NAMED THE NATION’S BEST NEWSLETTER BY NAREE
JULY 2018 VOL 12 ISSUE 7
MY TAKE AN ATTORNEY’S GUIDE TO REAL ESTATE INVESTING BY KEVIN KIM P13 CLIENT CORNER DATA-DRIVEN PROPERTY STORIES ENDING IN A PERFECT MATCH FOR REALTORS BY ROY DEKEL P18
BIG DATA SANDBOX THE HOME AFFORDABILITY TREADMILL P26 SPOTLIGHT BOISE HOUSING MARKET BURSTING AT THE SEAMS P20
Contents
FEATURED ARTICLE
P1 THE RETURN OF RISK: SUBPRIME SNEAKING BACK
P1
Subprime financing is on the upswing, and for a lot of people that’s a problem. The mortgage meltdown is widely identified with subprime lending so why should the return of such loans be welcomed? A look at why many claim this brand of subprime is different and if the data is supporting that claim.
P13 AN ATTORNEY’S GUIDE TO REAL ESTATE INVESTING
Real estate investments have become an attractive alternative to investing in traditional investments such as stocks, bonds and mutual funds. In fact, it has become a significant method to build wealth for generations. In this article, attorney Kevin Kim of the Geraci Law Firm explores several of the opportunities that real estate investment provides, along with the pitfalls to expect while investing. SetSchedule’s multi-patented matching engine for real estate agents leverages AI- powered predictive data, insider insights and automated marketing software tools to deliver the right opportunities, appointments and valuable insights to close deals, writes CEO Roy Dekel. Dekel explains how automated valuation model (AVM) data integrated into the company’s consumer-facing application streamlines the process of matching consumers with agents. P18 CLIENT CORNER: DATA-DRIVEN PROPERTY STORIES ENDING IN A PERFECT MATCH FOR REALTORS
P13
P20 SPOTLIGHT: BOISE HOUSING MARKET BURSTING AT THE SEAMS
Crowned by Forbes as America’s fastest-growing city for 2018, Boise is enjoying many of the benefits of rapid population growth — rock-bottom unemployment, economic diversity, and skyrocketing home prices. But local experts are also beginning to question how fast is too fast when it comes to population, economic and housing market growth.
P18
P20
P26 BIG DATA SANDBOX: THE HOME AFFORDABILITY TREADMILL
Annual home price appreciation slowed to less than 5 percent in the second quarter of 2018 — down from more than 9 percent a year ago — providing some hope that prospective buyers could gain ground when it comes to home affordability. But rising interest rates and continued sluggish wage growth meant that U.S. home affordability dropped to its worst level in nearly 10 years.
P26
HOUSINGNEWS REPORT
SECTION TITLE
LEAD ARTICLE
The Return of Risk: Subprime Sneaking Back
BY PETER G. MILLER, STAFF WRITER
Subprime financing is on the upswing, and for a lot of people that’s a problem. The mortgage meltdown is widely identified with subprime lending so why should the return of such loans be welcomed? “Riskier U.S. mortgages are creeping back into the bond market again,” reported Bloomberg in May. “The
loans in question are nowhere near the toxic mortgages that brought down the financial system last decade. But they’re being made to people with lower credit scores and with more debt relative to their income.” Average wage earners purchasing a home at the U.S. median sales price of $245,000 in Q2 2018 would
need to spend 31.2 percent of gross income on the monthly house payment for that home — assuming 3 percent down and including mortgage, property taxes, and insurance, according to the ATTOM Data Solutions Q2 2018 U.S. Home Affordability Report.
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U.S. HOME AFFORDABILITY TRENDS
PCT OF ANNUALIZED WAGES TO BUY MEDIAN-PRICED HOME
AFFORDABILITY INDEX
180
50.0%
45.0%
160
40.0%
140
35.0%
120
30.0%
100
25.5%
80
20.0%
60
15.0%
40
10.0%
20
5.0%
0.0%
0
That 31.2 percent of average wages needed to purchase a median-priced home in the second quarter of 2018 is the highest in nearly 10 years since Q4 2008, when the share of income needed to buy was 34.3 percent. What was previously known as subprime is now increasingly branded as nonprime to differentiate it from past loan offerings. But whatever it’s called, why is subprime returning? Isn’t the economy doing well with little unemployment and strong numbers on Wall Street? If subprime is back, will we see the return of the old shortcuts and abuses? Or something different? In just 10 years the housing market has gone from bust to boom, a transition of massive proportions. Home prices are rising just about everywhere, inventory is in short supply, and multiple offers are as common as crabgrass. Most Americans believe the good news will continue.
Gallup reported in May that 64 percent of Americans expect local home prices to be higher a year from now. “That is up nine percentage points in the past two years,” said the polling company, “and is the highest Gallup has measured since the emergence of the housing bubble in the mid-2000s.” Yet despite such public expressions of confidence, the reality is that many potential borrowers can’t crack the application code. The Qualified Mortgage (QM) standards can be tough and inflexible, especially for borrowers with stalled incomes and mounting debts. There are few places for them to turn. As Mike Fratantoni, chief economist with the Mortgage Bankers Association, explains, 98 to 99 percent of all loans now originated are QMs. It doesn’t have to be this way. Not only are there QM loans, lenders are also allowed to originate non-QM
financing such as jumbo mortgages and nonprime financing. Nonprime loans provide a path to mortgage financing for borrowers hobbled with low credit scores, debt issues and other concerns, but whom some lenders consider to still be good mortgage risks. Are Credit Standards Too Tight? The typical credit score for a closed loan was 723 in April 2018 according to Ellie Mae, down from 745 in April 2012. In either case these are great numbers, evidence of solid credit. lending standards are just too tight. The Urban Institute (UI) found “that the number of borrowers with FICO scores above 700 shrank by 7.5 percent from 2001 to 2014; Borrowers with FICOs between 660 and 700 shrank 30 percent; and those with FICOs below 660 shrank 77 percent.” Such high numbers may also be evidence of something else, that
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The numbers tell us that mortgage borrowing has become increasingly restricted to the credit elite. For some that’s a problem because many applicants who would have gotten mortgage financing in the past no longer quality. “The mortgage market operated under reasonable standards in 2001,” said the Urban Institute in a separate report. “Using the standards from that year for comparison, we know that the increased reluctance to lend to borrowers with less-than-perfect credit killed about 6.3 million mortgages between 2009 and 2015. That’s too many families missing out on homeownership.” The tightening credit standards from 2009 to 2015 demonstrate that the mortgage industry became extremely risk-averse during that time period in reaction to the foreclosures and financial fallout from the high-risk mortgages originated in the previous five years. Foreclosure rates by loan vintage offer more evidence of the risk-averse nature of loan originators immediately following the foreclosure and financial crisis in 2008. More than 1 percent of still-open loans originated between 2005 and 2008 are in some stage of foreclosure, while the foreclosure rate on 2004 vintage loans is 0.85 percent — still about twice the long- term average, according to ATTOM Data Solutions. But foreclosure rates on loan vintages from 2010 onward are all below the long-term average, with particularly low rates on 2011, 2012 and 2013
vintages. Foreclosure rates jumped 41 percent for 2014 vintage loans but were still below the long-term average. More on what caused the 2014 increase later. April 2018 figures from Ellie Mae show that borrowers with credit scores below 650 represented roughly 10 percent of the purchase market and 15 percent of refis. Those with scores below 600 were less than 1 percent of purchases and less than 5 percent of the refi market. more than any other factor — have increased demand and pushed up home prices. Yet while mortgage rates slumped during the past decade, ownership costs actually increased. In 2008 the typical existing home sold for $116,039 and the annual interest rate stood at 6.03 percent. The Growth of Debt Low mortgage rates — arguably
With 5 percent down ($5,801.95), a borrower could finance $110,217 and face a monthly cost for principal and interest of $662.93. The typical existing home sold for $257,900 in April 2018, according to the National Association of Realtors (NAR), the 74th straight month of year-over-year gains. With 5 percent down ($12,895) the loan amount will be $245,005. At 4.45 percent the principal and interest cost per month is $1,241.40 — almost twice as much as the 6 percent borrower from 2008. Borrowers are increasingly tapped out. It’s not just that home values and interest rates have risen in tandem, it’s that other major debts are also growing. The Federal Reserve Bank of New York says recurring debt levels soared between 2008 and the end of 2017.
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U.S. FORECLOSURE RATES BY LOAN VINTAGE
SHARE OF ACTIVE LOANS IN FORECLOSURE
FORECLOSURE RATE - ALL LOAN VINTAGES
“We know there are many unconventional borrowers out there who are being held back from getting a home loan because they don’t fit the typical borrower profile. Many potential homebuyers have great income, for example, but because they are self-employed or do not have consistent paychecks, many lenders are turning them down.”
1.60%
1.40%
1.20%
1.00%
0.80%
0.60%
0.40%
PARKES DIBBLE DIRECTOR OF MORTGAGE PRODUCT INNOVATION EMBRACE HOME LOANS
0.20%
0.00%
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
• Student debt grew from $580 billion to $1.38 trillion. The total now exceeds $1.5 trillion.
weekly wages have increased just 13 percent during the same period, according to ATTOM. Combine growing debt levels with lagging incomes and rigid QM debt-to- income (DTI) limits and the result is that borrowers off even by a few dollars can’t get financing. explains real estate columnist Jack Guttentag, professor emeritus of finance at the Wharton School of the University of Pennsylvania, “the loan does not qualify, even if the borrower is putting 40 percent down and has a perfect credit record. The borrower, in this case, would have to go to a non- qualified mortgage lender.” The Nonprime Alternative There’s no standard definition for such terms as subprime, nonprime or near-prime . It’s not just a credit score of 550, 600 or 620. The Consumer Financial Protection Bureau (CFPB) If the borrower’s debt-to-income ratio is 44 percent instead of 43 percent,
says that a subprime loan is “generally a loan that is meant to be offered to prospective borrowers with impaired credit records. The higher interest rate is intended to compensate the lender for accepting the greater risk in lending to such borrowers.” In reality nonprime status can be triggered by a variety of factors. Borrowers may find they do not qualify for prime financing because their debt payments are too high (DTI issues), they lack reserves, the property does not provide enough security for the loan (LTV concerns), or their paperwork does not meet the usual standards — a particular problem for the self- employed and small business owners. “We know there are many unconventional borrowers out there who are being held back from getting a home loan because they don’t fit the typical borrower profile,” said Parkes Dibble, director of mortgage product innovation with Embrace Home Loans.
• Auto debt rose from $810 billion to $1.22 billion.
• Total non-housing debt went from $2.71 trillion to $3.82 trillion.
While monthly costs have been rising, incomes are largely flat. Real median household income in 1999 was $58,665 according to the Census Bureau. Despite declining unemployment levels, the figure rose to only $59,039 in 2016, a bump of just a few hundred dollars over 17 years. And while wages have increased more substantially on a percentage basis over the last five years — thanks to a sharp drop in average wages in the wake of the Great Recession — they have still been far outpaced by increases in home prices. Since bottoming out in Q1 2012, median home prices nationwide have increased 75 percent while average
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“Many potential homebuyers have great income, for example, but because they are self-employed or do not have consistent paychecks, many lenders are turning them down.” Nonprime loans do not fit into the usual financing pattern, but that’s okay: a lot of potential borrowers will not qualify under traditional standards, not because they have weak credit — though that’s plainly the case with some — but because the economy itself is in transition.
people work and earn income,” says Fannie Mae, “the inclusion of gig worker income for mortgage underwriting should not be overlooked. Borrowers with a sufficient income history that fit within investors’ guidelines are being served today, but a majority of lenders say that it is difficult to underwrite a mortgage loan with gig economy income due to its instability and unpredictability. This very nature of gig economy income makes it difficult to meet investor requirements, although most lenders believe that the current underwriting standards for self- employed borrowers are about right.”
A catch — a big catch — is that someone with woeful credit today might actually be a good risk. The Smiths may have had excellent credit, but then their employer failed and there was that auto accident. Suddenly the Smiths have low credit scores. Should we exclude the Smiths from the mortgage marketplace? The real answer is that you have to know your borrower; credit scores and data points may not tell the whole story. While a lot of attention has been given to the use of automation and artificial intelligence for mortgage underwriting, that’s not the approach used in some nonprime programs. “At the present time we don’t view any AI programs robust enough to handle the intricacies of nonprime loans,” says Will Fisher, senior vice president of sales & marketing with Citadel Servicing Corporation. “Additionally, if
“Given the growth of the gig economy and its impact on how self-employed
“As subprime grew, eyes were taken off of the automated underwriting systems decisioning, which only exacerbated the problems of the financial crisis.”
WILL FISHER SENIOR VICE PRESIDENT OF SALES & MARKETING CITADEL SERVICING CORPORATION
U.S. HOME PRICE GROWTH VS. WAGE GROWTH
ANNUAL HOME PRICE APPRECIATION
ANNUAL WAGE GROWTH
20% 15% 10% 5% 0% -5% -10% -15% -20% -25%
SOURCES: ATTOM DATA SOLUTIONS, BUREAU OF LABOR STATISTICS
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you look at the past, lenders tried to automate subprime lending only to find that individuals were able to game the software and fund bad loans. As subprime grew, eyes were taken off of the automated underwriting systems decisioning, which only exacerbated the problems of the financial crisis. “At CSC,” he continued, “we hand underwrite every loan that comes through. Because of our systems and processes, we’ve scaled far larger than our competition. In the future there may be opportunities for AI to play a role in nonprime mortgage lending, possibly in the lower-risk trenches.” Carrington Mortgage Holdings, in an interview with DS News. “They don’t go into an automated underwriting system and let the system crunch out an approval or denial of the loan. We have very highly trained individuals who look at the borrower’s whole profile for this process. That obviously includes a thorough review of their financial situation, too.” Right now nonprime activity is just a small part of the overall mortgage marketplace, but that may be changing. Tom Schopflocher and Jeremy Schneider with S&P Global Ratings explained in a December report that “because not everyone is eligible for a QM loan, some would-be homeowners have been unable to get conventional financing because they can’t or don’t provide standard documentation (e.g., W-2s) or because they have recently experienced a credit event. The demand from those who fall “These loans are manually underwritten,” said Rick Sharga, executive vice president with
outside the conventional credit box has created a niche market for lenders prepared to provide non-QM loans.” Qualified mortgages include popular products such as FHA, VA and conforming loans as well as certain portfolio mortgages. Done right, the QM lender is virtually immune to lawsuits. Done right, QMs can also include subprime financing. “The Dodd-Frank Act,” says the CFPB, “does not prohibit high-cost mortgages from receiving qualified mortgage status. While the statute imposes a points and fees limit on qualified mortgages (3 percent, generally) that effectively prohibits loans that trigger the high-cost mortgage points and fee threshold from receiving qualified mortgage status, it does not impose an annual percentage rate limit on qualified mortgages. Therefore, nothing in the statute prohibits a creditor from making a loan with a very high interest
rate such that the loan is a high-cost mortgage while still meeting the criteria for a qualified mortgage.”
“Where the consumer has an acceptable debt-to-income ratio
calculated in accordance with qualified mortgage underwriting rules,” added the CFPB, “there is no logical reason to exclude the loan from the definition of a qualified mortgage.” Even though some subprime financing can be a Qualified Mortgage, such financing often makes more sense as a non-QM product. For lenders non-QM financing can mean more flexibility and higher rates but also more liability exposure. Foreclosure Fissures The massive foreclosure glut that took place after the mortgage meltdown has become an increasingly distant memory. Measures to drive risk out of
MAY 2018 FORECLOSURE STARTS BY METRO YOY PCT CHANGE IN FORECLOSURE STARTS
-275%
-275%
CLICK HERE TO VIEW INTERACTIVE VISUAL
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U.S. FHA FORECLOSURE RATES BY LOAN VINTAGE
“There’s ample research that suggests loans issued to otherwise qualified borrowers who make a low down payment don’t perform significantly worse than those issued to borrowers who make higher down payments. That said, common sense, fundamental underwriting practices suggest that if there’s a risk in one part of a borrower’s profile, the lender needs to offset that risk elsewhere.”
SHARE OF ACTIVE FHA LOANS IN FORECLOSURE
FHA FORECLOSURE RATE - ALL LOAN VINTAGES
3.00%
2.50%
2.00%
1.50%
1.00%
RICK SHARGA EXECUTIVE VICE PRESIDENT CARRINGTON MORTGAGE HOLDINGS
0.50%
0.00%
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
the marketplace — the Ability-to-Repay rule and Dodd-Frank in general — have been successful. Stark foreclosure headlines have gone away. Rising home values and low mortgage rates have allowed owners in financial trouble to largely avoid foreclosure by simply selling while less risk has brought more investors into the marketplace, thus holding down rates. However there are some early signs that gradually increasing risk introduced in mortgage originations is resulting in higher foreclosure rates — particularly on lower down payment, lower credit score loans such as those backed by FHA. The previously mentioned 41 percent increase in the foreclosure rate on 2014 vintage loans compared to 2013 vintage loans was driven largely by a 53 percent jump in 2014 vintage foreclosure rates for FHA-backed loans to 1.28 percent. That’s well above the long-term average of 0.96 percent for all FHA loan vintages,
according to ATTOM Data Solutions. Despite the increase, the 1.28 percent foreclosure rate for 2014 vintage FHA loans is still less than half the peak foreclosure rate of 2.62 percent on FHA loans originated in 2007. The uptick in foreclosure rates is resulting in rising foreclosure numbers, even in some red-hot real estate markets. Foreclosure starts increased from a year ago in 43 percent of the 219 metropolitan statistical areas tracked by ATTOM Data Solutions in May, including Houston, Texas (up 153 percent from a year ago); Los Angeles, California (up 14 percent); Miami, Florida (up 4 percent); Dallas- Fort Worth, Texas (up 46 percent); and Atlanta, Georgia (up 7 percent). Are these foreclosure fissures an early sign of a return to the massive foreclosure levels which followed the mortgage crash?
“There’s ample research that suggests loans issued to otherwise qualified borrowers who make a low down payment don’t perform significantly worse than those issued to borrowers who make higher down payments,” he said. “That said, common sense, fundamental underwriting practices suggest that if there’s a risk in one part of a borrower’s profile, the lender needs to offset that risk elsewhere. So a borrower applying for a loan with a 3 percent down payment probably needs to have an excellent credit score, three to six months of cash reserves, a strong employment record, and a reasonably low debt-to-income (DTI) ratio. And the lender will almost certainly require private mortgage insurance (PMI) on the loan, which will protect the lender in the event of a default.” The Nonprime Mortgage Marketplace If there was one unmistakable outcome which arose from the financial crisis
Sharga with Carrington doesn’t think so.
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U.S. MEDIAN DOWN PAYMENT TRENDS
MEDIAN DOWN PAYMENT
MEDIAN DOWN PAYMENT PCT OF MEDIAN HOME PRICE
10.0%
$20,000
9.0%
$18,000
8.0%
$16,000
7.0%
$14,000
6.0%
$12,000
5.0%
$10,000
4.0%
$8,000
3.0%
$6,000
2.0%
$4,000
1.0%
$2,000
0.0%
$0
For borrowers, the idea is to get financing today, re-establish credit, hope that local home values go up, and then refinance to a lower rate and smaller monthly cost. It’s not an easy path and it requires commitment. The Lenders’ Achilles Heel Mortgage originators have an Achilles Heel when it comes to identifying risk, both for prime and subprime borrowers, according to one industry expert who asked not to be identified in this article. The Achilles Heel ties back to a repercussion from the last housing downturn — exponentially longer foreclosure timelines that vary drastically from state to state and even county to county — making it difficult to accurately identify the presence and proper timestamp of a previous foreclosure action against a prospective borrower now applying for a new loan.
it was the establishment of a new mortgage marketplace. Going forward, said the government, lenders were welcome to originate a wide range of residential mortgages, including nonprime financing. What isn’t allowed are loans with insufficient underwriting and abusive terms. Even with passage this year of the Dodd- Frank fix, risk-reducing mortgage reforms remain firmly in place. In fact, Barney Frank, co-author of the landmark legislation, told CNBC that “it does not in any way weaken the regulations we put in there for the largest banks or that were there to prevent the kind of crisis we had 10 years ago.” In today’s market, non-QM financing is for those who in many cases are struggling, striving, trying to get past financial mistakes and hard times. It’s mortgages with by-the-book underwriting standards where every claim is verified and every file is thick
and fat. You can’t get these loans with just a pulse. The Ability-to- Repay rule sets the standard, and savvy mortgage investors, regulators, shareholders and insurers won’t accept anything less. As an example, Will Fisher of Citadel Servicing said its Verification of Employment Only program “was designed for increased efficiency and minimal paper work while also limiting exposure for the lender in the form of a higher down payment or up to 30 percent equity in the home. This program is ideal for line employees or service professionals such as bartenders, waiters and the like. In the same vein that self-employed borrowers take full advantage of the tax code and use bank statements to qualify for a nonprime mortgage, these individuals also have grey areas in regards to cash income. This program helps them to state their total wages for qualification.”
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AVERAGE DAYS TO COMPLETE FORECLOSURE
1200
1000
800
600
400
200
0
“Lenders face numerous challenges in correctly identifying a foreclosure, or foreclosure-related activity, associated with a loan applicant,” he said. “The seven-year period from the date of the actual foreclosure completion can begin six months to years after the date of first delinquency and therefore the credit report and the actual ‘completion date of the foreclosure action’ will not coincide,” he continued, referring to the seven- year waiting period that most lenders require before approving a loan for a borrower who has gone through a foreclosure. “This is the primary reason that the seven-year period calculated by the credit report may be different from the seven-year period from the date of judgment. For this reason alone, lenders should look to other data sources to ensure that they have accounted for all foreclosures associated with a borrower.”
“The seven-year period from the date of the actual foreclosure completion can begin six months to years after the date of first delinquency and therefore the credit report and the actual ‘completion date of the foreclosure action’ will not coincide. This is the primary reason that the seven-year period calculated by the credit report may be different from the seven-year period from the date of judgment. For this reason alone, lenders should look to other data sources to ensure that they have accounted for all foreclosures associated with a borrower.”
Subprime Mortgages: a Scapegoat? Writing for The Balance earlier this year, Kimberly Amadeo explained that “the subprime mortgage crisis was caused by hedge funds, banks and insurance companies. The first two created mortgage-backed securities. The insurance companies covered them with credit default swaps. Demand for mortgages led to an asset bubble in housing.” But — while it may not be popular — there is research which suggests that subprime mortgages were more victim
than cause, that they are less risky than generally thought.
“The rate of default in the subprime market throughout the bubble and the bust remained steady compared with before the crisis,” explains Vulture. “It was buyers from the top and middle top who account for the skyrocketing rate of default — and it wasn’t that they were buying bigger family homes that they couldn’t afford. It was that they were buying additional houses to flip for a profit, and when
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holding on to them stopped making financial sense, and with no personal and emotional connection to them, they began walking away in huge numbers.” “Most economic analysis of the recent American housing market bust and the subsequent default and foreclosure crises focuses on the role of the subprime mortgage sector,” write Fernando Ferreira and Joseph Gyourko with the Wharton School in a 2015 report. “Roughly three-quarters of the papers on the crisis reviewed in the next section use data only from the subprime sector and typically include outcomes from no later than 2008.” Instead, to find the real cause of the mortgage meltdown, the Wharton researchers looked at the financing and refinancing of “33 million unique ownership sequences in just over 19 million distinct owner-occupied housing units in 96 metropolitan areas from 1997 to 2012, resulting in almost 800 million quarterly observations.” The real problem, say Ferreira and Gyourko, was negative equity. The key to foreclosures is not the credit
status of the borrower but their equity in the property.
marketing and sale of inappropriate financial products which led to the loss of homes, investor red ink, and mammoth liability settlements. For borrowers the conclusion is obvious: they have to shop around. “Mortgage interest rates and loan terms can vary considerably across lenders,” said the CFPB in May. “Despite this fact, many homebuyers do not comparison shop for their mortgages. In recent studies, more than 30 percent of borrowers reported not comparison shopping for their mortgage, and more than 75 percent of borrowers reported applying for a mortgage with only one lender. Previous Bureau research suggests that failing to comparison shop for a mortgage costs the average homebuyer approximately $300 per year and many thousands of dollars over the life of the loan.” Alt-A Mortgages “More recently,” explained the Urban Institute (UI) in April, “researchers have found that the largest contributors to poor credit performance was not first time home buyers; rather it was borrowers who chose to obtain cash-out refinances and second liens; many of these borrowers had stronger credit profiles.” According to UI, “these borrowers often used non-traditional instruments such as interest-only loans and negative amortization loans to stretch their buying power.” Translation: Remember Alt-A mortgages? These were such things as option ARMs and interest-only mortgages which required little or no
“The crisis was largely one of sound borrowers falling into negative equity because of very large declines in house prices.” The catch — and it’s a big one — is that many and perhaps most subprime borrowers before the mortgage crisis actually qualified for better financing. In 2007 The Wall Street Journal published the results of a study involving subprime loans worth $2.5 trillion. It found that 55 percent of all 2005 subprime borrowers “went to people with credit scores high enough to often qualify for conventional loans with far better terms.” The situation in 2006 was even worse. The paper found that 61 percent of the subprime mortgages issued that year went to borrowers who likely would have qualified for conventional financing. The evidence is that some number of improperly underwritten borrowers lost their homes to foreclosure because they faced needlessly steep monthly costs. In such cases it was the
GROWING SHARE OF CO-BUYERS CO-BUYER PCT
17.4%
Q1 2018
16.3%
Q1 2017
14.9%
Q1 2016
13.7%
Q1 2015
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A SAMPLING OF NONPRIME FLAVORS • Carrington Mortgage Services offers nonprime home loans that can be used to purchase, refinance or cash-out. Credit scores from 500 to 640 may be acceptable and the program is open to those with “high debt-to-income ratios, who are self-employed or who have had a recent credit event — such as foreclosure, bankruptcy, short sale, missed credit card or late mortgage payments — and may not be eligible for conventional or government loan products.” To make such fixed and adjustable-rate loans work, Carrington manually underwrites the loans and requires a solid down payment — in practice perhaps 15 percent or more — as well as a strong DTI. Mortgages up to $1.5 million are available and cash-out borrowers can get as much as $500,000 at closing. • Citadel Servicing Corporation offers a VOE only program which is available for those with credit scores down to 650. Loans for as much as $5 million are available, first-time buyers can finance as much as $1 million. The program requires 25 percent down to purchase and 30 percent equity to refinance. No IRS Form 4506T is required. Instead the borrower must be able to document two years of employment. There are additional requirements for a business owner or officer. Employment is also verified at closing.
“Remember Alt-A mortgages? These were such things as option ARMs and interest-only mortgages which required little or no documentation, had adjustable rates, and allowed negative amortization during start periods. According to the Federal Reserve Bank of Chicago, Alt-A loans were “generally made to borrowers with good credit ratings, but the loans have characteristics that make them ineligible to be sold to the Government-Sponsored Enterprises (GSEs) — for example, limited documentation of the income or assets of the borrower or higher loan-to-value ratios than those specified by GSE limits. ”
documentation, had adjustable rates, and allowed negative amortization during start periods. According to the Federal Reserve Bank of Chicago, Alt-A loans were “generally made to borrowers with good credit ratings, but the loans have characteristics that make them ineligible to be sold to the Government-Sponsored Enterprises (GSEs) — for example, limited documentation of the income or assets of the borrower or higher loan- to-value ratios than those specified by GSE limits.
assured that such mortgages could only be refinanced after several years. Too often while Alt-A balances grew, home values declined. Once start periods ended, Alt-A borrowers were then in the position of not being able to sell the property because it was worth less than the loan balance and also not able to carry the fully- amortizing monthly payment. The result was a disaster for borrowers, lenders, and mortgage investors. Rate Risk The ultra-low mortgage rates which made rising prices tolerable are now
That’s not all. For many Alt-A borrowers hefty prepayment penalties
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THE RETURN OF RISK: SUBPRIME SNEAKING BACK
WHERE HOMEBUYERS ARE THE MOST SHARING CO-BUYER SHARE OF Q1 2018 HOME SALES 6.1% 48.3%
A SAMPLING OF NONPRIME FLAVORS • Embrace Home Loans says for some borrowers “maybe your income doesn’t quite fit the traditional nine- to-five paycheck. We won’t hold that against you. After all, home loans aren’t one-size-fits-all.” It offers the Beyond mortgage for “self-employed borrowers who show business cash flow on bank statements for qualifying income instead of what is reported on tax returns.” As much as $2 million is available, credit scores below 700 will be considered, private mortgage insurance is not required, and Embrace says it may be open to applicants with “some history of bankruptcy” as well as those who have had “a prior foreclosure, modification, short sale, or deed in lieu.” Embrace also says it will consider financing for non- warrantable condos in projects with a high concentration of commercial units. • Wells Fargo has the fixed-rate yourFirstMortgage program for those with credit scores down to 620. Borrowers can purchase a single-family prime residence with as little as 3 percent down. Maximum loan amounts are consistent with Fannie Mae and Freddie Mac loan limits. The Wells Fargo loan is a QM product, fully eligible for sale to a GSE and backed with private mortgage insurance. Borrowers can earn up to $750 toward closing by completing a homebuyer education course. The program requires full documentation — such things as pay stubs, W-2s, tax returns, etc.
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disappearing. Between November 2017 and June 2018 rates increased roughly 0.75 percent to the highest levels seen in seven years. “Mortgage rates so far in 2018 have had the most sustained increase to start the year in over 40 years,” said Sam Khater, Freddie Mac’s chief economist. “Through May, rates have risen in 15 out of the first 21 weeks (71 percent), which is the highest share since Freddie Mac began tracking this data for a full year in 1972.” These are big moves in a short period. Lawrence Yun, NAR’s chief economist, says the market loses 35,000 sales with each 0.1 percent rate increase. And, sure enough, May existing sales were down 3.0 percent when compared with a year earlier. Less financing demand combined with fixed costs mean smaller lender profits — and maybe no profits. The Mortgage Bankers Association
(MBA) reported that in the first quarter, lenders had a net loss of $118 per loan. “In the first quarter of 2018, falling volume drove net production profitability into the red for only the second time since the inception of our report in the third quarter of 2008,” said Marina Walsh, MBA’s Vice President of Industry Analysis. “While production revenues per loan actually increased in the first quarter, we also reached a study-high for total production expenses at $8,957 per loan, as volume dropped.” Given the dizzying decline in profits — and with the threat of more declines in 2018 — what are lenders to do? In such an environment nonprime and near-prime have begun to slowly emerge as mortgage financing’s new frontier, not as a replacement for traditional origination activity but as an addition to the product lines now available, a new market.
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MY TAKE
An Attorney’s Guide to Real Estate Investing
BY KEVIN KIM, ESQ. CORPORATE & SECURITIES PARTNER, GERACI, LLP
Owning Rental Property Rental properties have been around since the nation’s founding and have been a popular wealth generation tool for generations. With a rental property, the owner is usually responsible for paying the mortgage, taxes, insurance, and maintenance costs for the property. Typically, the investor will purchase a rental property with the hope that the amount of rent received will cover most, if not all, of the costs associated with owning the property.
income to provide much profit until after the mortgage is paid off. Once the mortgage is paid off, however, most of the rent collected will become profit. This result is known as a “cash- flowing” property. There is another benefit to owning rental property: appreciation. Owners receive all of the financial benefit that comes with the property’s appreciation in value, including any improvements to the property. On top of cash flow, this is the most significant benefit of owning a rental property.
Real estate investments have become an attractive alternative to investing in traditional investments such as stocks, bonds and mutual funds. In fact, it has become a significant method to build wealth for generations. While purchasing a home is a worthwhile investment, adding real estate investments to a portfolio can add a powerful hedge and strong foundation as compared to the volatile stock market. In this article, we will explore several of the opportunities that real estate investment provides, along with the pitfalls to expect while investing.
This strategy requires patience, as there may not be enough in rental
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potentially make him or her a profit, purchases the asset, and “flips” it for a profit. Most investors who employ this technique buy a home with the intention of holding it for a short period of time, usually six months to one year, and reselling it. The strategy can be challenging, in that the investor needs to identify properties that are significantly undervalued for their neighborhood while ensuring that the cost of repairs or renovation will not eat up too much of the potential profit. The recent recession provided ample inventory and opportunity; however, many contend that opportunities in larger markets like California have become oversaturated. The lower value must provide enough equity so that the investor can make improvements and still be able to sell it at market value and earn a profit. Another challenge is that the improvements to the property have to be appealing enough to compel
“The neighborhood where the property is located will influence the type of tenants you will have, and your vacancy rate. By choosing the right neighborhood, you reduce the risk associated with high tenant turnover rates. Choose the wrong area, and you may be saddled with bad tenants, lower rent, and damage to your property.”
Based on the location of the property, appreciation rates may vary, but the value of the property can increase by double digits over a relatively short period, particularly in high profile regions such as Southern California. The neighborhood where the property is located will influence the type of tenants you will have, and your vacancy rate. By choosing the right neighborhood, you reduce the risk associated with high tenant turnover rates. Choose the wrong area, and you may be saddled with bad tenants, lower rent, and damage to your property. There is also concern over the maintenance of the property. Many times, a rental property will need exterior and interior work after it is purchased. The difference between
being a landlord and participating in other types of real estate investments is the amount of time you must spend renovating and maintaining it. You could hire a professional management company, but then, of course, you would have to deduct that expense from any potential profits gleaned from the property. Fix-and-Flip Properties This type of investment has become very popular because of a massive number of older homes hitting the market since the 2008 recession. Reality television shows have furthered the popularity of fix-and-flip investments. The fix-and-flip strategy is the opposite of buy and hold. It is similar to trading stocks, in that, an investor identifies an asset that could
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of returns your property generates. Research is key to finding the right group for you. Real Estate Limited Partnerships A real estate limited partnership (RELP) is similar to an investment group in that it holds and maintains a rental property or a portfolio of rental properties. However, a RELP is an entity that is formed to hold these properties for only a specific number of years. An experienced real estate property management company typically acts as the general partner. Individual investors are invited to provide capital in exchange for an ownership share of the limited partnership. The partners in the venture typically receive periodic income distribution based on the rental income that the group of properties generates. Depending on the terms of the partnership, the properties are sold for a profit, the partners split the proceeds, and the RELP is dissolved. This investment strategy allows investors to participate in the real estate market without having any previous real estate investing or management experience. The downside is that since the properties are held for a specific period, the money you invest may be tied up for quite some time. Real Estate Investment Trusts A real estate investment trust (REIT) is similar to a RELP, except that the properties form a holding trust. The trust is converted to certificates, similar to a stock, which is then sold off to individual investors.
prospective buyers to accept the market price. However, there is a risk that an investor will be unable to sell the property for whatever reason, saddling them with those expenses associated with the property, namely, the mortgage and maintenance. The costs associated with purchasing this type of investment are also high. Many times, flippers will have to take out a short-term loan, typically with a much higher interest rate than a traditional mortgage, to outbid competitors. If the property doesn’t sell or they run into problems with the renovation, the investor may get stuck making those high mortgage payments for many months, or be forced to dump the property for a loss. Real Estate Investment Groups Real estate investment groups are a type of investment vehicle, similar to a mutual fund, which invests into rental properties in specific markets. This strategy is a good investment for those who like the idea of owning rental properties but don’t want the
headache associated with collecting rents, maintaining the property, and filling vacancies. Under this scenario, a management group will build or buy rental properties, typically apartment buildings and multi- family dwellings, and hold them in a rental portfolio. Individual investors are then asked to join the group with one or more properties that they own, but the management company will take care of the duties related to operating all of the properties held in the group. In exchange for overseeing the group of properties, the management company will receive a percentage of the total rents collected. Typically, the investor still holds the lease for his or her property, while contributing a portion of the rent into a fund each month to cover the management fees and other expenses shared by the group. There are several variants of this type of real estate investing group depending on the type of property you own, the area where the property is located, and the kind
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Why Real Estate is a Great Investment
In a REIT, a corporation acquires a group of income-generating properties that it holds and manages. These properties may include medical buildings, office buildings, malls, or other high-capacity rental properties. The money raised from the certificate sales is used to finance the purchase of additional revenue-producing properties to be held by the trust. The revenue generated from mortgages or rents on the REIT’s properties is distributed to the certificate holders on a regular basis and is a good strategy for real estate investors that want a steady rental income without the hassles of being intimately involved in the buying and management of physical properties. Real Estate Mutual Funds Real estate mutual funds invest in REITs and other real estate-related
companies. Investing in real estate mutual funds allows individual investors to dabble in real estate without risking much capital. Mutual funds invest in a diversified group of real estate assets, therefore reducing risk and exposure to the investor. By using this approach, they allow individuals to participate in a broader range of real estate investments than provided by REITs. With real estate mutual funds, novice investors can get involved in real estate after making an educated and informed decision. Mutual funds have a wealth of analytics and other data that can provide investors with all the tools they need to diversify their investment into those sectors of the industry that makes the most sense for their investment goals.
Real estate has proven to be a great wealth-generating tool over the past several decades. Even after factoring in the housing crisis of 2008, private commercial real estate investing returned 8.4 percent annually over the decade of 2000 to 2010. Real estate investing is also a great way to diversify a portfolio of stocks and bonds. Historically, real estate has low volatility compared to the stock market. While stocks can lose nearly all of their value, it is improbable the same will occur with physical real estate that you own. Most people are invested in the stock market in one way or another, be it through work retirement programs or private investment. With real estate, an investor can hedge against a market downside by owning tangible assets, with low risk of severe devaluation. Real estate has a negative correlation to the stock market. Meaning that when the stock market drops, real estate-related investment products are usually up. Although the Great Recession was somewhat of an anomaly, residential real estate prices continued to rise after 14 of the last 15 recessions. Inflation Hedge During expanding economic conditions like we are experiencing now, demand for housing rises. When demand rises, rents and values rise along with it. In this respect, the correlation between GDP growth and real estate passes Diversification of Your Asset Portfolio
“Most real estate investing offers the power of leverage. Other investments, such as stocks or bonds, require the investor to pay the full value of the investment, whereas, with real estate, a buyer can leverage his or her credit and assets to finance their investment strategy.”
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some of the inflationary pressure onto tenants, while generally retaining the purchasing power of the investor’s capital. Leveraging Capital Most real estate investing offers the power of leverage. Other investments, such as stocks or bonds, require the investor to pay the full value of the investment, whereas with real estate a buyer can leverage his or her credit and assets to finance the investment strategy. Investors often obtain a second mortgage on a property they already own to place a down payment on another income-producing or flip property. No matter their plan for the investment property, they have leveraged a fraction of the assets they already own to purchase additional assets, without having to come up with the full price of the property out of pocket.
conventional mortgages require 20 percent down payment, many investors turn to alternative private lending to complete a transaction. With a private loan, an investor can leverage his or her existing assets, or the future value of the property to secure higher loan-to-value financing. Real estate flippers especially like utilizing private lenders, where they can obtain quick financing based on the future value of the property after it is renovated, and their track record of making profitable decisions. This option offers them the flexibility to put up less cash and leverage more of the asset’s value against the potential to make a profit. Drawbacks for Real Estate Investing The most significant impediment to investing in real estate is illiquidity. Most real estate investing requires patience and a longer-term commitment to achieving a profit. Unlike stocks or bonds, which are traded daily, real estate takes time to liquidate and convert to cash.
Another drawback to real estate investing is the market itself. While economic upswings can have a positive effect on rents and property values, local or regional issues can result in a drop in value for specific neighborhoods. If an investor is overleveraged by carrying too much mortgage debt on individual properties, he or she could become stuck, unable to sell the property if values drop significantly. Most investors realize this risk and balance their mortgage debt against current property values appropriately. Final Verdict Real estate investing makes good sense to balance out an investor’s portfolio of stocks and bonds, mutual funds, and physical commodities. While real estate investing is generally accepted as an “alternative investment,” it can help investors hedge against wild stock market swings, provide appreciation and a steady income stream, and improve balance to an investment portfolio of securities and other physical assets.
Flippers especially take advantage of this power of leverage. While most
KEVIN KIM
Kevin Kim is an experienced corporate and securities law attorney with Geraci Law Firm, dedicated to providing reliable and innovative legal solutions. Mr. Kim focuses his practice on real estate matters, focusing on private placements and other alternative investments for private lenders, real estate developers, and other real estate entrepreneurs.
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