howardpr

Why Europe Matters to Your Mortgage (Now)

When most of us think of Europe, we think of the Tower of London Bridge, the Leaning Tower of Pisa, bullfighting at La Plaza De Los Toros in Barcelona, or dining at the Eiffel Tower in Paris. For many of us, the slightest mention of these places take us on a time warp of days gone by. Nonetheless, the place to be right now in Europe is Frankfurt. You might say “Frankfurt? Nothing is in Frankfurt.” I would agree, as there is nothing awe-striking in this city. However, the European Central Bank (ECB) is headquartered in Frankfurt and some big decisions are taking place now, which are having a huge effect on our mortgage market.

Most would agree that our world is now interconnected, and what we do here in America effects the world. Conversely, what the world does effects us. Accordingly, the ECB, or Europe’s “Fed” recently made the decision to purchase $58 billion dollars in bonds per month. This is Europe’s nascent attempt at quantitative easing (QE). Our American Fed recently wrapped up its third round of QE in October of last year and many considered it to be a smashing success. If the intent was to drive down rates, it did just that. Mortgage rates hit a 55-year low of 2.875 percent, a rate unseen since the presidency of Harry Truman. Now, the ECB is engaged in its own efforts to kick start its economy as demand for Gucci bags, Hermes shoes, Siemens trains, Rolls Royce cars, French cosmetics, and British TV shows have gone off the cliff.

Now, the ECB’s move has resulted in an erratic real estate market in the U.S.  Our stock market has fallen, but then rebounded.  Prices of U.S. Treasuries increased sharply, and then fell like a brick. Mortgage rates initially skyrocketed, and then topped out; now, rates have been falling ever since. What’s going on?

For starters, Europe’s economy is weak. Outside of Germany, every country in the Union is experiencing a bit of the economic flu. Europe was slow to kick start its economy when things got rough and the US got tough. The US Fed went through three different rounds of QE to get the economy growing. Now, Europe is just starting its first QE. Many view Europe as weak on immigration, soft on unity, and lax on regulation. Accordingly, investors are running away from the mighty Euro, and into the arms of the American greenback and other dollar denominated instruments such as mortgage bonds that sent rates down and fast.

As we can all see, the decline in oil prices has lowered rates at a steady pace. The European flu has hastened the fall. The more that we believe that Europe is not recovering fast enough, the more that we, the American citizenry and the world’s citizens will run from the Euro, European stocks, and will even be fearful of German bonds. People will tepidly avoid French bonds, Spanish, Portuguese, and Italian bonds. They will have absolutely no interest in Grecian bonds whatsoever, as Greece still has no forecast of stability anytime soon. Instead, the world that once looked to Europe for financial stability will return to investments originating on American soil.

The world is putting its full faith and credit in our investments, particularly bonds backed by the mortgages built on American shoulders. As such, interest rates are falling because investors are looking for safety and not necessarily a return on their investment. What is far more important is the return of the investment! Now, faith is in the homeowner making their monthly payment to protect the American dream. Faith is in the factory owner striving to pump out product and keep the lights on. Faith is in the apartment complex just outside of the Central Business District. As the worldwide demand for debt backed by American real estate debt rises, the interest rate that banks can offer falls. At this time, the world doesn’t seem interested in French debt, Italian debt, Japanese debt, Chinese debt, or Argentinian debt. Instead, it finds itself running for the greenback, and Americans will watch rates fall and enjoy every minute.

It’s sad to say this for now, but what’s bad for Europe is great for the American borrower. The lack of demand for anything financial in Europe is a boon to us. The ECB has to buy bonds to kick start its economy because other investors won’t move. Increased demand drops interest rates, and others around the world will be motivated to buy U.S. treasuries, corporate, and mortgage bonds by the billions. We the people will be laughing with our interest savings all the way to the bank (literally)!

Preston Howard is a mortgage broker and Principal of Rose City Realty, Inc. in Pasadena, CA. Specializing in various facets of real estate finance, he can be reached at howardpr@rosecityrealtyinc.flywheelsites.com.

The True Tightness of Residential Finance

There has always existed a subtle Chinese wall in between the worlds of residential and commercial mortgage finance. One relies more on the borrower, the other relies on the property. One looks at DTI (debt to income), while the other looks at DSCR (debt service coverage ratio). Each camp has “purists,” of those who never have considered originating a loan on the other side of the aisle, and would rather refer it out to someone that they trust to do a good job in an area of expertise that is not their own. Fannie and Freddie actually provide very attractive financing to both sides of the fence, with regards to SFR-4unit properties on the residential side and multi-family units on the commercial side. As much of a dichotomy as it has been, the pendulum is swinging in favor of the commercial loan, and even the highest people on the financial food chains of capital markets agree.

First of all, the banks have a strong preference for strong collateral, which lends to the idea that commercial real estate finance is the darling of the ball at the moment. Borrowers have been so decimated by the recession, that whole generations, namely Generation X, have found themselves in a financial funk that is caused and characterized by underemployment, reduced wages, slaughtered credit scores, and compromised mortgage histories which include loan mods, short sales, and foreclosures.

On the residential side, Fannie Mae and Freddie Mac have handed down the verdict that borrowers with the preceding mortgage issues have to have four years of good payment since the original incident. Every document imaginable is being asked for. Proof of child support for 23 year old children, copies of $2,400 social security check stubs for multi-millionaires, and 24 months HOA payments to show continuity of obligation are all some of the asinine requests that are coming from the residential regulatory camp which is sending the buyers running into the streets pulling their hair out in frustration.

It has gotten so bad that the chief architect of our country’s recovery from the brink even ran afoul of some the regulations. Former Fed Chairman recently shared how he and his wife were recently turned down for a home loan. Yes…the man who had his hand on the control button for the world’s economies got denied financing on his Washington DC home that has about $1,000,000 in value and very little debt. As Fed Chair, Dr. Bernanke made $199,000 as our central bank chief, and even now commands $250,000 a speech as an independent financial policy expert. The Fed’s website says “after completing five years of service, you are vested and entitled to a monthly retirement benefit that can begin as early as age 55.” Dr. Bernanke is 61 and served in the Chairmanship for 8 years, so needless to say, he’s got more than enough income. He has the equity in his home, and given his prominent position, we can assume that he has pristine credit.

So what gives? Why is he put through the ringer? The current system is indiscriminating towards a borrower no matter who they are. For now, the black box rules. The post-2008 guidelines make it hard to get residential financing in spite of ones stature or position. So the best of borrowers will fume and cuss, shake a fist and protest, but truly, que será sera. Unless one is buying their personal residence, it makes all sense to buy a commercial property. The guidelines aren’t as tough, the underwriting isn’t as onerous, and the conditions for closing are totally predictable. There is no conceivable reason outside of owner occupancy why one would buy residential property right now. Everyone has to put down 25%, so one might as well get as much as they can with whatever their capital can buy.

So residential lending is still stuck in a rut after almost seven years. What’s it going to take to loosen the lever? Will envy do it? I don’t know. Will new policy do it? Probably…but all interested parties need to come to the table. The market for residential money is tight, and the pathway to commercial greatness is the road less traveled. I think that there is time for a change and a new reality. Commercial rules the day (for now) and residential appears to be the relic of the days gone by. What do you think? For me……I think that I want to buy some units or a strip mall, and I wont have to sell my child to qualify!!

Preston Howard is a mortgage broker and Principal of Rose City Realty, Inc. in Pasadena, CA. Specializing in various facets of real estate finance; he can be reached at howardpr@rosecityrealtyinc.flywheelsites.com.

Oil and Interest Rates

Has the American consumer been partying or what? It seems like it was just yesterday that Americans were paying $4.70 for a gallon of gas. People were trading in their Excursions for Priuses, and their full-sized Tundras for monthly passes on the Metro. Well, the advent of the hydraulic fracking of Bakken shale has yielded an oversupply of oil unseen since the 90s and consumers are lovin’ it. People are filling up the tanks of their Navigators and spending the savings on dinners, movies, bags and boots. With prices down from $4.70 to $2.35, the 50% price reduction has shifted disposable income into other goods and services and also savings accounts. But what about oil’s effect on interest rates? In many ways you would be surprised.

First of all, as oil prices fall, the dollar rises. This makes American produced items more expensive to the outside world. Oil, or to use a more general term, energy is a major component in the calculation in the rate of growth within our economy. at times it can account for 9% of total GDP. The Fed would like nothing more than for the economy to grow at a rate of 2-3%, however, with such a drastic reduction in the price of oil, the Commerce Department feels that inflation may not exceed 1.5%. Accordingly, the Fed may choose not to raise interest rates as broadly expected by the American people and predicted by economists around the globe. If rates don’t rise and inflation doesn’t catch hold, we are due for more stagnation, as prices of goods aren’t going up, but neither are workers’ wages.

For the consumer, the short term has been great. Not only are fuel costs down, but also the 10-year Treasury is down to almost 2.00%. This has translated into residential rates falling back into the 3.5% range. Commercial loans on apartments hover in the high 3s, and traditional loans on office and retail are solidly in the low to mid 4s. So for those who felt that the party is over, think again. Historically low mortgage rates are still available and present, but in the broad scheme things, oil’s decline is of great concern to the macro economy.

Because oil prices are falling, prices of all types of goods are falling. If prices of goods are falling, manufacturers are not raising the prices of the goods they produce. So if manufacturers don’t raise their prices, wages remain flat, or they fall! When wages stay flat or fall, it creates doubt and pessimism. In spite of the record low oil prices and low interest rates, the lack of inflation, and corresponding increases in interest rates, leaves the country in economic and emotional doldrums. This leaks into society and turns into reduced desires to buy homes, apartment buildings and other structures. People sit on the sidelines and worry. This new phenomenon is exacerbated by the fact that Venezuelans are pilfering grocery stores, Russians are selling rubles by the garbage bag and Brazilians are standing in mile long unemployment lines due to costs of having a society that is primarily reliant on oil. So the cheaper the oil is, the less money these countries have, and the more their citizens suffer.

In our own bubble of living life from day to day, low oil prices and low mortgage rates are absolutely great. Unfortunately, in the macro analysis, lower oil prices and lower rates translate into lower faith and confidence in our economies as a whole.

So oil is driving people back to the pump and away from the bus stop, but it is also driving a lot of the world into ruin. The basic rule of thumb still stands, when the economies of the world are celebrating, rates go up. When the economies of the world are in ruin, rates go down. Domestically, our low cost oil and amazingly low rates are a boon. However on a global scale, they’re a bust.

Preston Howard is a mortgage broker and Principal of Rose City Realty, Inc. in Pasadena, CA. Specializing in various facets of real estate finance; he can be reached at howardpr@rosecityrealtyinc.flywheelsites.com.

Doing Deals With Foreign Financing

“Access to capital” was the catch phrase of the day, not only real estate markets but also high finance. Many people had “hot” business plans with wonderful ideas, and “the inside scoop on a great deal”; in fact, the missing piece was access to capital to close it. Banks have been the traditional source of capital; however, with the advent of Dodd-Frank and Basel III, banks which normally originated business loans stopped for fear that these dollars wouldn’t come back. Now, there is so much scrutiny involved with the ABC alphabet soup of Federal regulators from the OTS, FHFA, and the SEC, to the Fed and the DOJ. As you can very well imagine, there are deals that need funding right now! Well, with the advent of foreign investors coming to the fore, a new breed of lender is here and want to make waves in the industry.

There is a purported $3 trillion in capital waiting to be deployed in the marketplace. I have seen this type of lender pursuing the lowest cap rates (NOI/sales price) in history and satisfied with low returns of 2% or less. Investors, both individual and institutional, are coming to the United States looking for deals and a higher yield. Individuals and investment funds from China are purchasing apartments, office towers, mixed-use properties, strip malls and power centers for their own accounts. The returns are paltry, ranging anywhere from 2-4%; yet, the rate of return (for the moment) is satisfactory, as many of these purveyors of capital have a low “hurdle rate” of required return on their investment.

I recently sat down at a coffee house with a gentleman with roots from the Middle East. As we were sipping coffee, he shared his connection with someone from his home country charged by the national government with devising a multi-billion dollar fund for real estate investments to invest in both debt and equity transactions. Obviously for his colleague to look abroad, opportunities in their home country must be scarce. Accordingly, they are fishing and trolling for all types of transactions in all of the four food groups (multi-family, office, retail, and industrial). As you can imagine, there are deals that need to be funded in all four groups, and this is an example of alternative financing to make deals happen. Just to be clear, this is not the only example of capital looking for deals from around the globe. Currently, sovereign wealth funds, international debt and equity funds, along with global hedge funds have an insatiable appetite for transactions, especially if they are providing double digit yields. It is just a matter of finding quality deals of quality and size that fit.

Our American yields are sub-5%, and are barely able to keep up with inflation and taxes. Hence, we are in the same boat as foreign investors. However, with creativity and an ever watchful eye that looks for good deals that make sense, transactions can be found that make sense on Class A and Class C properties in transitional areas which make sense for redevelopment.

In summary, foreign money is attractive when you have a good deal. Everyone wants to make a substantive yield on their investment, and American real estate is still one of the most reliable investments around. The foreign buyers have already come to make all-cash deals as buyers; now, they are looking to become creditors too. Who knows, with the right combination of a common sense business plan and a common sense debt fund, we could be in store for a whole new wave of lending.

Preston Howard is a mortgage broker and Principal of Rose City Realty, Inc. in Pasadena, CA. Specializing in various facets of real estate finance; he can be reached at howardpr@rosecityrealtyinc.flywheelsites.com.