The other night, I was out having drinks with a friend of mine who works for a homebuilder located just outside of Atlanta.
As a builder, his company is doing well; while the current market has certainly affected their business, they’re still chugging along and closing around five sales each month. But they are in a good market: they build moderately-priced homes in the low-to-mid hundreds, and really concentrate on first-time homebuyers with good credit. As he said: they’re the last ones to feel a drop in the housing industry, and the first ones to recover.
But, even though his company is continuing to thrive, my friend was interested in where I thought the housing market was going and what real estate investors were going to see in the near future.
As a
real estate closing attorney, I follow the housing industry very closely. I have always thought that knowledge is the most important resource that one can have as a real estate investor; if you know more than the other guy, then you’ll probably do better than he will. Knowledge, they say, is power.
One thing to recognize is that the spectacular boom of the past few years in real estate investing came as a direct result of the access to easy mortgage money. Mortgage lenders were willing to lend trillions of dollars to those least able to repay. Why? Because there was an insatiable appetite for these types of products on the secondary market up on Wall Street. Hedge funds, pension plans, overseas banks couldn’t get enough.
This resulted in one of the most dangerous loan products out there, and one that I believe is at the root of the majority of difficulties facing the real estate market in Atlanta: the 100% adjustable-rate mortgage.
As a
closing attorney, I closed hundreds of these loans, subprime and not. Buyers came to the closing table with no money and got a low interest rate on their loan for the first couple years. Everyone looks only at that initial payment, because they expect to refinance before the loan to reset to a higher rate; and as long as property values keep increasing, then there’s plenty of equity to pay for that refinance. Like I said, I closed hundreds of ‘em.
Well, of course, we know what happened: prices didn’t keep increasing.
These charts, in one form or another, have been on the wall of my office for the past year. They are, I believe, the single two most important indicators of where the mortgage industry is headed, and how long it will take to recover.
Both were created by Bank of America, the top is the original, the one below revised. And they show, in billions, the amount of adjustable-rate loans resetting to their higher rates.
Why is this significant? Because it is primarily the ARM resets that have driven down the housing market for the past year. As borrowers found their payments increasing, many of them quickly realize that their new payment was not affordable. Burdened with a home that they can’t afford, with little-to-no equity, these borrowers started scrambling for options.
Unfortunately, the options are few and far between. Refinancing isn’t possible for most because of tightening credit standards and reduced loan programs. Unable to refinance, borrowers try and sell their homes, leading to the glut of homes on the market. And with more homes on the market, there is more competition for the few buyers out there.
Prices are pushed downwards.
Lastly, there’s the final option for borrowers in these loans: foreclosure. And of course, foreclosures are at an all-time high and are expected to increase. The flood of REOs back onto the market again push prices down.
Both of the charts are very telling: that we haven’t seen anything yet. All of the homes on the market, all of the lenders going out of business, home prices deteriorating; and we haven’t yet even reached the peak of ARM resets.
The original Bank of America chart showed that peak in March of 2008; the revised has ARMS peaking in June.
For most borrowers, once the rates adjust, they’ll do everything they can: but the odds are definitely against them. They may struggle to make payments, and some certainly will. But the great majority won’t – and faced with a home most-likely worth less than what is owed, they’ll be unable to refinance or sell. Eventually they’ll fall behind on their payments.
So: as an example, let’s take someone who has a loan that adjusts in March. Their payment increases, and they make them for as long as they can. Say, four months. In August, they miss their payment.
Is the lender going to foreclose then? Probably not. It’ll probably take another four months for the lender to initiate foreclosure proceedings. So the borrower may get their foreclosure notice in December.
In Georgia, foreclosure is a fairly speedy process, generally taking two or three months. For our hypothetical borrower, it’s March of 2009 before the property is deeded back to the bank.
What does this tell to us? That as an industry, things are much more likely to get worse before they get better, and that the housing slump we’re in now is probably going to last for some time to come.
What else does it tell to us? That there are still ways to survive and profit as a real estate investor. I can't say this enough. My friend who works for the builder; they are still doing well. And other investors, who recognize and understand the broader market forces at play continue to thrive. Traditionally, in down times, investors do well. There’s a smorgasbord of potential deals out there. The smart investors recognize that, and continue to work today’s and tomorrow’s market to their advantage.
