Real Estate is dying? Investment-wise what is the next Asset Class Du Jour?

"With stated-income mortgages, some may blur truth to get into a home - and get in over their heads

By Andrew LePage -- Bee Staff Writer

Robyn DeLong was in a jam.

The self-employed real estate agent was eager to refinance two fourplexes she owns in Sacramento's Oak Park neighborhood to lower her monthly mortgage payments, which the rents weren't covering. Difficulties documenting her commission-based income with tax documents meant she didn't qualify for conventional financing. Her loan consultant offered a solution: With her relatively high credit score, DeLong qualified for a "stated-income" mortgage, for which the lender would simply take her word for her income. No need for verification.

"Thank God they had stated income," said DeLong, who lowered her monthly mortgage payments from $2,200 to $1,300 by switching to "interest-only" home loans.

In Sacramento and across the country, the marketing and use of stated-income mortgages have exploded this year. Some mortgage brokerages in Sacramento and elsewhere in California report that stated-income loans now represent as much as 40 percent of their home purchase business.

These and other newfangled loans, which allow people to borrow more than with traditional financing, have helped keep the housing market in the Sacramento region humming despite price run-ups of 20 percent or more in the last year.

Lending experts say the growth in stated-income loans stems partly from the swelling ranks of the self-employed and others - such as those relying on commissions, tips or bonuses - who find it difficult to easily document their full income, often because of tax-related complexities. For a borrower with the necessary good credit, stated income is a blessing that sometimes costs little or nothing extra.

But the trend is also raising concerns that a growing number of desperate buyers are fudging their incomes to qualify to buy homes.

Stated-income loans have been around for more than a decade, but more recently have been made available to wage and salary workers who have pay stubs and W-2 tax forms but still choose to just "state" their income. Lenders are also now allowing borrowers to combine stated income with other relatively risky loan programs such as zero-down, interest-only and adjustable-rate loans, a practice that economists say makes the housing market more vulnerable to any economic shock.

"It's not that the stated income in and of itself is a problem," said Vicky Henderson, a Vitek Mortgage Group loan consultant in Sacramento. "It's the combination of risk factors: high loan to value, interest-only, an adjustable rate, modest cash reserves ... ."

Some in the mortgage and home sales industries say that as prices keep soaring, more borrowers are stretching the truth about their income to stretch financially into houses they couldn't otherwise afford. They include first-time and move-up buyers as well as rookie speculators expecting to "flip" homes within a year.

"Stated income wasn't invented to allow borrowers to misrepresent their income. Does it happen? Yeah, that's the unfortunate part of it," said Bruce Van Patten, vice president of CTX Mortgage in Sacramento. "The intent was to make the process for people with good credit that much smoother."

Although lenders don't verify borrowers' income with stated-income loans, they do typically verify their employment and are supposed to check to ensure that the income stated is reasonable for the profession. They'll often check to make sure a self-employed borrower has a business or professional license or has advertised his services.

Buyers who lie about income to get a bigger mortgage are more likely to default on their loan if they suffer financial distress, such as a job loss or divorce.

Housing analyst John Schleimer said he wasn't trying to be funny - though some people laughed - when he asked a recent gathering of hundreds of Sacramento real estate professionals whether sales of $500,000-plus homes to stated-income borrowers seemed sustainable.

"I'm hearing about more of it and I'm concerned," said Schleimer, president of Roseville-based Market Perspectives. "I think there might be a lot of homes that come back on the market if there's devaluation and people start losing jobs and can't make the payment."

More homes on the market probably would mean less price appreciation, and if more borrowers default then lenders will make it harder for buyers to borrow.

"With low interest rates and financing programs, right now the ability to borrow money is the easiest it's ever been," Van Patten said. "If and when the market changes, then underwriting standards will tighten up."

Lenders say they feel comfortable offering stated-income mortgages because they're convinced that a good credit score is the best indication of the likelihood borrowers will pay off their debts on time. Also, some stated-income loans require at least a 5 percent or 10 percent down payment.

The loans typically require at least a decent credit score of about 620. Depending on that score and other factors, such as down payment size, the loan might entail a fee or higher interest rate, perhaps half a percentage point. In some cases, those with great credit and adequate cash reserves don't pay anything extra for a stated-income loan.

Many stated-income mortgages fall into a varied group of home loans known as "Alt-A," meaning they're alternatives to other grade A loans made to borrowers with good credit. For a variety of reasons, Alt-A loans don't conform to the lending guidelines of mortgage purchasing giants Fannie Mae and Freddie Mac.

In the first 10 months of this year, investors bought $122 billion worth of Alt-A mortgages, up 64.4 percent from the total for all of last year, reports Inside Mortgage Finance, a Bethesda, Md.-based newsletter. This year's purchases were up 128 percent from all of 2002.

Many in the lending community defend stated-income loans as a consumer-friendly innovation that shouldn't be judged based on the dishonest actions of what they say are a few.

"Most of the time these products are used responsibly ... and have helped a lot of people get into houses," said Jesse Passafiume, an executive with Roseville-based American Pacific Mortgage. "It's unfortunate there are a couple of bad apples that have abused it because, honestly, it is fairly easy to abuse."

Passafiume, president of the Sacramento chapter of the statewide mortgage brokers association, said it's consumers' responsibility not to overextend themselves, but loan officers should help them set limits.

The mortgage industry is full of neophyte loan officers in the wake of the long refinancing boom, veteran brokers point out, and some are desperate for business.

"Professionals in the industry are explaining things to borrowers but the people just trying to make a loan or real estate commission are saying, 'Here's a loan program, here's your payment,' without thinking about where the borrowers will be in three to five years," Van Patten said.

Real estate agent DeLong said more of her clients are choosing stated-income loans. She's not aware of any of them lying about their income, she said, but it wouldn't surprise her if some buyers are.

"In the climate we have, where people are trying to qualify for homes priced above where they technically qualify ... they may be tempted to fudge," she said. "That's not something the lender or the Realtor are necessarily privy to, nor do we want to be."

Putting a positive spin on a loan application
Here are some of the most common ways borrowers are reportedly stretching the truth:

* They apply under their own name alone, perhaps because a spouse has poor credit, but then add all or a portion of the spouse's income to their own.

* They state an income that assumes they will receive nonguaranteed raises, bonuses or commissions.

* They simply make up an income that enables them to borrow as much as they need, hoping the lender doesn't question it.

Mortgage industry officials say borrowers are obligated to give their own current income.

"It's not wishful thinking and it's not what's happened two or three years ago," said Ted Grose, director of consumer research for the California Association of Mortgage Brokers. "It's what your income is right now."

 

Everywhere you look, there's talk about a real estate bubble. Richard Russell refers to the rule of 10, where if annual rent income doesn't equal 10% of the property value, the property is overvalued.

If rates skyrocket (something triggered by our Asian buddies dumping their US paper), interest rates will soar, driving ARM loans and new origination payments through the roof, making housing less affordable, killing property values, and popping this so called bubble.

The problem I have with this is that everyone's been talking about it for so long, the concept of the real estate bubble is so mainstream, that I honestly believe that most of these suckers out there will lose money betting on a real estate bubble bursting.

My opinion, the US dollar will be devalued so much that the real estate bubble will never "burst", persay. The bubble will burst in terms of a 500K house today being worth maybe 250K in todays dollars several years from now, but the dollar value will remain constant.

Gold, silver and uranium mining shares, that's the next Asset Class Du Jour, hands down. These plays hold their value, even if catastrophe doesn't strike, and the fundamentals support them, unlike the majority of the stock, bond, and real estate markets.

Check out articles/links here:

http://www.marginalthoughts.com/

 

Not exactly. I am saying that for those who did buy houses (and there are a lot of them) who locked in on rates, they will have many, many years where they don't have to worry about paying ever increasing rents. My father in law, for example, has a mortgage payment dating back 25 years ago that is only a few hundred bucks. He has extra money, which he *can* put in the bank, or spend on goods. For years, there are many many people who will have extra funds left over after paying their housing bill who can spend money on other things manufactured here, or elsewhere.

 

Everyone seems to agree (even myself) that there exists a housing bubble.

Isn't that a classic indicator that we haven't reached the top yet?

I'm not trying to be sarcastic but come on - everybody is anticpating this crash/slide/bubble burst.

To me that seems like a "buy" indicator if I've ever seen one.

Regards,

Mike

 

The Specter of Deflation

John P. Calverley

U.S. house prices rose 13% in the year to Q3, including an astonishing 42% leap in Nevada, 27% in California and 23% in Washington DC. Prices have risen a long way on the coasts over the last 7 years with gains of 134% in California, 103% in Massachusetts and 92% in New Jersey and 89% in New York. Inland regions have generally been more stable so the nationwide average gains since 1997 is a more moderate 65%. Nevertheless, with house price inflation accelerating, it looks as though the United States is in the early-to-middle stages of a bubble. In the U.K. and Australia more advanced bubbles are key factors in economic performance and monetary policy. The United States is likely to go the same way.

One of the causes of the bubble is that people seem to have forgotten that house prices can fall as well as rise. And the risks of a significant fall are more acute now than for over 50 years because of the low rate of inflation in consumer prices and the threat of deflation. Between the 1950s and the mid-1990s falling consumer prices, deflation, was virtually unknown anywhere. The world’s attention was focused entirely on battling rising prices, inflation, which had become the number one economic problem. But by the late 1990s the battle against inflation was won and deflation had emerged in several countries in Asia including Japan.

Deflation is a new and troubling threat for all of us, brought up in an era of continuous inflation. Almost nobody alive today, even the venerable Mr. Greenspan, was an active market participant or policy-maker in the 1930s, the last time the United States suffered deflation. Yet, during the 19th century and right up to the 1930s, deflation was common, indeed even normal, while inflation was usually only seen at the height of economic booms and in wartime.

In the U.S., deflation is still only a hypothetical possibility, but in Japan it is a painful reality. Japan’s stock and property bubbles deflated rapidly in the early 1990s and a series of short-lived upswings were each soon ended by a new downturn. In this weak environment, inflation gradually dropped to zero and then deflation set in, starting in 1995. As of the end of 2004 Japan’s price level has fallen a cumulative 10%.

A world of very low inflation, and potentially deflation, makes the current house price bubbles more dangerous than in the past and, from an investor and homeowner point of view, means that houses are a more risky investment. After past price bubbles, house price adjustments were limited in nominal terms by the cushion of high underlying inflation. Indeed in the United States, the nationwide price index has never fallen in nominal terms. In fact, there was a 10% adjustment in real prices in the 1990s, but it was hidden by the high consumer price inflation of the time. In some regions, the real price adjustment was greater and so nominal prices fell too. For example, Californian home prices fell 10% in nominal terms in the early 1990s, with a 24% decline in real terms.

How much effect would a fall in house prices have on the economy? The bursting of the 1990s stock market bubble wiped about $5 trillion off U.S. household wealth. It would take a 33% fall in home prices to have the same impact. A decline of this magnitude cannot be ruled out if valuation ratios for housing, such as the house price-earnings ratio or the house price-rents ratio returned to past cyclical lows, but it would only be likely in the context of a serious recession and a new rise in unemployment. However, wealth effects from declining house prices are usually found to be more virulent than those from falling stock markets, so a fall of "only" 10–20% in house prices could present Mr. Greenspan, or his successor, with a similar headache to the aftermath of the stock crash.

But a housing crash would have other effects too. In past housing downturns residential investment fell sharply, by 40% in 1980–82 and by 24% in 1988–91. This is reflected in the monthly housing starts data, which typically halve during recessions. But starts only ticked down briefly during the 2001 recession and have since risen close to past peaks. Residential investment accounts for about 5% of GDP, so a severe house-building recession would be enough to cut GDP by 1–2% on its own.

How likely is a U.S. housing bust? The economy enters 2005 with considerable momentum and with interest rates still low so it seems likely that house prices will continue to rise for a while, inflating the bubble further. Good news on the economic front will support house prices while rising mortgage rates (likely as bond yields move up) will threaten them. The outcome of these opposing forces will depend partly on how much mortgage rates do in fact rise. Continued good news on consumer price inflation would keep bond yields low and make higher home prices more likely. But house prices will also depend on whether the growing signs of a bubble mentality, now evident in some regions, extend further. When a bubble reaches the euphoric phase, rising interest rates may have little effect because people are entirely focused on the prospect of quick gains.

The ideal outcome from here would be a period where house prices were broadly stable, allowing earnings and rents to catch up and valuations to moderate. A small fall in the market of 5–10% would help that process along, without causing too much hardship, though a nationwide 5–10% fall would almost certainly imply falls of 10–20% in parts of California and New England and other particularly high-priced areas. The most dangerous scenario is if house valuations are still extended when the next major shock hits the U.S. economy. Stock prices would likely be falling too, so that the economy would face a double dose of asset prices effects adding up to a much more lethal mixture than in the aftermath of the stock market bust.

A large correction of house prices at some point, 20% for example, would be a painful process for homeowners as well as investors in housing. Moreover prices would likely only recover gradually since inflation and incomes growth would likely be very low at that point. Hence it is probable that prices would not return to their peak levels for 15 years or more. This might not worry some owner-occupiers. Many will have bought before the peak of the bubble so that, while they will see some erosion of their equity and perhaps suffer some disappointment, they may not be losing much, except on paper. Moreover, since mortgage rates would likely fall, people would be able to refinance at lower rates.

However, people relying on future appreciation to help fund their retirement could be very disappointed. Moreover some people would find the value of their house falling below the outstanding on their mortgage, i.e. negative equity, because of the greater decline in nominal house prices.

For an investor in housing the scenario above would, to say the least, be a huge disappointment, because there is no capital gain for more than 15 years. Of course, provided he could find tenants and provided rents did not fall, his net rental yield should be positive so there would be some income after costs, though not much given the low level of rental yields, especially in the more bubbly areas. It is difficult to define exactly where the investor would end up, because a great deal depends on how big a loan he has and what rent he could obtain. But there is no doubt that this is what disappointed investors call "a very long-term investment," or in other words a mistake! The choice is either sell and accept the loss or wait it out, but then miss the opportunity to make money elsewhere.

A big adjustment like this is most likely when we see a sharp slowdown or recession and especially if house prices continue to rise rapidly in 2005, as seems likely unless mortgage rates rise very rapidly. The United States avoided a major recession in 2001, with the help of massive fiscal stimulus and rapid cuts in interest rates. But another downturn will come one day and, if house building and consumer spending crash too, the recession will be more severe than in 2001. In a low inflation world, housing bubbles are a much more dangerous phenomenon.



John P. Calverley [send him mail] is Chief Economist and Strategist at American Express Bank in London. He is also the author of Bubbles and How to Survive Them. This article first appeared in Bill Bonner's Daily Reckoning.

Article can be found here http://www.gold-eagle.com/editorials_04/calverley122604.html

 

Everyone was also talking about the tech bubble for a long time before it burst, but burst it did like every other bubble before it. The longer this bubble takes to burst the greater the damage will be when it bursts and the longer it will be before things recover – just look at Japan.

Just like the case in various parts of South America over the years, the ultimate winners in the US will be those that managed to take their money out of the country before things collapsed. The ultimate losers will be those who are fully invested in US assets as the world’s aversion to those assets intensifies. Property, as everyone here would be aware, is the most illiquid of assets. To be taking on debt at this late stage to invest in property is sheer folly IMHO.

Best wishes to all for the New Year.

 

We the gold bugs would like to reiterate our message. Buy Gold. Not only has this so called precious metal lagged every investment since the beginning of time but our ramblings on other topics should be deemed credible! We would like all of you to sell everything and do what we do, buy gold, live in a cave and wait for armageddon.

Harumph!

 

I understand what you are saying, but I don't think by any long shot that "everyone seems to agree that there exists a housing bubble."

Witness record percentage of home owners, record appreciation in the last few years, record levels of speculation in properties, and reduction of rents because of lack of demand for rentals (everyone has bought homes).

IMO that means most everyone has boarded the "train". Voices like the ones heard on this thread are the extreme minority in contrarian viewpoint (and are dismissed by vested "longs").

 

LOL So true. But every once in a while there is an article there worth reading.

 

Other asset classes and ideas. The dollar is one asset class. Other currencies. Cheap labor. Commodities. Debt leverage may be an asset class, say thru real estate purchase.

I don't know the writer, but the ideas are interesting.

"Many countries, resource rich and otherwise, believe erroneously that the strength of their domestic economies depends entirely upon their ability to supply the United States with a readily transportable supply of cheap labor value – labor value exported through the physical transfer of trade goods and the telecommunication of services which readily flow to the unflappable American consumer.

If resource rich countries were organized and confident, they could unilaterally set the market price for many commodities. These countries could also influence which “currency” will be accepted as a store of value.

But which paper currency has value?

Perhaps those things that we think of as real and tangible commodities are really currencies. Historically strong evidence exists to support this contention. Commodities, oil, and food have the conceptual and historic potential to be used as measures of transferable value or currency. Therefore, as the United States dollar (USD) weakens, the subservience of the resource rich countries to the United States declines.

Over a long period of time, something happed to reduce the efficacy of the USD as a measuring tool of value. The United States ceased being able to build the kind of productivity it needs to offset the inflow of wealth that it imports. Instead the United States took advantage of the fact that it held a monopoly of currency designed to provide an advantage to global trade.

What broke this protectionist advantage down was the free flow of cheap global labor value. The United States cannot produce a return on investment because it cannot trim its labor value added costs. This means that debt levels and deficits have to increase.

Deficit spending has gone unnoticed by the majority because labor deflation (China,India) temporarily offsets declining purchasing power. The global economic system has to be rebalanced.

With the dollar in the middle of every transaction and every livelihood, many blocking forces exist to keep the status quo in place.

China of course, and India as well, are at the nexus of global labor deflation. Both have well-trained labor pools willing to outbid any competitor. Information technology and inter-modal global transport facilitate the international flow of labor value. Again, the story of labor deflation masks the demise of American purchasing power. Beyond the details, the world needs to figure out how much labor will be worth, where goods will flow, and to whom purchasing power will be allocated."

A correct answer to the last sentence will point the way to the next asset classes.

2005 should help answer the questions. I doubt getting into debt will lead to riches at this time. But maybe it is the answer.