The Impact of Private Equity Investors After the Crash

Before the housing bubble came into effect in the early 2000s the percent of cash buyers was closer to 20%.  After home prices crashed cash during the Great Recession, cash buyers across the United States made up over 40% of home purchases in 2011 and 2012.

As property prices began to recover, private equity & hedge fund investors which purchased hundreds of thousands of homes across the country pulled back from the market & the volume of transactions driven by cash buyers declined.

In 2016 the US Treasury department started tracking all-cash buyers of high-end real estate in markets like New York and Miami.

Almost two-thirds of property purchases worth more than $2m in Manhattan and Miami were made in cash in 2015, according to research group RealtyTrac. More than half those purchases in Miami and almost a third of them in Manhattan involved limited liability companies used to shield the identity of buyers, according to RealtyTrac.

Outside of core hot markets cash purchases have been rather uncommon, until recently. Cash purchases are once again rising across the broader real estate market.

According to ATTOM Data Solutions 28.8% of US home purchases in 2017 have been cash purchases.

Five years after the housing market hit rock bottom, mortgage credit is finally returning to the healthy levels of the early 2000s, before the boom-bust cycle began. But all-cash deals remain well above normal levels, even as prices in many markets have pushed to record highs.

Many sellers prefer to work with cash buyers since the transaction is prompt and almost certain to go through. In some cases the cash buyer can also win with a lower bid as sellers value the certainty.

Cash rich foreign buyers & people who are either downsizing or moving from hot coastal areas inland also benefit from cash purchases as they save on loan origination fees and closing costs.

Proposed changes to the tax code which have passed both the House and Senate may accelerate internal migration away from the rich coastal states to lower tax flyover states, as state income tax payments will no longer be deductible from federal income taxes when the final bill is signed into law.

A Wall Street Journal article about the  “cash buyer” phenomena highlights the trend is hitting markets that are not traditionally known as hot home markets. They mention Boise, Minneapolis & Raleigh as seeing a sharp uptick in cash buyers, with 42% of purchases in Raleigh being all cash purchases.

Where cash purchases dominate the local market, some buyers hoping for a quick flip might be buying unanticipated problems. On the above WSJ article a comment from Harvy Bogard stated the black tarry putty used by some builders stops working after 8 to 10 years, leading to foundation problems which would not occur if they used French drain systems:

It doesn’t surprise me that 42% of home sales in Raleigh, NC are now cash. Every other day I get a flyer in the mail, “We will buy your house now for cash.”

I believe a lot of the cash sales are driven by informed sellers unloading a house with foundation problems to uninformed speculative investors.

After looking in the crawl spaces of about 80 homes (for my third home purchase in Raleigh), I’ve concluded about 1/3 of the homes in Raleigh have foundation or moisture problems. The problems arise from our clay soil, combined with poor grading, water management, or location.

Some mortgage lenders and banks are trying to adjust to shifting consumer preferences toward cash purchases and faster real estate transactions.

• Better Mortgage Corp. is testing offering a loan which can be underwritten in a single day.
• Bank of America is offering new home owners a mortgage of up to 80% the property value after the home purchase is closed.

A few months have passed since I last offered an update on the state of the housing market. Since then, there have been a number of developments which suggest that 2011 could witness double-digit declines in housing prices, and that the long-awaited double-dip will finally materialize.

In an analysis of the housing market, it’s difficult to know where to begin. So much has been written on this topic over the last month and a trove of new data [Gary Shilling has dutifully compiled all of this data in a must-read research report] has been released, to the point that I experienced an acute case of information overload when researching this article. Here’s where we stand: the bellwether Case Shiller Housing Index “has risen 4.4 percent from its April 2009 bottom. But it remains 29.6 percent below its July 2006 peak.” According to some measures, this is already a larger decline than that which transpired during the Great Depression. While the national housing market stagnated in 2010, there was tremendous regional disparity. While prices fell ~20% in Dayton and Columbus, Ohio, they actually rose in 70% of major markets, including Washington DC (5%) and Honolulu (7.5%).

Meanwhile, the number of foreclosures also exploded: “Banks seized more than 1 million homes in 2010, according to RealtyTrac. That was up 14% from 2009 and the most since the company began reports in 2005….About 3 million homes have been repossessed since the housing boom ended in 2006…That number could balloon to about 6 million by 2013.” While the number of foreclosures fell in December because of legal uncertainty over the rights of lenders to repossess, delinquencies and defaults are still rising, and foreclosures will almost certain follow. 10% of all residential mortgages are now past due, and 4.5% are in foreclosure. (5 States: California, Arizona, Florida, Illinois and Michigan have accounted for more than half of the foreclosures). In addition, distressed properties accounted for about 30% of all home sales in 2010.

The clear consensus is that the only reason that the housing market didn’t completely collapse in 2010 is because the government intervened, in the form of a homebuyers tax credit. In hindsight, the tax credit merely pulled demand forward, instead of creating new demand. According to economist Nouriel Roubini, “If you look at the data, Case Shiller has been falling every month since the tax credit expired in May. Everyone who wanted to buy a home did so by April. That tax credit stole demand from the future…”

Going forward, there is more reason than not to believe that further declines are in store. There remains a massive shadow inventory of unsold foreclosed properties, which will expand further before it contracts. Mortgage rates have ticked higher in recent months from record lows, and besides, tighter underwriting standards are making it more difficult to obtain a mortgage. (Fannie Mae and Freddie Mac now underwrite almost 100% of residential mortgages). Meanwhile, the economy has only just escaped from recession, consumer confidence is low, and unemployment remains at a 30-year high of ~9.7%.

Even if you ignore the fundamental picture, econometric analysis suggests that housing prices have yet to “revert to the mean” of their long-term trend. Based on almost every measure, housing prices are still above historical levels, rent ratios remain high, and affordability indexes reflect inflated prices. From a purely financial perspective, then, housing prices would have to fall 20% in order to offset the appreciation of the bubble years. Moreover, it’s possible that the correction will “overshoot,” in which cases prices could drop by 25-30% before resuming their long-term average rise of 3.5% per year.

Yet, there are some economists who are cautiously optimistic. According to in Frank Nothaft, chief economist of Freddie Mac, “I do think we’ll see these housing prices bottom out, maybe by the spring.” Due to a drop-off in new housing developments, supply (not including the shadow inventory) is low. There is also hope that the economy will recover, and lift employment and consumer spending with it. As one columnist summarized, “The minute Americans see a real reason for hope…housing will come roaring back.” Even the most dire housing forecasts concede that some regional markets will probably rise in 2011.

From where I’m sitting, however, there really isn’t cause for much optimism. Unless you live in Hawaii or Texas, the next year (or two or three) will probably witness further declines.

Last week, I reported that mortgage rates have declined to another record low. Unfortunately for the housing market, the resulting uptick in mortgage activity was dominated by refinancings, and there is little evidence that low rates are spurring new borrowers. This is confirmed by the updated S&P Case Shiller Index, which shows that while prices are still rising on average, they are rising at a slower rate than before and appreciation could soon turn negative.

Morgan Stanley may speak for everybody; “It expects 2011 home prices to fall 5% to 10% from this year with four years of flat prices after that, although ‘the risk of slight additional downside in prices, and extension of the trough to 2012, has increased.’ ” Most of the government home-buying incentives have expired and lending standards have tightened. If the government doesn’t continue to support the mortgage industry, declines could be even more significant.

The biggest variable is the ongoing foreclosure scandal, in which lenders have conceded to fraudulently processing foreclosures for tens of thousands of borrowers. As a result, foreclosure listings have been pulled until the investigation is resolved. Most analysts have argued that this will be roundly negative for the housing market, especially in depressed areas were foreclosure sales represented the brunt of buying and selling: “These delays ‘are just going to cause more chaos and confusion. At this point, this is probably the nail in the coffin for housing. I think worse times are still ahead of us.’ ” As a result, the shadow inventory of foreclosures will be unable to clear, and prices continue to fall.

While I think this is a reasonable argument, I think the opposite interpretation is also justifiable. Think about it- if the foreclosure probe causes the housing supply to shrink, should that shift the balance back in favor of sellers. Of course you could argue that the shadow housing inventory will continue to exist, or that buyers who would have foreclosed properties now won’t buy anything, or that lenders will be stuck with these properties on their books and will cut down on new lending to compensate. Still, the shrinking of supply should have at least a temporary stabilizing effect on the market. Incidentally, Shaun Donovan, head of the Department of Housing and Urban Development (HUD) has sided with the majority in this debate: “A national, blanket moratorium on all foreclosure sales would do far more harm than good — hurting homeowners and homebuyers alike.”

If you’re in the market for a home, you should probably stay away from foreclosed properties for the time being, due to uncertainties over title. Otherwise, remember that there is not one national housing market but hundreds of regional markets. Each of these markets has its own nuances, and may be governed by different trends and demographics. Some markets remain depressed, while other markets have barely suffered. [For value shoppers, Coldwell Banker compiled rankings of the most/least affordable markets]. Finally, consider that it’s still a buyers’ market and that there is certainly no rush to buy. If historic trends are any indication, prices will decline slightly as we move towards winter, a period when the market usually slows down.

Update: the above link to hlr.coldwellbanker.com went offline, so I updated it to reference the current file location.

The current housing market is downright murky. Every day brings new pundits wielding new statistics and new predictions. Some insist that the housing market has bottomed, while others argue that it could fall further. Worst of all, both sides doggedly believe that they are unassailably correct. Even worse is that this same argument appears to be unfolding on the ground level: buyers insist that their homes are fairly priced, while sellers wait patiently for prices to fall further. In this kind of climate, how is one to determine a fair price?

For the record, it is clearly a buyers’ market: “There are now so many homes for sale, and so few of them are selling that, at the current sales pace, it would take over a year to clear the existing inventory on the U.S. market. That is more than double the time required in a healthy market and up significantly just since June.” In other words, buyers can afford to be selective, and can afford to declare a target price and stick to it. As a result, buyers are finding that in order to even receive an offer, they must reduce their expectations significantly: “Almost a quarter of all listings on the market at the beginning of July had at least one price reduction. The average discount from the original listing price? Ten percent, according to Trulia.com.” (quote via cnbc.com/id/38642589)

The best indication of what a home will fetch has been and will continue to be is a comparative market analysis. This kind of analysis is exactly as it seems: a real estate agent or appraiser will look at what similar homes in the same region are selling for and establish a price range. The relative size, condition, amenities, etc. of your (target) home will dictate whether it falls closer to the high end or the low end of the scale. It’s worth noting that short sales and foreclosures will usually be priced at a slight discount.

From the seller’s perspective, where you price your home depends on how eager you are to sell it. You should understand that potential buyers probably has other options, and unless you can match their patience, you might have to cut the sale price. Experts recommend that you make one big cut rather than several smaller cuts, as this will show buyers that you are sincerely interested in selling the home. If price cuts don’t work, you can also try selling the house through an auction, which will expedite the process significantly, involving a few open houses and one 30-minute auction. The offer is binding, and you can expect to have the cash in hand in a month or two. Auctions are also attractive to buyers because of the mindset that, “We don’t want to wait around or negotiate and, more important, we want to pay the price we want to pay.”

Otherwise, you might have to take the home off the market and try selling it again after the market has had more of a chance to settle. In the mean-time, you can consider refinancing any mortgage debt (to take advantage of record low mortgage rates) and renting out the home.

Auction sales were booming even at the height of the housing market, says Chris Longly, deputy executive director of NAA. He attributes some of the uptick to the popularity of sites like eBay. “Consumers today want it now,” he says. “We don’t want to wait around or negotiate and, more important, we want to pay the price we want to pay.”

Mortgage rates have remained relatively stable. How has this trickled down into the housing market? In a nutshell, housing prices are stabilizing, but it’s unclear whether the market has yet to bottom. In addition, national averages mask regional differences, and soft spots remain in certain markets, and in high-end housing.

Let’s zoom in on some specific data points: “The Standard & Poor’s/Case-Shiller price index, a closely watched gauge, showed that single-family-home prices rose 0.5 percent from April to May, the first monthly increase since 2006…The federal government reported an 11 percent rise in new-home sales from May to June, the largest monthly gain in nine years. Sales of previously owned homes jumped for the third straight month, up 3.6 percent in June.” Meanwhile, “The median sales price was $206,200, down from $234,300 a year and $219,000 from May.”

At face value, these statistics seem to portray a market that has entered the recovery stage, but they should be interpreted in context. First of all, “Home sales quite often jump in June, the height of the spring selling season.” This June was particularly bountiful because of the federal government, which is offering an $8,000 tax credit for first time buyers, and implemented a de facto moratorium on foreclosures.

However, given the seasonality of the housing market and the fact that both of these government programs are slated to expire soon, “It makes more sense to compare them [home sales] with the same month a year ago. That comparison is less kind — sales were down 21.3% from June of 2008. Seasonally unadjusted data show a total of 36,000 new homes were sold last month, the lowest June total since 1982.” It should also be pointed out that the data is derived from a survey – rather than from actual numbers- and carries a margin of error, such that the true figure could very well be negative.

There are also significant regional disparities contained in these numbers. “Sales were strongest in the Midwest, where they jumped 43 percent from May’s total. Sales climbed 29 percent in the Northeast and 23 percent in the West. They declined slightly in the South.” In California, Florida, Nevada, and Arizona, prices continue to fall, and foreclosure rates are rising.

The high-end market, meanwhile, continues to tank, due mainly to a delayed bursting of the bubble and changes in lending standards. “The supply of unsold homes priced above $750,000 swelled to around 17 months in June, up from a 14.5-month backlog one year ago. A recent forecast by analysts at J.P. Morgan Chase & Co. said it would take until at least 2012 for the expensive-home market to recover and that peak-to-trough declines could surpass 60%, compared to 40% for the rest of the market.”

It’s quite obvious that from an historical standpoint, then, the housing market remains quite depressed. But what about the future? “ ‘The freefall is over,’ says Dean Baker of the Center for Economic and Policy Research.” Warren Buffet agrees: “Most of the problems in the housing market will be over in 18 months or something like that.” Alan Greenspan, however, thinks that “Home prices had stabilized only temporarily. ‘It is possible that could get a second wave down.’ ” Other analysts point out that for as long as the overall economy – specifically the employment situation – remains weak, the housing market will fail to recover. In addition, should interest rates rise suddenly and/or another wave of foreclosed properties hit the market, the market could certainly trend downward.

There seems to be an important exception to that notion that this is a buyers’ market when it comes to housing: distressed real estate. Properties that are delinquent and nearing foreclosures or are already in foreclosure are now attracting bubble-like interest.

According to a report by RealtyTrac, “1.5 million U.S. owners have been told they are in danger of losing their homes. The company Thursday said one in every 84 households got at least one foreclosure notice during the first six months of the year, a new record.” As a result, “The existing home market is still vastly oversupplied, and we continue to be inundated with an influx of distressed and foreclosed properties,” observes another analyst.

Unfortunately – at least from the standpoint of “genuine” buyers – many of these properties are being snatched up by speculators and institutional investors, who have finally found a corner of the real estate market that remains buoyant. “Vornado Realty Trust, one of the biggest real-estate investment trusts in the U.S.,” made headlines when it announced its intention to “raise $1 billion for a private-equity fund to invest in the wave of distressed properties expected to hit in the next few years.” According to marketing materials, the fund is aiming for a 20% annualized return on its investment, which is in indication of just how excited people are about the market for foreclosed properties. Distressed commercial real estate, meanwhile, is nearing $100 Billion and growing rapidly.

Other investors, meanwhile, are hoping to benefit indirectly from a new federal program “designed to stabilize and revitalize neighborhoods ravaged by foreclosures and abandonment.” Across the country, “Out-of-state speculators continue to swoop into these neighborhoods, plucking properties they might fix up and rent out. Then again, they might try to flip them or simply sit on them, perhaps fouling any attempt to stabilize these areas.” These properties are being snatched up for eye-poppingly low prices- under $10,000.

Real estate agents are also getting into the game. A just-announced arrangement “will give local RE/MAX agents…access to RealtyTrac’s database of properties that are in some state of foreclosure — including properties in default, homes scheduled for public foreclosure auction and bank-owned properties…Going forward, prospective homebuyers visiting remax.com also will be able to search RealtyTrac’s database.” While ostensibly affording both buyers and sellers of foreclosed homes more opportunities, a byproduct of this arrangement is that speculators will also have an easier time spotting such properties.

Investors have another advantage – beside deep pockets – over regular homeowners; they almost always pay cash. Until the credit crisis is fully resolved and banks once again trust each others’ credit, it seems speculators will have the upper hand.

Along with predatory lenders, ignorant homebuyers, and greedy investors, overly optimistic appraisers have been one of the main targets of those looking to mete out blame for (the collapse of) the housing bubble. Specifically, appraisers have been criticized for their lofty valuations, which may have contributed to “excessive” house price inflation. Appraisers counter that they were only doing their job, and that the real blame lies with the lenders that pressured them into simply confirming sale prices in order to make sure that deals closed.

Now, however, the pendulum may have swung too far in the opposite direction, such that appraisers have suddenly become overly conservative. Again, the appraisers blame the lenders, who this time around are driving appraisal valuations down in order to make sure that they don’t lend more than the home is actually work. “In some cases, lenders are requiring that appraisals be based on sales closed within the past three months rather than the prior six-month norm, appraisers said. Some lenders are also asking for comparisons with at least one sale in the past 30 days.” Also faulted is the new mortgage appraisal system, whereby home valuations are performed by appraisal management companies. While the change was supposed to prevent banks from directly pressuring appraisers by placing a buffer between them, the actual result was to commoditize the appraisal and drive down quality.

A similar trend can be seen in the rise of Broker price opinions, or BPOs, which “are performed by real estate agents who, unlike licensed appraisers, have no regulatory oversight of their valuations. BPOs are attractive for lenders because they cost between $40 and $65, compared with about $350 for an appraisal.” Meanwhile, since the agents have also been engaged to sell the property, they are incentivized to keep prices low, in order to maximize the chances of a sale. [It should come as no surprise that BPOs are illegal in 23 states].

The result is that appraisals are still leading the market, only this time around they are tugging prices downward instead of dragging them upward. Naturally, homeowners are furious. “When the homes are then sold at ‘fire-sale prices,’ the rest of the neighborhood suffers, especially in areas with clusters of distressed sales,” which is causing prices to fall across the board. Some home-sellers are being forced to drop their prices at the last minute in order to hold onto buyers with appraisal contingencies built into their mortgage contracts.

Homebuilders are also suffering since banks will no longer approve mortgages for properties that are determined to be overvalued, with the result that some new homes are being sold below cost. Meanwhile, those looking to refinance or take out home equity lines of credit are facing an uphill battle. Appraisals are coming in so low that creditworthy borrowers are being rejected outright for refi’s and/or watching the bank freeze their LOCs.

The keys to making sure that you get an appraisal that you’re happy with is to understand how the appraisal process works and then to double check the final report for errors. Most appraisals use a weighted average of the estimates from a sales comparison approach, income approach, and cost approach. Begin by making sure that comparative sales are actually comparable, and that there are not a couple of questionable homes dragging down the average. From a cost perspective, make sure that the appraiser took accurate stock of your home. For example, did he factor in all of the rooms and all of the renovation work you have completed recently?

In the end, unfortunately, appraisal is more of an art than a science. In other words, prices are constantly fluctuating and your home’s “true” value might be different yesterday from tomorrow. Really, a home, like anything else, is only “worth” what somebody else is willing to pay for it.

This last week saw a flurry of data, painting a predictably contradictory picture of the housing market. The debate over whether housing prices have stabilized now looks something like this: “House Prices Have Bottomed;” “No They Haven’t;” “Yes They Have;” “Not Yet!” That’s not to say that the conclusion is that in fact housing prices have not yet bottomed, but instead that “evidence” can be found to support either conclusion and also that there is unreported data muddying the picture.

On the plus side, pending home sales rose 6.7% nationally in April, and even faster in some regional markets. Previously owned U.S. homes rose by 2.9% over the same period. Meanwhile, “Existing-home inventories are down to 9.8 months’ supply, higher than their long-term average of six months, but off their recent peak of 11.3 months.” [See chart below courtesy of WSJ] In other words, almost all of the data points appear to be either improving, or at least slowing in their rate of decline…..that is, until you look at what’s not being directly captured by the numbers.

First of all, the data itself is prone to manipulation, since much of it is self-reported, rather than compiled in accordance with some kind of universally-accepted standard. For example, pending home sales are being booked earlier and earlier, such that a smaller percentage are ending in actual sales. “A 33-percent jump in pending sales from February to March, for instance, did not bring a corresponding increase in closings a month later. In fact, April closings were up less than 4 percent from March.” As a result, “closed sales went from 89 percent of the previous month’s pending sales in June to 80 percent in July and have ranged from 60 percent to 84 percent since.”

Then there is the inventory data, which by its very nature doesn’t reflect homes whose owners would like to sell, but haven’t yet been listed. “There is a massive shadow inventory of bank- and investor-owned homes, enough to push existing-home supply to 12 months, notes one economist.

Ultimately, a full housing recovery is unlikely for as long as house prices remain depressed. The data and analysis surrounding this question is perhaps the most nuanced.

On the one hand, “The Federal Housing Finance Agency’s quarterly purchase-only house price index shows nationwide home prices fell 0.5 percent from the fourth quarter 2008 to the first quarter 2009,” compared to a decline of 3.3 percent in the previous quarter. An analysis of San Diego, where the housing market collapse was especially sever, indicated that prices are now well below their long-term average.

On the other hand, “Healthier regions, including ‘many parts of the Northeast, have only just begun to suffer price declines…Together, these factors could drag on prices through much of 2010, pushing the Case-Shiller index to a total decline of 40%.’ ” (It has already declined by 27%). Banks are certainly conscious of this possibility and are taking longer to approve mortgages. Given that interest rates are now rising and mortgage applications are leveling off, it could be a while longer before the market really stabilizes.