construction are on the rise to feed the appetite for new rental units.

Yes, for all practical purposes, it appears that real estate’s recovery has begun.  But at best, it is a fragile recovery that can be derailed by any new bumps in the economy.  Job and GDP growth, key metrics indicating economic stability, have improved but at tepid pace.  And a rash of recent near-defaults of foreign economies poses a lurking threat to ours.  Any unexpected economic shocks caused by unemployment, poor retail performance, European recessions, or any combination of these factors will serve to undermine real estate’s stronger performance this year.  The good news is that after six months of shrinking foreclosures, lower interest rates, more buyers returning to the market, rising rents, contracting REO inventories, and new construction activity, we’re significantly through the tunnel. The positive momentum of the first two quarters in 2012 may just be enough to propel real estate through any new headwinds it could encounter for the rest of the year.  

The Truth Behind the Numbers on Declining Foreclosures

Recent first quarter research from numerous sources supports industry sentiment that the bottom of the current real estate cycle has been reached, and the new cycle has begun. In an unlikely alliance, government, the private sector, and even the media have all identified the unrelenting wave of foreclosures as the source of the problem and directed all of their efforts to hunting down the beast and killing it. Based on recent numbers, the foreclosure crisis could appear to be contained. According to the numbers:

• Overall foreclosure filings are down 19% -- their lowest level in four years.

• The volume of “pre-foreclosure” sales hit a record 109,593 transactions as homeowners and banks adopted short sales as a preemptive strike to losing their homes.

• Analysts monitoring mortgage delinquency rates, the accepted metric predicting foreclosure volume, are reporting continuing month-over-month declines in delinquencies.

• Credit-reporting agencies, well known for keeping falling FICO scores top of mind, are now proud to report that consumers shed mortgage debt to the tune of $350 billion over the last year and are continuing to trim the fat.

• The Obama Administration’s assault on the housing crisis through no less than 12 separate programs since 2009 have provided millions of distressed homeowners permanent modifications, refinancing opportunities, forbearances, short sale incentives and even in some cases, mortgage forgiveness.

While these are impressive metrics, the real estate industry would be wise to season its interpretation of the data with a dose of skeptical pragmatism. Too much emphasis is being placed on surveys and reports to validate a recovery instead of taking a hard look at what is transpiring on a day-by-day and case-by-case. Albeit mitigated, the foreclosure crisis is still very much alive and well.

When the pundits are silenced, and the analysts are deprived of their spreadsheets, what remains is a staggering number of homeowners, over 3.5 million, having lost their homes since 2008. No metric accurately represents this devastation on families, their surrounding communities, and the overall economy. Granted, foreclosure filings are at record low levels and continue to fall. Nevertheless, nearly 200,000 new borrowers received Notices of Default during the first quarter of 2012.

Looking at the crisis from the lender perspective, the numbers don’t fully portray the battle lenders face to minimize losses. While data publicizing lower defaults points to a possible end to the drag of REO on lender balance sheets, that end is years away and the current cost of loss mitigation has proven to be expensive. Case in point: recent settlements with individual states over foreclosure improprieties cost lenders $25 billion, and still provide loopholes for more claims. Tougher standards implemented to avoid lax processing of foreclosure filings require more auditing and personnel to implement. And clearly, lenders have been forced to accept larger losses on REOs and to embrace short sales to prevent further hemorrhaging. In short, the numbers use a wide brush to paint a possible outcome of the foreclosure crisis, but ignore the present reality that homes are still being lost today.


A more holistic approach is needed to properly measure the effectiveness of the war on foreclosures. To be fair, the real estate industry and consumers alike should feel real hope as a result of data showing a consistent downward trend in new foreclosures quarter after quarter. The housing industry is at its strongest place in three years and is getting stronger. However, we shouldn’t allow backwards-looking or forward-projecting reports distract us from the ever-present reality of the severity of the foreclosure crisis. Conditions are improving, but the battle is far from over. Success is measured not by aggregate numbers, but by one homeowner at a time who avoids a foreclosure.

How Reducing Foreclosure Inventories Impact the Real Estate Recovery

Nearly halfway through 2012, the real estate industry is making headway in finding prescriptive solutions to return to some state of stability. An improving economy and increased government involvement in modulating anti-foreclosure programs has caused many real estate pundits to declare the housing crisis near its end. And while these factors play a pivotal role in restoring equilibrium to the market, what could be the most significant indication that the” light at the end of the tunnel” is not just a myth is the slow and steady erosion of the inventory of distressed properties on the market.

It’s no secret that the saturation of distressed assets on the market has driven home values down, underwriting standards for new mortgages higher, and prospective buyers out of the market during the first years of the housing downturn. As the dust of 2011 settled, however, we saw the emergence of certain forces continuing into this year that are helping to shrink the numbers of distressed assets. Lower distressed home values gave rise to the all-cash investor with a voracious appetite and deep pockets for bargains. The government even stole a page from the investor playbook by piloting a bulk REO to Rentals program in 2012. Investors are enjoying healthy returns as a result of the popularity of single-family residential housing over multifamily housing, and are on the lookout for more deals.

Ironically, the banks themselves proved the next major force that emerged as a key factor in reducing distressed inventories. Or more accurately stated -- a shift in bank policy toward previously-disdained workout solutions. Banks finally did the math that everyone else did and realized it was cheaper to accept a lower value through short sales than let a property languish on its asset sheets. Banks not only embraced short sales, they proactively reached out to distressed borrowers to consider short sales as a way out with huge incentives in store for them if they sold. Moreover, other workout solutions such as deed-in-lieu or “cash-for-keys” programs gained favor with lenders as they sought more drastic solutions to reduce existing inventories. One lender is even experimenting with a long-overdue twist to the deed-in-lieu solution by taking back title and renting the property back to the distressed homeowner at a rate lower than their mortgage payment.

The combination of private investors and lender initiatives, with a healthy dash of regulatory pressure has resulted in such an alarming decrease in housing inventory that values on non-distressed properties have not only bottomed out, but risen in select markets. And while not nearly approaching the volume of the housing boom in the last decade, multiple offers on properties have returned. Shrinking foreclosure inventories coupled with other key indicators such as falling mortgage delinquencies and more promising employment statistics seem to reflect a healthier real estate sector.

What does this mean for real estate professionals? Agents, brokers, and other ancillary real estate service providers should see increased activity compared to 2010 and 2011, but to make the most of new opportunities must be able to handle complex transactions involving distressed assets. Any investors that have been sitting on the fence waiting for a true bottom to hit to find even more bargains may miss their window of opportunity if they don’t throw their hat into the ring now as the availability of discounted properties as investment vehicles will become harder to find. And as conditions improve, more sellers will be enticed to bring their homes to market demanding (and holding out for) a higher asking price. While a renewed sellers’ market with stronger pricing would of course be the best scenario for housing, investors will have to shift their strategy to take advantage of the market.

There’s indeed reason for renewed optimism that the worst of the real estate downturn is in the rear view mirror. The road ahead for real estate should prove less treacherous in the next cycle if travelled with a cautious strategy that includes finding more ways to liquidate distressed assets from the marketplace.