The Following Article is from the Winter 2007 Newsletter
If you’ve been paying even the slightest attention to the news in the real estate industry, you have been inundated with information on the credit crunch – arguably the most significant financial event to occur in the last decade or perhaps ever in the residential and commercial real estate markets. While much of what has been reported falls on the negative side of the ledger, what’s happening out there is not all bad. In fact, things cannot be that bad when you are still able to borrow with long term fixed rates hovering in the low 6.0% range for 30 year conforming mortgages (maximum $417,000) and jumbo mortgage rates around the mid-7% range. There has been fear of a total lack of liquidity in the marketplace, but in actuality, that doesn’t appear to be the case. Rates remain at near-historic lows relative to the last 50 years and lenders are actively quoting transactions.
The problem is in the Wall Street Secondary markets where the jumbo loans have inappropriately been penalized for the sub prime situation, creating a temporary aberration in jumbo mortgage pricing as investors are holding back on buying anything jumbo, regardless of the quality. Keep in mind that virtually all banks sell off their mortgages, but retain the servicing. It is unlikely that you would ever know that the check you send into your big or small bank is being forwarded to the major insurance company or hedge fund that owns the mortgage.
It’s likely that the jumbo rates will come down, but not to the now obviously unsustainable (and inappropriate) spreads of the past few years, but to a spread more closely tied to historic levels, which take into account the premium necessary for real estate backed assets. The economic events this time are declining home values and increased demands by investors for premiums for mortgage paper. Clearly, there has been major carnage that we are now seeing in the mortgage business. It is a major shake out of the proliferation of mortgage players. While the root causes are different from the tough times the sub prime industry has been going through, the effective causes are the same. Investors are spooked about any risky product and as a result the secondary market has severely contracted in the short run. And it is more than just the sub prime companies that have gotten caught up in the carnage. American Home, for example, was not a sub prime lender, but did do a lot of nonconforming (Jumbo) A paper product. Its demise caught much of the industry in shock. The fallout has resulted also in Green Point Mortgage being closed by its parent company, Capital One.
Whereas previously, sellers and borrowers held all the cards, these players are becoming more cooperative with buyers and lenders and we’re already beginning to see positions softening. As the market cools and returns to a more moderate level of activity, participants will hopefully accept that they are mutually dependent and that a zero-sum stance won’t get the deal done. The result is a return to a more traditionally processed transaction and a more realistic real estate-focused investment.
The desire to invest in hard assets fueled by cheap debt and weak credit standards drove many to acquire real estate based more on a financially engineered yield expectation than on the fundamentals of real estate values. As we return to a more traditional business model for acquiring and financing real estate, the environment will reward well-capitalized (less leveraged purchases) and we will return to experience real estate increased asset value though fundamentals, not financial engineering.
While it’s easy to blame softening real estate values on less attractive leverage offered by Wall Street, that wouldn’t be entirely accurate. July’s credit implosion, for which it will take months to normalize, masked the fact that the economy is weakening, forcing buyers and lenders to reevaluate property growth assumptions. In the end, the economy drives value more than anything else, so the saying, “It’s the economy, stupid” might prove true again.
Joseph Levy, is the Owner of Affiliated Capital Resources, a mortgage banking firm in Santa Monica, CA. Mr. Levy received
his MBA Degree in Real Estate Investment Finance from University of Connecticut. The opinions expressed here are strictly those of AFFILIATED CAPITAL RESOURCES and are subject to change without notice. AFFILIATED CAPITAL RESOURCES is a mortgage banking firm which advises accounting and business management firms pertaining to residential and commercial real estate financing services for their clients. DRE License No. 01125517
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