Apr. 27, 2013: Where remodeling dollars are going; blather on the link between underwriting, appreciation, and loan volumes
“Home improvement” for a guy often involves changing the shelf his sweatshirts are on, or perhaps shifting the cinder blocks holding up the book shelves. Well documented studies show that 97.8% of home improvement decisions are made by females. Okay, I just made that up, but it might be close. Regardless of who is deciding on a new bathroom or potting shed, lots of folks are remodeling, and we can only expect this to increase as families stay put in their house with those sweet 3.50% 30-year fixed rate loans. The Census Bureau is here to tell us how much and where we’re spending our remodeling dollars: http://www.census.gov/newsroom/releases/archives/housing/cb13-tps44.html; just click on the link near the, “How do we know? Infographics;” note.
What impact does home price appreciation have on the securities market, and will prices keep going up? I am the first to admit that I don’t have a crystal ball, but there are some things upon which most experts agree. US home prices have surged in the past year, in part due to home improvements like those above. Some believe that this increase in prices will last about six months until the demand is satisfied – and then what? But unlike the brief rally in early 2010, this latest turn in home prices seems sustainable and not driven by one-off factors (such as the 2010 tax credit). Others believe that home prices should increase over the next two years driven by momentum and a surge in investor demand. But remember, much of our economy is helped by jobs and housing, housing and jobs, and usually jobs lead to income. Longer term, a strong housing market is not sustainable without a commensurate increase in incomes.
What do investors in residential MBS think about housing appreciation? In agency MBS, any upside surprise in home prices should still have a limited effect on how fast pools of loans prepay – their “speed.” Speeds on pre-HARP or low-LTV post-HARP borrowers are unlikely to be affected. But high LTV pools should prepay faster. Barring a very strong recovery in housing, most believe the GNMA MIP protection is likely to deteriorate as FHA borrowers are able to refinance into conventional loan products (with or without MI). At the same time, discount speeds on these pools should stay elevated when rates rise. In non-agencies, an upside surprise in home price appreciation could lower losses an additional 10-15% versus base case expectations. The incremental benefit from an upside house appreciation surprise is greatest for the most leveraged subprime, followed by option ARMs/alt-B and alt-A/prime. Finally, while non-agency issuance should pick up as housing improves, it will likely remain impeded by regulatory uncertainty on QRM and rep and warranties.
One cannot ignore the psychological impact of appreciation. Who doesn’t want to see their house increase in value from one year to the next? Think of how many neighbors visit open houses on Sunday’s, sniffing around to see how the house stacks up versus their own place both in appearance but also in price? And, just like when the value of one’s 401(k) increases makes one feel better, when one’s house is worth more it helps their outlook and in turn perhaps their financial decision making and spending.
There are many measures of home prices (Existing Home Sales, FHFA, Case-Shiller…the list goes on and on). But most show an increase. Let’s say that overwhelming evidence shows that home values have been increasing steadily across the nation since they hit a bottom in October 2011. Since October, they are up 6.5 percent. Just over the past year, home values have appreciated by 5.8 percent. This rate of appreciation is higher than the historical average of around 3 percent.
As we might expect, the areas that took the biggest hit are showing the biggest bounce. Some metropolitan areas have experienced even higher rates of appreciation. For example, Phoenix has appreciated by almost 23 percent over the past year, Las Vegas is up 18.1 percent and Miami’s home values have increased by 11.5 percent. While home values are still below their peak values in most areas, they are alarmingly high given income levels and mortgage rates.
Old-timers remember a general rule of thumb that someone should be able to buy a house at roughly 3x their yearly income. Someone making $50k a year could buy a $150k house. The industry sure shot past that in the early 2000’s as many programs accepted stated incomes, or programs offered different amortization schedules to fit different incomes. Most, if not all, of this has gone away, and veterans think underwriting has returned to the early 1990’s, including how income is viewed. Incomes have either been stagnant over the last years, or have been making up declines of past years. Median household income in the United States is currently at 2008 levels. This in turn will impact how much house consumers can afford. During the housing boom, the United States price-to-income ratio had increased to a high of 4.0 from a historical average (measured from the first quarter of 1985 to the fourth quarter of 1999) of 2.6.
After the market peaked in May 2007, home values fell and so did the price-to-income ratio. Recently home values have gained much upward momentum due to inventory shortages across the nation. On the demand side, investors have been very active in the market, taking advantage of lower home values and an uptick in the demand for rental housing by converting lower-end for-sale properties into for-rent properties. Real estate buyers have been enjoying record-low mortgage rates when buying homes, boosting their buying power. Taken together, these factors have been the recipe for bidding wars and homes that sell for more than the listing price, lifting overall home values.
Whether or not you are a fan of big government, it has given the industry low rates and great refi programs. Specifically, mortgage rates have given consumers an incredible purchasing power boost, as home affordability is at an all-time high. While income levels are not expected to grow significantly beyond their normal rate in the next years, mortgage rates will eventually increase as the Federal Reserve decreases their quantitative easing efforts. We all know that rates will go up, it is just a matter of when – and plenty of lenders are “making hay while the sun shines.” With increasing mortgage rates, buying power decreases and affordability levels will return closer to their historical averages.
In turn, the price-to-income relationship will once again be too high as home values are no longer sustained by demand fueled by low mortgage rates. Home values will have to either remain stagnant, while incomes catch up, or – the more likely scenario – home values will decrease. This will especially be the case in those markets that have seen strong home value appreciation. So enjoy the rally in home prices. No tree grows to the moon, and no market goes one direction forever. But experts think that the rate of current home value appreciation in most areas is not permanently sustainable and is due to inventory shortages and more importantly record low mortgage rates. The future for many areas could have stagnant or depreciating home values and a price-to-income ratio that is more in line with its historical average.
The home building industry has been on a tear lately. It seems like eight months ago builders were crying in their beer, sitting on swaths of vacant land, saying no one wanted homes. Now that has changed for the most part as demand has picked up. Pollsters ask builders if they are optimistic or not, and over the winter and into the spring optimism had really picked up. But home builder sentiment recently fell for a few months in a row despite a booming housing sector. This is probably because small builders face increasing difficulty finding lots, spec loans are still largely off limits, lumber prices have doubled, and labor shortages abound. Despite these woes, housing starts will rise by 200,000 units in 2013. The question to ask is will small builders or big builders get most of this business.
And lots of first time home buyers buy new tract homes using FHA financing – one of the reasons the industry & politicians want to keep the program alive. Originators who know the product, and changes to it, have a distinct edge over those that don’t. Back in March I received this note from a veteran LO. “This week we had the pleasure of meeting with a couple that wanted to purchase a home. They told us they were approved for an FHA loan with a large money center bank. Not very long into our initial discussion we learned that they had 10% to put down. When they told us about the 10% down, alarm bells went off in our heads. Very rarely would a borrower put that much down on a FHA. The main reason you would do that is if you have a low credit score, which they did not (there are some others reason too).”
The note went on. “We knew that the monthly Mortgage Insurance Premium (MIP) for FHA would be increasing with all case numbers pulled after April 1, 2013. But what we also knew, but that was rarely talked about when clients are getting an FHA loan, is when the borrower can bail out of the MIP. Up to 4/1 if you have a loan with a term greater than 15 years and the loan to value is greater than 78%, then you will have MIP for 5 years AND must pay the loan down to 78% LTV based on the original sales price (unlike a conventional loan which will use current market value to determine LTV). After April 1, 2013 not only is the MIP going up, the amount of time you have MIP is changing too. For loans with an LTV greater than 78% up to 90% LTV you will be living with MIP for 11 years. If the LTV is greater than 90% you are in for life of the loan (ouch). Bailing out of MIP using LTV is out; it is strictly a function of time. When we explained this to our client (which the big bank did not), and offered them an 80-10-10 solution they were greatly relieved and appreciative.”
(Parental discretion advised!)
A man and a woman were sitting beside each other in the first class section of an airplane.
The woman sneezed, took out a tissue, gently wiped her nose, and then visibly shuddered for ten to fifteen seconds.
The man went back to his reading. A few minutes later, the woman sneezed again, took a tissue, wiped her nose, and then shuddered violently once more.
Assuming that the woman might have a cold, the man was still curious about the shuddering. A few more minutes passed when the woman sneezed yet again.
As before, she took a tissue, wiped her nose, her body shaking ever more than before.
Unable to restrain his curiosity, the man turned to the woman and said, "I couldn't help but notice that you've sneezed three times, wipe your nose and then shudder violently. Are you ok?"
"I am sorry if I disturbed you, I have a very rare medical condition. Whenever I sneeze I reach a peak of sexual pleasure."
The man, more than a bit embarrassed, was still curious. "I have never heard of that condition before" he said. "Are you taking anything for it?"
The woman nodded, "Pepper."
If you're interested, visit my twice-a-month blog at the STRATMOR Group web site located at www.stratmorgroup.com. The current blog is, “How Changes in FHA Loan Pricing Will Lead to Changes in Investor Demand." If you have both the time and inclination, make a comment on what I have written, or on other comments so that folks can learn what's going on out there from the other readers.
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