Is The Housing Rally For Real? Panic Locks; a Primer on Texas Cash Out Refis

Where's the Fed's head when it comes to housing? I can't say for sure, but Fed Governor Duke's speech on "The Mortgage Market and Housing Conditions" is usually a good read.  Duke tends to provide a pointed view of the Fed's take on housing and lending conditions.  If any of this filters into their timelines for QE3 with the objectives of securing the housing, mortgage lending, there is a long journey ahead.

But where is the market's head when it comes to housing, especially investment properties? Small investors can certainly tag along by buying stock in companies like Blackstone. About three weeks ago IMN held its second Single Family REO-to-Rental Forum in Miami. (Attendees primarily included private institutional funds investing in the space, third-party property managers, and service providers.) The participants remained optimistic on the outlook for the business in terms of both potential home price appreciation and cash returns. Of course all real estate is local, but rental yields remain in the 8-14% range on a national basis, with the highest-quality homes and locations modestly below that and opportunities on some specific acquisition criteria (by location, price point, or rental profile) remaining modestly above that - and it is all certainly better than I am earning on my bank account! The consensus on operating expenses as a percentage of revenues appeared in the 40-45% range. Observers noticed increased attention toward the importance of proper tenant selection, as well as a majority of participants focusing on the buy and hold strategy as opposed to flipping. While longer-term rates of rental inflation are fairly stable, participants expect to prioritize retention of high-quality tenants over rent increases. Some companies provided examples of tenant outreach and relationship management; one made the interesting comment that a public REIT could issue OP-units to its tenants as a way to align incentives.

There is a lot of concern, however, as home prices continue to climb and housing construction trucks along that the housing recovery is too good to be true.  There are three main concerns. The first is that the gain on demand owes to investors and international buyers, which could mean its temporary. The second is that the Fed's QE3 is creating another housing bubble. And the third is that the home building industry is not prepared for a gain in construction (which explains the fall in sentiment).

A report by Bank of America/Merrill Lynch suggests that the first concern is overblown. Primary home buyers still make up the largest share of the market although the tight credit conditions have resulted in a larger share of all-cash purchases. Over 20% of buyers who are relocating and 60% of second home purchases have been all cash. In the markets that took the biggest dive (Las Vegas, Phoenix, Atlanta, Florida), investors (major and minor) have played a key role in spurring the housing recovery and have made up a disproportionate share of sales by buying properties in bulk. They've soaked up much of the "excess" inventory and stabilized the market, prompting primary buyers to return, and certainly international buyers are important in places like San Francisco, Manhattan, and Miami. Investor concentration held at 22% over the last three years while international buyers made up 2%, holding true to the past 3 year average.

Regarding the Fed's third round of Quantitative Easing (QE3), yes, mortgage rates are being held artificially low - but is it really creating a bubble? I don't necessarily agree with the experts who say that the term "bubble" is used to describe an asset priced above a level determined by economic fundamentals, and real estate is not there yet. They say many markets just went through a 33% decline in prices, and has not entirely corrected yet. In fact, many are creeping back to being "stable" and home ownership percentages are somewhat steady in the mid-60% area - much closer to the historical average. The credit market has been very tight and every LO and underwriter will tell you that the quality of borrower has improved dramatically in today's mortgage market. So yes, the experts argue, prices are rallying in many areas, but with a much more stable base than we had 10-15 years ago.

Lastly, have you visited Home Depot or Orchard Supply lately? Prices have moved higher. Even the Census Bureau gives us home improvement trends, and retail sales on building materials are up nearly 10% recently. The price of lumber and cement have increased putting construction costs at a +5.5% gain year-over-year. The good news is that there's a positive correlation between new home sales and construction cost inflation indicating a stronger housing market and greater demand. With the forecasted price improvements and the stability in the market, there are positive signals to believe in the housing recovery.

One state that is seeing its share of appreciation is Texas. And there are many state-specific lending laws, one of the more notable being cash-out loans in Texas. I received this note: "I'm a mortgage LO outside of Texas but I have a potential borrower in Texas who would like to pull equity in order to make home improvements.  I explained, as best I could, the lending laws in his state which he was unaware of.  He would like to know the state laws, statues etc. and I would like to provide that information.  Can you direct me to the best place for consumers to become educated on Texas Equity Laws? I searched the web and sent him this. 'Legislative Development of Home Equity Lending: The Texas Constitution, Article XVI, Section 50, has protected homesteads from forced sale for over 150 years. Historically, constitutional provisions did not permit liens on the homestead for equity homestead loans. (Note: The Texas Legislature meets only in odd-numbered years.)."

But Brad Luo with Gregg & Valby, PC wrote, "Texas home equity lending laws are, arguably, the most stringent in the country.  Detailed and specific rules are set forth in the Texas Constitution, Article 16, Section 50(a)(6).  Therefore, Texas home equity loans are also commonly referred to as "(a)(6) loans".  The texts of §50(a)(6) can be accessed here. In addition, the Texas Finance Commission issued its regulations, interpreting the constitutional provisions under § 50(a)(6).  The full texts of the regulations as embodied in Chapter 153 of the Texas Administrative Code may be accessed here. Unless your potential borrower is very versed in interpreting laws and regulations, he may get more confused, a headache, or both trying to read through these materials."

Is the economy expanding enough to support higher rates? Jobs and housing, housing and jobs - and both seem to be doing okay at the moment. Lenders are reporting "panic locks" by borrowers and LOs. We all know, however, that a sudden wave in locks, thus "shaking the tree," does not portend well for steady lock growth. But for last week, the MBA's survey of 75% of retail production showed that mortgage apps were down 7.3% - the first drop in six weeks. Purchases were down 4.1% and refis were off 8.1%. And conventional refis were off 9.1% while GNMA refis were off 2.4%.

So yes, locks picked up this week due to fear as yesterday agency MBS prices took a tumble, dropping nearly .5 in price from the early morning as the 10-yr closed at a yield of 1.95%. Lenders and investors scrambled to changes prices, some a couple times. The primary relevant economic news was that the expert investors interviewed in the financial news strongly recommended stocks over bonds - so it is a shift in sentiment rather than substantive news that is moving rates. This negative trend in bond prices has been in place since the release of the April Employment report, and the downward pressure on bonds increased on Friday.

Looking at the big picture, and debt, since the recession ended four years ago the federal budget deficit has topped $1 trillion every year. But now the government's annual deficit is shrinking far faster than anyone in Washington expected according to a new report released yesterday by the nonpartisan Congressional Budget Office. It estimated that the deficit for this fiscal year, which ends on Sept. 30, will fall to about $642 billion, or 4% of the nation's annual economic output, about $200 billion lower than the agency estimated just three months ago. The agency forecast that the deficit, which topped 10% of gross domestic product in 2009, could shrink to as little as 2.1% of gross domestic product by 2015. And economist Elliot Eisenberg points out that in the first quarter of 2013, total household indebtedness fell to $11.2 trillion, "1% lower than in Q4 2012 and way down from the peak of $12.7 trillion in Q3 2008. Mortgage debt now stands at $7.9 trillion, HELOCs are at $522 billion, student loans are at $986 billion (yikes) and auto, and credit card and consumer loans total $1.8 trillion. While less debt is good in the long-run, deleveraging is delaying the recovery."

So we find the U.S. Treasury's 10-yr. risk free yield back up to where it was in mid-March. Hey, if it's there because the economy is doing well, good! But when the 10-year yield was last at this level, agency MBS prices were about .250 better. Have mortgages become riskier? Probably not, and MBS investors are in sniffing around to buy more given the attractive comparative levels. Tradeweb and Thomson Reuters reported that "Mortgage banker selling was modest at close to $2.5 billion which is manageable at the Fed's average pace of over $3 billion" and that "MBS volume was slightly above normal at 108 percent of the 30-day moving average based on Tradeweb's experience."

We will have news to chew on today, so something more than "changing investor sentiment" to move the markets. We already had the MBA's application numbers (see above) but later we'll see a May number: Empire State Manufacturing Survey (projected slightly higher). We also have the Producer Price Index (expected unchanged at -0.6%), and the Industrial Production and Capacity Utilization duet for April. In the very early going we saw a little buffeting from Asian and European markets, and the 10-yr is sitting around 1.96% and MBS prices are roughly unchanged.