Buyers' #1 Bugaboo?

Divining Buyer Psychology

What's keeping Buyers from buying?

I see three factors operating at the moment:

One. Can't qualify for a mortgage/bad credit.

If you don't have a job, or any money in the bank, you're not going to get a loan.

At least not one from a bank.

Sadly, a couple years of grinding recession has pushed more people into this category.

Two. Can't sell what they have.

You've got a job and some savings (Yeah!).

But you've also a got a house that you can't sell, or that may be underwater -- meaning you owe more than it's worth (Drat!).

Ultimately, to a Realtor, this is just another, less dire variation of Factor #1.

Three. Worried about home prices falling further.

I can't prove it, but I think this is the real bugaboo for Buyers at the moment.

Interest rates are in the basement, courtesy of the Fed; unemployment is apparently stabilizing (albeit at very high levels historically); and home prices have already taken a major whack almost everywhere -- meaning that payments for a decent home have seldom been this low.

Ever.

Lastly, signs of inflation -- historically a positive for hard assets like housing -- are becoming manifest in all manner of commodities and stocks lately.

Everywhere, apparently, except the housing market.

Deflationary Mindset?

Ironically, while inflation concerns appear to be dominant outside the housing market, inside it, there are signs that a deflationary mindset has taken hold.

Which means that many Buyers evince an attitude of, "my choices will be better and cheaper if I wait."

Unfortunately, there's only one, 100% guaranteed cure for that: a year or two of sustained gains in housing prices.

If enough people wait for that to happen . . . current Buying demand suffers, and lower prices become a self-fulfilling prophecy.

P.S.: If inflation expectations are on the rise, wouldn't interest rates be rising?

Normally, they would be -- and that would send a signal to the Fed to act.

Except in this case, it's actually Fed intervention that's suppressing interest rates.

Got that?

Always a smart idea to disable the brakes before you hit the gas . . .

Next: "Defensive Housing Plays"

"How much does that home rent for?"

How to Predict (House) Rental Rates

Want to know the best predictor of what a given home rents for?

Figure out when the owner bought.

If they bought between 2004 and 2008 -- especially if they didn't put much down -- they want an arm and a leg.

Or more accurately, they need an arm a leg.

That's because they bought at the peak.

And since they bought at the peak with little down, they're now underwater.

Which means they can't refinance to take advantage of today's shockingly low rates.

So, to cover their monthly "nut," they need to collect a hefty monthly rent check.

Financial Wherewithal + Patience

At the other extreme, there are other would-be "home landlords" who bought decades ago, and now owe little or nothing on their homes.

Some are earning essentially zero on their retirement savings (remember those shockingly low rates); others are convinced that the market will be higher in 2-3 years than it is now.

In either case, they're looking for a renter to tide them over till the markets -- investing and housing -- improve.

Throw in a renter who might be a family friend (or a friend of a family friend), and suddenly such homes can be rented at very attractive prices.

So, what are market rental rates?

Somewhere between these two extremes.

Strategic Default Double Standard

Business Decisions,
Big and Small

What happens to a homeowner who strategically defaults? (that is, they walk away from their home because it's worth less than what they owe).

Their credit is damaged -- if not wrecked -- for as long as seven years.

What happens to a commercial property owner who strategically defaults?

If it's a REIT, its stock goes up, due to its improved cash flow -- and hence greater appeal to investors:

In the business world, there is less of a stigma [associated with strategic default] even though lenders, including individual investors, get stuck holding a depressed property in a down market. Indeed, investors are rewarding public companies for ditching profit-draining investments. Deutsche Bank AG's RREEF, which manages $56 billion in real-estate investments, now favors companies that jettison cash-draining properties with nonrecourse debt, loans that don't allow banks to hold landlords personally responsible if they default. The theory is that those companies fare better by diverting money to shareholders or more lucrative projects.

"To the extent that they give back assets or are able to rework the [mortgage] terms, it just accrues to the benefit" of the real-estate investment trust, says Jerry Ehlinger, RREEF's co-chief of real-estate securities.

--"Commercial Property Owners Choose to Default"; The Wall Street Journal (8/25/2010)

Good luck getting Joe and Jane Homeowner to honor their underwater, $300,000 mortgages when Corporate America is ditching their $30 million (or $3 billion) mortgages.

What's that line about "what's sauce for the goose is sauce for the gander?"

The Plight of the "Move-down Buyer"

Stuck in Place

A healthy housing market functions like a gigantic escalator.

The bottom rungs are occupied by first-time Buyers. As they purchase entry-level homes, the Sellers of those homes ("Move-up Buyers") typically buy larger homes, enabling Sellers of those homes to buy even bigger homes.

And so on, and so on.

One of the most remarked consequences of the housing bear market the last three(?) years is that falling real estate prices have clobbered the equity of move-up Buyers.

So, the money they need for a downpayment to buy a bigger home is either diminished -- or gone.

In the most distressed housing markets -- places like Florida and Las Vegas -- many people who bought at the peak are now "underwater" (they owe more than their home is worth) to the tune of tens (or hundreds) of thousands of dollars.

Voila! No more moving escalator.

Stranded at the "Top of the Food Chain"

All of the foregoing is now very-well documented.

Less remarked is the plight of the "move-down Buyer" -- the owner of a bigger home, typically close to retirement age, who is ready for a smaller dwelling, but is unable to sell (also known as a "down-sizer").

If move-down Buyers are lucky, they bought decades ago, and have so much equity that even a 30% drop in housing prices still leaves them able to sell (and they've been prudent enough -- and financially secure enough -- to leave that equity untapped through the years).

It's also true that financial products like reverse mortgages can help move-down Buyers (at least the ones over 62 years old) transition to a smaller home.

However, the flip side of buying a bigger home decades ago is that the same home today could easily require hundreds of thousands of dollars of updating and remodeling to appeal to today's (financially hamstrung) Buyers.

Even if those Buyers can still muster a six-figure downpayment and qualify for a jumbo mortgage, coming up with a couple hundred grand for remodeling, out-of-pocket is (often) the kiss of death.

So what happens?

Nothing.

Move-down Buyers can't sell, which means that the owners of homes at lower price rungs can't sell -- and so on, and so on.

Public Policy Implications

The foregoing dynamic suggests that the best way to unfreeze the housing market isn't to buttress first-time Buyers, as policymakers have done so far.

Rather, the smarter approach is to help move-down Buyers.

That could be done by making a pot of cheap money available to Buyers undertaking major remodeling (cheap purchase money, courtesy of the Fed, doesn't do it); by giving tax credits to Buyers who tackle such projects; or even by giving incentives to investors to buy and remodel such homes.

Such a strategy not only would unlock the housing market's frozen upper brackets, but it would have a huge ripple (multiplier) effect as billions of dollars spent on labor and materials coursed through the economy.

Which all makes eminent, common sense.

After all, as everyone knows, a working escalator needs to go down as well as up.

Selling Hurdles -- Financial & Psychological

The Psychology of a Spurned Offer

Sometimes, financial considerations prevent home owners from selling.

If they owe more than their home is worth, they must either be able to write a check for the shortfall at closing, or, persuade their lender(s) to reduce the mortgage balance.

However, such "underwater" home owners only account for a slice of the Twin Cities housing market today.

What accounts for all the "above water" homes that seemingly linger on the market month after month (and in some cases, year after year)?

By definition, such Sellers don't need to sell; otherwise, they would have.

In Realtor-speak, such Sellers are said to "lack motivation."

Psychological Hurdles

Take away economics, and that leaves . . . psychology.

Sometimes the rub is what a neighbor sold their home for.

That's especially the case if the home didn't measure up to theirs.

The catch, of course, is that market conditions can and do trump home features; I can think of dozens of Twin Cities homes that sold for more -- a lot more -- three years ago than their more impressive neighbors are listed for today.

Even closer to home (sorry, bad pun) is the would-be Seller who turned down an offer above their current asking price earlier in the listing.

In fact, I just heard about an Edina home, now under contract for $900k, that had been on the market for over 2 years, starting at over $1.2 million.

Along the way, the owner apparently rejected two such offers -- one for $1.1 million, and another, later one for $1 million.

You'd guess that they have plenty of company (albeit at less lofty prices).

Baby Boomers & Reverse Mortgages

Next Big Thing:
Reverse Mortgages

Take 80 million Baby Boomers fast closing in on retirement age, many of whom (still) have lots accumulated equity in their now too-big homes, and what do you get?

A vast potential market for something called a reverse mortgage.

Like its name suggests, in a reverse mortgage, the lender pays the borrower, instead of the other way around (it can either be a lump sum, or periodic payments).

The benefit to the borrower?

They get to tap their home equity without making payments -- and without qualifying for a new, conventionally amortizing loan (which could be difficult, given the now-retired borrower's lower income).

In fact, there are no income tests for reverse mortgages; to qualify, the borrow only has to: 1) be at least 62 years old; and 2) have sufficient equity in their home, as determined by an appraisal.

Reverse Mortgage Logistics

How big a reverse mortgage one qualifies for is then a(n actuarially determined) function of age: the younger you are, the less you can borrow.

Why no screening for pre-existing conditions, or other health issues that might affect the borrower's longevity?

Because someone in poor health is actually a better risk for the lender. If they die the day after taking out a reverse mortgage, the lender pockets the borrower's residual equity.

Conversely, it's the 62 year-old who's fit as a fiddle and lives to be 100 that causes lender losses (because the unpaid principal and interest keep accruing).

Fortunately for the reverse mortgagors, it's impossible to owe more than their home is worth (a condition called being "underwater").

For the 3% of (long-lived) borrowers where that would otherwise happen, insurance kicks in to cover the shortfall.

Benjamin Franklin, Strategic Default, and Economic Recovery

Strategic Defaults Driving Retail Sales?

A penny saved is a penny earned.

--Benjamin Franklin, circa 1780

A penny defaulted on is a penny earned.

--Benjamin Franklin, 2010??

No, I have no way of knowing whether a modern-day Benjamin Franklin would have uttered the second quote. In fact, he didn't even say the first one (that hasn't stopped him getting credit for it, though!).

But the sentiment is well-placed.

More and more economists now see a connection between rising strategic defaults -- the term for owners who walk away from their underwater homes to preserve their cash flow -- and recovering retail sales.

That link helps explain a conundrum -- namely, why are retail sales improving when hiring is anemic and unemployment is still high?

Strategic Default Economics

The (partial) answer appears to be that people who've ditched their expensive mortgages have more disposable income to spend at Target, Bed Bath & Beyond, restaurants, etc.

Sometimes, A LOT more.

So, somebody who bought a home at the peak in Las Vegas (or Southern Florida, or Phoenix) for, say, $600k and has seen prices subsequently drop 40% could easily rent for $2,500 a month, instead of paying their $4,500 monthly mortgage. And live in just as nice a place.

Voila! An extra $2,000 in monthly disposable income.

Multiply that phenomenon by a couple hundred thousand people, and suddenly it's no surprise to see retail sales pick up.

Here's what David Rosenberg, former chief economist at Merrill Lynch and now playing the same role at Canadian firm Gluskin Sheff, says in today's edition of his daily market analysis ("Breakfast with Dave"):

Speaking of the U.S. housing market, we are convinced that strategic defaults by various homeowners, along with double-digit growth in tax refunds, have spurred the jump in retail sales (Easter timing helped too) of late. The economy is growing, the bulls are in a great mood, apparently we are into a new phase of job creation, and yet somehow 320,000 mortgage loans that were current when 2010 began were at least 60 days past due in March. Interesting.

--David Rosenberg, "Breakfast with Dave" (4/19/2010)

Of course, more borrower defaults ultimately means more foreclosures, which translates into more housing market supply -- and more bank write-off's.

But thanks to the Federal Reserve's policy of zero percent interest rates, banks are now booking huge profits to help offset their mortgage and housing-related losses ("Citigroup Posts $4.4 Billion Profit" -- WSJ).

They also continue to benefit from the government's unofficial policy of "too big to fail," with the implicit promise of future bailouts, if and when needed.

It all sort of recalls the chorus from a classic rock 'n roll song:

Take a load off Annie, take a load for free;
Take a load off Annie, And (and) (and) you put the load right on me

--The Band; lyrics, "The Weight"

The (financial) weight, indeed.

Obama Seeks White House "Short Sale"; Creditors Balk

White House "Short Sale"

Washington, D.C. (April 1, 2010) --President Barack Obama today announced plans to sell the White House as part of the government's ongoing efforts to reduce the national debt. However, with an estimated fair market value of $200 million, secured by a $13 trillion mortgage, President Obama acknowledged that, at present, the White House was deeply "underwater."

"We believe it is in the best interests of our creditors -- China, Japan, and various OPEC members -- to reduce the principal balance on the White House, rather than risk an even greater loss by forcing the property into foreclosure," President Obama said.

Representatives of the various creditor governments were reportedly studying the proposal. A spokesman for Chinese Premier Wen Jiabao said, "Before we consider such a dramatic write-off, we, of course, will require the United States to provide a complete and candid picture of its financial situation -- something that it has not offered to date," the spokesman said.

Ross Kaplan, Edina Realty City Lakes, has the listing.

Strategic Default Like Pre-'70's Divorce?

From Stigma to "the Norm"

I was at an industry conference yesterday where the speaker compared "strategic default" -- making a business decision to walk away from an "underwater" mortgage -- to society's notion of divorce up until the 1970's.

Back then, relatively few people divorced, so there was a stigma attached to it.

Fast forward a couple decades, when more than half of all marriages end in divorce.

Voila! No more stigma.

Similarly, "strategic default" is a big deal -- until everybody does it.

With millions of homeowners deeply underwater in markets like Las Vegas, Southern California, and Arizona, you'd guess that a similar evolution is in store for the housing market.

And yes, if enough people strategically default, you'd expect the lending rules to change: the same speaker speculated that FHA will face pressure to reduce its "rehabilitation period" for defaulting borrowers from the current 7 years to 3 years.

Stuyvesant Town Collapse

Strategic Default . . . Minus the Consequences

Imagine you bought a house 4 years ago for $540,000, putting in a (very) modest 2% down payment, or $11,000, and borrowed the other $529,000.

Today, your home was worth $180,000 (no, not a typo), yet you were still faced with making payments on the original $529,000 mortgage.

What would you do?

Now, change two of the facts: 1) the property in question isn't a single family home, but a huge Manhattan apartment complex called "Stuyvesant Town": 2) the buyer isn't a person, but a big-time real estate investor, Tishman Speyer Properties.

Oh, and one other thing: add 4 zeros(!) to the numbers cited above.

So, Tishman paid $5.4 billion for Stuyvesant Town less than four years ago; today, the property has lost more than 67% of its value, long ago wiping out Tishman's 2% equity stake.

Current estimated value: $1.8 billion.

Is the suspense building yet?

"Tish-Tosh"

Well, on a massive scale, Tishman just did what hundreds of thousands of underwater homeowners in especially stressed housing markets like Florida, Las Vegas, and Southern California have already done: it "strategically defaulted" on its mortgage.

That is, it handed title to the property over to the lenders, and walked away.

Left holding the bag: pension funds representing California and Florida school teachers, amongst (many) others.

Unlike homeowners who lose their home and credit when they default, Tishman is unscathed:

The Stuyvesant Town deal is one of several Tishman Speyer did at the top of the market that the company is trying to save. But the company itself isn't threatened. It took advantage of easy credit and investors' eagerness to buy into real estate during the good times. As a result, it didn't put much of its own cash into deals.

Of the $5.4 billion price tag on the Stuyvesant property, Tishman invested only $112 million of its own money, with about $56 million from Jerry Speyer and Rob Speyer, co-chief executives of the New York-based company.

--"Tishman Venture Abandons Stuyvesant Deal"; The Wall Street Journal (1/25/2010)

The article then notes that against the $56 million it put in, Tishman collected more than $10 million in property-management fees running the property.

Nice.

I guess that would be Exhibit A in artfully using "other people's money."

Liking (vs. Loving) Your Clients

Friends, Family -- & Clients: Tough Mix

You can love your pet, just don't LOVE your pet.

--"The Truth About Cats & Dogs" (1996)

That's one of my favorite lines from the movie starring Janeane Garofalo and Uma Thurman.

Oddly enough, it also applies to Realtors' relationships with their clients (and I mean that in a non-patronizing way!).

Certainly, there are lots of Realtors out there who've successfully worked with close family, friends, etc.

However, Realtors who LOVE (vs. love) their clients do so at their (and their client's) peril, for a couple of reasons.

One. They tend to over-identify -- and therefore react emotionally.

Case in point: your best friend/client gets a lowball offer -- not exactly uncommon today.

Instead of taking it for what it is -- a sort of backhanded compliment -- you get indignant, or even mad.

That doesn't help advance any possible deal.

Two. They suppress bad news.

Your best friend/client's home isn't selling -- or even getting showings -- after 4 months on the market.

The obvious conclusion is that it's overpriced, understaged -- or some combination of both.

Instead of relaying that news, you ignore or deny it, letting market time continue to creep up and making the inevitable upcoming price reduction bigger than it has to be.

Three. They over-empathize.

Your best friend/client has lost their job, and is underwater on their house (that is, they owe more on their mortgage than their home is currently worth).

Instead of telling them what their home is likely to sell for, you let yourself be persuaded that it's worth what your friend "needs" it to be worth (memo to sellers: homes are never worth what you "need" -- only what the market is paying).

Bottom line: friends need to be loyal, supportive, and empathetic.

Realtors need to be objective, rational, and business-like.

The two roles may not be mutually exclusive . . . but it's not a natural combination, either.

P.S.: So what about Realtors who don't even like their clients? Or come to hate them? (Rare, but it can happen.)

Thought #1: everyone probably already knows. Thought #2: probably best to move on, for everyone concerned.

The predicament reminds me of a cartoon that shows a lawyer on the operating room table, when suddenly there's a blip on the EKG monitoring his heart rhythm. The lawyer bolts upright, and says to the surgeon, "I'll have you know, I'm one of the best medical malpractice lawyers in town, and if you screw up this operation, I'll bankrupt you."

The second frame of the cartoon shows a thought bubble above the surgeon's head, with him thinking to himself, "Hmmm. . . . . "

The third frame shows the lawyer back on the operating room table, with the EKG now . . . flat.

Goldilocks Approach to Mortgage Modification

Stopping the Runaway Foreclosure Train

The [mortgage modification] rules now being applied . . . have a Goldilocks quality. To get a modification a borrower has to need it a lot, but not too much. If the home is “underwater” — worth less than the balance of the loan securing it — but the borrower can still afford the payments, there is to be no modification. If the borrower is in such bad straits that default is likely even with a modification, again that borrower is supposed to be turned down.

Modifications [go] to those who come up with the right income number, neither too high to qualify nor too low to be likely to meet the modified payments.

--Floyd Norris, "Why Many Home Loan Modifications Fail"; The New York Times (12/3/09)

The low percentage of successful mortgage modifications says volumes about (non-existent) underwriting standards in many parts of the country a few years ago.

In the language of another children's story, the "Three Little Pigs," mortgages are like homes made of straw, wood, and brick in their ability to withstand adverse financial conditions (the proverbial "wolf at the door").

Even straw is too generous in the case of millions of subprime and Option-ARM loans made to already marginal borrowers.

The material that comes to mind is paper -- as in all the Triple A, mortgage-backed "paper" sold by the trillions to investors world-wide.

How ironic.