Tag Archives: Nevada real estate

Playing Risk: Nevada and the secondary mortgage market

Risk game boardThere are some topics which engender eye-rolling and extended yawns, and the secondary mortgage market is one of them.  That peril acknowledged, Nevada’s housing market is precariously balanced on the edge of this subject, so it’s worth risking another foray.  Let’s start with an article in the Las Vegas Sun,  concerning the implications of the Obama Administration’s decision to wind down the Mortgage Twins — Fannie and Freddie — in the backwash of the Mortgage Meltdown.

Blue BookA Quick Review

The focus of the article concerns the (1) possibility of increased mortgage rates in a fully privatized secondary mortgage market, (2) pressures on first time home-buyers which could be exacerbated by a privatized mortgage market, and (3) problems with establishing home values.

What is the Secondary Mortgage Market?

Here’s the standard definition:  “The market where mortgage loans and servicing rights are bought and sold between mortgage originators, mortgage aggregators (securitizers) and investors. The secondary mortgage market is extremely large and liquid.”  [Investopedia]

The mortgage originators (banks & other lenders) sell their home loans to “aggregators” who securitize (package the mortgages into bonds) and sell them to investors.   The second sentence in the definition might well qualify for inclusion in the Understatements Of The Century awards.

The idea behind this “large and liquid” — or Big and Squishy — system is to minimize RISK.  The bankers don’t have to keep all their loans on their own books, thus reducing their exposure to defaults, and the aggregators can re-package loans in ways to attract investors who want yield without too much RISK.  We’ve already covered all those intriguing and creative “financial products” (swaps, etc.) manufactured to further reduce RISK — which in some circumstances (read 2008) can create even more RISK.

Risky Business

There is one crucial point in the Sun article which should point us toward the critical problem with immediately  privatizing the secondary mortgage market:  What’s the value of the property on which the mortgage is based, and is the foundation for the securitization in the secondary phase?

If home values stabilize or increase the homeowners are more likely to be able to pay and not default on the loans.  When home values decline, as we learned to our peril, “underwater” home-owners are more likely to default which, in turn, de-values the aggregated and securitized ‘packages’ sold to investors.

Blue Book

The Rules of the Game

While those interviewed for the article use the term “guidelines,” let’s call those The Rules of the Mortgage Market Game.  One of the functions of the “Mortgage Twins” is to establish basic rules for home loan lending.  The Congressional Budget Office analysis explains:

“They purchase mortgages that meet certain standards from banks and other originators, pool those loans into mortgage-backed securities that they guarantee against losses from defaults on the underlying mortgages, and sell the securities to investors–a process referred to as securitization. In addition, they buy mortgages and MBSs (both each other’s and those issued by private companies) to hold in their portfolios. They fund those portfolio holdings by issuing debt obligations, known as agency securities, which are sold to investors.”

The two essentially risk reduction elements are in the first part of the explanation quoted above. (1) Fannie and Freddie have mortgage lending standards.  (2) Fannie and Freddie operate as aggregators who will re-sell the mortgage packages to investors.

When the banking system collapsed in a heap in 2008, the Mortgage Twins ended up holding most of the bag.

“…in 2009, the two GSEs owned or guaranteed roughly half of all outstanding mortgages in the United States (including a significant share of subprime mortgages), and they financed three-quarters of new mortgages originated that year. Including the 20 percent of home loans insured by federal agencies, such as the Federal Housing Administration (FHA), more than 90 percent of new mortgages made in 2009 carried a federal guarantee.” [CBO]

Not to put too fine a point to it, but when the banking system took on too much risk during the Housing Bubble, the explicit federal guarantee for the secondary mortgage market backstopped the home loan lending process in this country, and in this state.  That’s the good news.  That doesn’t mean there aren’t still some intrinsic problems with the Mortgage Twins.

The Backstop Effect:  Little encourages more risky behavior than the notion that someone else will end up holding the bag.  As long as the federal government assumes responsibility for the home loans, then the bankers can see the system as one that privatizes the profits and socializes the risks.   This rationalizes the practice of offering exotic home loan products to people who might never have qualified otherwise.

The Quis custodiet ipsos custodes?  Factor:  Who was watching the watchers before 2008?  Before 2008 the Mortgage Twin’s regulators lacked the authority to increase the capital requirements for Fannie and Freddie.  Nor could the regulators place the Twins in receivership as the government could in the instance in which a bank went under.  No one should have been surprised when the Twins were placed in conservatorship in the wake of the Housing Bubble deflation.

There’s little appetite from most quarters to leave the current system in place.  However, the next step in the reform process must address some difficult questions.

Blue Book  “Students are required to provide their own 8½ x 11 bluebooks. Do not use the smaller sized bluebooks. Bluebooks are available at the University Bookstore. The exam proctor will also always have some emergency blue books available.”  [Law.Wash.EduAnd the test questions are:

#1.  What configuration for the secondary mortgage market will best ensure a stable supply of mortgage financing?   Consider the consequences of a fully public model, a hybridized public-private model, or a fully privatized system.

#2. How are the underlying assets to be valued? Your answer should give consideration to (a) the standards by which the quality of the underlying loans are to be evaluated, (b) who should establish the standards for this evaluation, and (c) how the housing finance structures might be affected by the needs of the banking sector, the construction sector, and the needs of middle income prospective home-buyers.

— Good Luck —

For a fuller look at some possible answers, see Congressional Budget Office, ” Fannie Mae, Freddie Mac, and the Federal Role in the Secondary Mortgage Market” December 22, 2010.   New York Times, “Washington Steps Warily on Housing,” August 6, 2013.   New York Times, “Obama Outlines Plans for Fannie Mae and Freddie Mac,” August 6, 2013.   Federal Reserve Bank of Atlanta, “Financial Market Update, Volume 14, No. 1: Fannie Mae and Freddie Mac at work in the secondary mortgage market.”  University of North Carolina, Center for Community Capital, “Fannie, Freddie, and the Foreclosure Crisis,” September 2010.

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Filed under housing, Nevada economy

Before We Get All Sappy Happy: Housing and the Economy

Foreclosure StreetSurely, there was a homeowner somewhere in the Sand State of Nevada who saw the headline about home values increasing 9.3% nationwide and smiled.  Not to be a buzz killer and turn the smile into a grimace, but there’s a catch. ” Stan Humphries, chief economist at Zillow, a real estate data provider, cautioned that the national figures are being skewed by sharp rebounds in cities hit hard during the housing bust, including Las Vegas and Phoenix. Investors are helping drive up prices in those cities.” [RGJ]

What’s the meaning of all this?  Investors skewing the prices shouldn’t be news in any commodity, and for the moment let’s think of houses as a commodity.   Who are the investors?  Perhaps they’re the ones who looked at the Local Market Monitor and decided that of 316 cities in the United States, Las Vegas was the best in “estimated returns on investment for single-family rental properties.”  [CNN] Let’s assume for the moment that no one has repealed the law of supply and demand, so a return on investment would be bolstered by having a low initial price for the commodity in question.  At this point there’s a second catch.

Getting a return on the investment in rental property means there have to be people who want to rent and they want to do so at a price which will achieve what the investor believes will be an acceptable rate of return.  As of July, 2012 rental rates across the country were up 5.2%, enough to whet the interest of potential investors.  [HuffPo] However, since all real estate investments are local, someone should have noticed that as of the middle of last year the Las Vegas rental market was the only major one not to see YOY increases in rental prices.

Investors would like to see returns of 7.5%-9.5% (after HOA fees, and taxes, are included), but there are some factors mitigating against those estimated rates of return which are so attractive to the investors.

What happens, for example, when an investment group moves into a local residential housing market and makes offers for homes about 20% over the current market price?   This strategy is fine when there is a glut of residential properties on the market and the home values have taken a real pounding, circa 2008-2010.  The strategy is not so productive when the cream has been skimmed off and properties which have been vacant for some time are still included in the supply figures, circa 2011-2013?

If markets for commodities don’t function well with uncertainty, then Las Vegas could be a poster child.   Foreclosures, a nice source of residential real estate suitable for renting, were running rampant prior to the enaction of AB 284 in the last session of the Nevada legislature.   As of 2012 foreclosure rates were down as banks swanned about trying to clean up their acts in regard to robo-signing and blatantly consumer-unfriendly practices.   The pendulum may be swinging back?   Realty Trac reports that Nevada’s foreclosure rate declined by about 14%, but the 1:320 ratio was still among the highest in the country. [VegasInc]  This might be a good sign for those “investors” if there weren’t so many gray areas in the picture.

A “No Show” doesn’t simply mean absence.  There are “no show” properties as well.  A property could be on hold (H) when there is a valid listing contract but the seller has requested a “no show” because of personal circumstances or because repairs are needed.  A property might also be subject to third party or court approval, in which case it’s “on market” but in a “back up status.”  A residence could also be pending (P) meaning that there is an offer which has been accepted but not finalized.  Then there is the following:

“Las Vegas has thousands of homes with delinquent mortgages where  home owners who have been living mortgage free in their home for more than 2 years, have no motive to short sale their severely under water homes. In a normal market threat of foreclosure would motivate these home owners to seriously market their home as Las Vegas short sales, right now Las Vegas MLS is full of no show, highly over priced short sales that are marketed just to prevent foreclosure. A good example is an agent who has put his own no-show home in Las Vegas MLS at twice the price of comparables; he knows that his home has zero chance of selling.”  [LV4us]

“In a normal market” — but this isn’t a normal commodity market.  We have investors trying to scoop up “value” in residences for speculation offering inflated bids, and sellers who are listing “no shows” without much intent to sell, combined with the prospect of another surge in properties listed as the bankers go for another round of foreclosures.

Timing is everything and nothing.  Or, as Warren Buffett once opined: “We continue to make more money when snoring than when active.” [CBS]  Is an investor likely to see those 7.5% to 9.5% returns if he’s timed his entry into the Las Vegas residential real estate market just as the “big players” have inflated prices and skewed the numbers?  Will the investor see those returns if she has entered the market when the number of short sales increases, and the value of her newly acquired “assets” trends down making the purchase price look good but the assets counted in the total value of the investment look a bit grimmer?    By how much would interest rates have to increase to turn a bargain into an unsalable elephant weighing down the finance planning?

Let’s guess for the moment that the private equity behemoth Blackstone Group is one of the major players in the Las Vegas real estate game.

“The firm has also invested in Northern California. Statewide, Blackstone has poured close to $740 million into California real estate through January, according to DataQuick figures. Nationally, the firm has invested in seven other regions: Atlanta, Phoenix, Charlotte, Seattle, Las Vegas, Chicago and multiple cities in Florida.” [LAT]

And, further let’s review the part in which they have a very financialist version of a business plan for all this activity.

“These firms are also exploring ways of packaging rental income streams into securities, similar to the way mortgages were bundled during the boom years. Those mortgage bonds — often packed with risky home loans that produced mass defaults — turned into the toxic assets that helped bring down major banks during the financial crisis.” [LAT]

What is contorting the Las Vegas real estate market? Why are the prices skewed?

There’s “packaging rental income streams into securities.”  Instead of packaging the mortgages of single family homes into a “revenue stream,” they’re packing rental agreements.  An assortment of 1,000 rental agreements are packaged up as a bond.  Some are very good agreements, others are to people who may vanish with stealth comparable to the Irsays moving the Colts out of Baltimore.  The “value” of the bonds depends upon the quality of the rental agreements included in it.  How does a potential investor in the bonds know the value of the package?  Does fiduciary responsibility require the investor to examine each of the rental agreements or — in a wrenching reminder of days not so long by — does the bond investor rely on the rating agencies to stamp AAAAAAA’s on the paper?

Does the bond investor repeat history by repackaging the bonds, and by creating derivatives?  Will we see a repetition of the CDO quadrupled game as played by Wall Street firms who invest in both sides of the residential rental property market?  That a major private equity firm is willing to risk a repetition of the mortgage market mess created as of 2008 by creating a rental agreement mess culminating in a lovely crash in the not-so-far future seems prima facie evidence of how little Wall Street learned from its most recent escapades.

I’d like to smile about the return of value to Las Vegas homeowners, but the uncertainty in the residential real estate market, the machinations of the private equity crowd and some bankers who have the Bourbon-esque capacity to never forget and never learn, and the prospect of boiling yet another Securitization Stew, makes me want to grimace.

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Filed under Economy, Nevada economy

Could we get a little protection here?

We’re Number Two!  Nevada ranks second in the home foreclosure race to the bottom; Florida maintains the national lead. Full Story – Las Vegas Sun.  The Realty Trac Map:

RealtyTracForeclosures

The national foreclosure rate is down, and perhaps it’s time to start saying “Thank You” to the state of California:

“The U.S. foreclosure landscape in January was profoundly altered by the effects of new legislation that took effect in California on the first of the year,” said Daren Blomquist, vice president at RealtyTrac in a press release.

“Dubbed the Homeowners Bill of Rights, this legislation extends many of the principles in the national mortgage settlement — including a prohibition on so-called dual tracking and requiring a single point of contact for borrowers facing foreclosure — to all mortgage servicers operating in California. …As a result, the downward foreclosure trend in California accelerated into hyper speed in January, decisively shifting the balance of power when it comes to the nation’s foreclosure activity.”  [Business Insider]

Eliminating dual tracking and requiring a single point of contact for mortgage service are good ideas which should be adopted nationwide.   The final rules issued by the Consumer Financial Protection Bureau don’t completely prevent dual tracking (simultaneously pursuing foreclosure and loan modification) but they are a start.  [Bloomberg]

And, now we see another reason Republican members of the U.S. Senate, Senator Dean Heller (R-NV) included, are opposed to the confirmation of Richard Cordray as the CFPB, and are demanding that all rules propagated by the agency protect the profitability (safety and soundness) of the bankers.   How about we start protecting the “safety and soundness” of American (and Nevada) homeowners?

Speaking of protection.   Beware the War on Data.  One of the tools in the pro-gun manufacturers’ kit is the prohibition on data collection.  Michael Bender’s article for Bloomberg News, “Gun Lobby Helps Block Data Collection by Crimefighters,” is a must read.   A taste – one the infamous Tiahrt Amendment:

“His amendments stopped the ATF from requiring that gun dealers check their inventory for missing weapons and mandated the Federal Bureau of Investigation destroy background check results within 24 hours.”

How are anyone’s interests advanced by preventing the ATF from gathering information about missing weapons?   How is public safety advanced by having data collected destroyed within 24 hours?   But wait, there’s more:

“Since 1979, Congress has prevented ATF from keeping centralized gun-ownership records, according to the agency. Sales data instead are maintained by the country’s 58,900 federally licensed firearms dealers. When they go out of business, they’re required to send the paperwork to ATF, which stores it on microfilm and microfiche.”

So, we have no computerized data.  And if one component, the dealer or the manufacturer are no longer in business — no computerized data.  Imagine how much easier a job law enforcement might have tracking illegally obtained weapons IF we had a computerized system?  However, the NRA appears intent upon protecting the “rights” of the hysterical members of the  Fire On The Last Day Red Dawning Instant Militia of West Deer Breath County Camo Club, or the minions of some drug cartel than in assisting law enforcement with gun violence abatement.

Meanwhile KRNV reports:

” A new study says the number of people killed in Nevada by guns outpaced those who died in traffic accidents in 2009.  The study released Tuesday by the Washington, D.C.-based Violence Policy Center says Nevada is one of 10 states where guns deaths were greater than traffic deaths. The other states are Alaska, Arizona, Colorado, Indiana, Michigan, Oregon, Utah, Virginia and Washington.

In Nevada, 406 gun deaths were reported in 2009, compared with 255 people who died in motor vehicle accidents. Nationally, there were 31,236 firearm deaths and 36,361 motor vehicle deaths in 2009.”

Here’s the Chart:

FirearmDeaths

Homeowners whether facing foreclosure issues or looking at the prospect that a member of the family is more likely to die by a bullet than in a Nevada traffic accident — could use a bit more protection.

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Filed under Gun Issues, Heller

Colonial Las Vegas: Investing in the Big Bust

‘Interesting that a former private equity fund manager (Willard Mitt Romney, Bain Capital) would recommend that “the market take its course” in the instance of Nevada’s real estate market,  [LVSun] because one school of thought has private capital absorbing the surplus properties in the southern Nevada real estate market, and transforming them into rental units. [LVSun]

While this plan has much to commend it, there are some pitfalls.  First, the general business model depends on the perception that real estate property transformation from single owner to rental unit will be profitable in a range of 8% to 12% annually.  The problem herein is that not all real estate markets are created equally.  Rental units in an area with expanding employment (population) will obviously be more profitable than units offered in regions with declining or stagnant employment.  The most recent comprehensive study from HUD concerning the southern Nevada real estate market notes a “soft” level of demand for rental units (9.6% vacancy rate) and the loss of employment in gaming and hospitality.

Secondly, the level of profitability depends not only on demand, but also upon the initial sales (acquisition) price, associated rehabilitation or modification expenses, real estate management costs, and upkeep and maintenance expenses.  Returns may also be a function of appreciation.  If the business model being applied says that the firm is expecting to cash in on appreciated prices somewhere down the calendar, then there are more questions which should be raised in the minds of the investors.

Let’s assume for the sake of argument that a hypothetical private equity firm, Big Money LLC, is considering the creation of a property management company, Big Money Realty Management.  BMRM will buy up “distressed assets,” “turn them around,” and then Big Money LLC will sell off the subsidiary company at a profit.  This is the point at which generalizations aren’t particularly helpful.

We can generalize about acquisition costs and say that single family home prices in the southern Nevada market have spiraled down by 64.8% since the second quarter of 2006. [BrookingsWest pdf] If our BMRM is purchasing a large number of properties, then median prices might be a useful statistic to incorporate in the profitability formula.  However, the smaller the number of properties acquired the less useful the median price number becomes. A small investment level may mean that the median price is roughly analogous to putting one hand in boiling water, the other in an ice bath, and announcing the “average” temperature to be tepid.  The essential profitability question may hinge on the magnitude of the initial investment.

Third, success is in the eye of the beholder.  The Big Money Real Estate Management Company may be a successful operation in terms of properties under management, the rationalization of maintenance costs, and the stabilization of administrative expenses — but will it be “profitable” as perceived by the parent Big Money LLC?  There is at least one factor that might be seen very differently from either side of the white picket fencing:  Appreciation.

If the general business plan calls for the value of the properties under management to appreciate to a price of $X on the market, in order to render Big Money Real Estate Management Company an attractive “asset” for sale, then the management company may (or may not) meet the expectations of the Big Money LLC investors — for reasons which may have precious little to do with BMRM’s management practices.  BMRM may be running a very successful operation, but if the value of properties under management doesn’t appreciate significantly enough to satisfy the investors in Big Money LLC, then the exercise becomes one of futility.

Another element of Big Money’s  overall business plan may run counter to the effective operation of BMRM as well.  BMRM’s profitability will in no small part depend on keeping personnel, administrative, and maintenance expenses minimized.  However, real estate property management is not for the faint of heart.

Plumbing problems must be rectified immediately — nothing so readily puts an “underwater” property in jeopardy of further value reduction than to have it be literally underwater.  The very items which increase the value of property (repainting, landscape maintenance, pro-active physical maintenance) are those which increase the costs and depress the profits. The management of Big Money LLC must balance the profitability of its subsidiary’s operations with the desire NOT to become regionally known as a slum lord.   Those high flying predictions of 8% to 12% returns could easily descend to 1% depending on the nature of the properties, the necessity for substantial maintenance, and the administrative expenses.

In short, the hedge funds may be dabbling in dangerous waters.  Too small an initial investment and the overall profitability declines in the face of expenses and forces specific to the neighborhood market, too large and the expenses involved in maintaining property values engulf the initial profitability projections.  There are other factors which make large scale investments in the southern Nevada real estate market a questionable proposition for major money players.

(1) Digging out isn’t the same thing as climbing up.  Colorado Springs, CO was caught in the 2007-09 recession like every other metro area in the intermountain west.  However, its peak to trough employment rate dropped only 3.9%. By contrast Las Vegas plummeted downward by a whopping 14.1%.   Only Phoenix, AZ looked at similar numbers, dropping some 12.5% in the same period.  While Nevadans may look smilingly at the increase in the regional gross metro products gain of 1.6% since, it is handy (and reality grounding) to notice that no other metropolitan area in the intermountain west was starting from so far behind. [BrookingsWest pdf]  Without stronger employment numbers, the prospect for profitable rental management dims.

(2) Consumption without production.  The Nevada economy is overwhelmingly oriented towards consumption not production. Approximately 46.9% of all employment in the state is related to gaming/hospitality, retail sales, and the construction trades.  Of the 1,429,214 employed by all Nevada firms, some 1,123,358 were employed in the service sector.  [Brookings 2011, pdf]  Worse still, most of Nevada’s employment can be plotted in the quadrant with the lowest wages and lowest projected growth rates.  When demand drops Nevada takes a nose dive.

For a full sized version of this graph click here.

The number of employees in low wage industry sectors should give hope for those in the rental management sector. However, for many of these wage earners affordable housing may be better obtained in the multi-family home sector than in single family dwellings.

(3) Coming, then going.  Nevada was once the Destination, and the population of southern Nevada increased by 55% between 1990 and 1998. [Census] The population increased by 35% between 2000 and 2010. [Census] Then there was the bad news — the Silver State which had led the U.S. in population growth for 19 consecutive years fizzled in 2010 counts.  [USAT] Clark County lost 33,960 by 2011, Washoe County lost 7,699, and Carson City was down by 362. [NVDemographer] The boom was well and truly busted.  No longer could Nevada rely on in-migration for economic growth. Nor should property managers rely on in-migration to fill vacant units.

Before we decide that more or less “institutional” investors will save the day by absorbing excess Silver State vacant properties we might want to exercise a bit of caution.

Home prices may not have “hit bottom,” and we won’t know this until they start leveling off and going up again.  Unfortunately, listings still advertise “priced reduced” all too often in nice red lettering, which means we probably aren’t scraping the basement floor yet.  For the smaller investors this may mean more bargains as the number of REO’s and short sales continue, for larger operations (like the private equity funds) there is some peril that valuations may not move as quickly to the profitable end of the chart as short term investors would like to see.  Or, we might translate that more bluntly — 5% to 8% returns may not be on the immediate horizon, and there are other sectors of the economy that would likely see better returns, especially if re-sale prices are part of the formula.

As more REOs (bank owned properties) hit the market, and if short sales continue, then more properties are added to the surplus inventory further depressing local prices.  This, too, isn’t a positive trend for short term income oriented investors. [VegasREBlog]  There is a Scylla to this Charybdis, what if REOs and short sales trend towards the absorption of ‘bargain’ properties?  What if there is a one month surplus in REOs?  There go the opportunities for bargain hunters.

There are also some property management issues for those who want to invest in REO properties, not the least of which is politely called “deferred maintenance.”  Those who cannot afford to be in a house aren’t likely to be those who fix the place up before foreclosure.  A seller may not pay for lender required repairs, homes sold “as is” means there is no NRS 113 required disclosure, and putting these two elements together could be a formula for “Money Pit.” [LVREB] Again, these factors tend to lend themselves better to smaller investor interests than to the needs of large investment firms which may have more capital, but don’t have the expertise, or “boots on the ground” to efficiently manage properties in which the distress isn’t exclusively financial.

The bottom line is that we haven’t yet hit the bottom of the line, and there are no silver bullets to recoup the losses in the southern Nevada real estate market.   But we can hope.

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Filed under Economy, housing, Nevada economy, Nevada politics, Romney