4Q 2017 home loans down 20 percent from 3Q and 19 percent year-on-year

According to ATTOM Data Solutions, the number of residential property loans made in 4Q 2017 was down 20 percent from the previous quarter as well as down 19 percent from a year ago.  However, construction loans were up 12 percent from the third quarter and up 33 percent year-on-year, indicating more robust remodeling activity as well as rebuilding efforts after last year’s hurricanes.

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Relaxed credit standards and job growth bringing back the retail and first-time home buyer?

Last December, I wrote about a slow but steady housing rebound that seemed to suggest an even stronger 2015, and this is certainly still the case.  However, more updated economic information from the fourth quarter of 2014 and the first part of 2015 seem to point to a different type of animal:  Look for 2015 to be the year that we see the continued return of the retail buyer, and especially the first-time home buyer.

During the depths of the Great Recession, perhaps the single most important saving grace which led us out of the crisis were investors who realized that the crash in home prices meant that many owner-occupied homes were excellent rental property investments.  Their purchases of millions of otherwise vacant homes helped to establish a pricing floor for foreclosed properties.  However, by the end of 2013, rising prices and more competitive supply for these homes meant declining profits for these investors, so they gradually disappeared from the market through the middle of 2014.

At the time, traditional buyers who live in these homes – also known as retail buyers – were not yet ready to fill the gap due to a combination of tight credit, lack of down payments and a job market which was improving but still had yet to impact wage growth.  Since then, however, several important factors have changed, mostly due to a strengthening job market and the relaxing of credit standards.

For all of 2014, almost three million new jobs were added – the most since 1999, which was the peak of in the first phase of the Internet-related technology boom.  And, while many of these jobs were simply replacing the millions lost during the previous recession, these gains were across the board and included multiple industries.  During the last quarter of 2014, nearly 290,000 jobs were created per month, and in January 2015 another 257,000 jobs were added.

However, even with these impressive gains, during 2014 wage growth barely budged over two percent, which meant that employees simply didn’t have extra cash to use for down payments.  Until the prime-age employment-to-population ratio rises from the current 77.2 to closer to 80 percent, the U.S. economy likely won’t see consistent and meaningful wage growth.

It is mainly due to this weakness in wage growth – along with inflation that remains below its target of two percent and the decline in GDP growth during the fourth quarter of 2014 -- that Federal Reserve Chair Janet Yellen has continued to postpone any hike in short-term interest rates.

Despite the sluggishness in wage growth, consumer spending did rebound strongly in 2014, adding 1.7 percentage points to overall GDP growth and posting the best showing since 2006.  And while GDP growth was much faster in the middle of the year before slowing to 2.2 percent in the fourth quarter of 2014, much of that slowing was due to an increase in imports related to increased consumer spending and a decline in federal government spending.

For lenders, one way for them to encourage the return of the retail buyer is to relax lending standards – helped in large part by FHA, Fannie and Freddie.  Last December, FannieMae launched its own program for first-time homebuyers with FICO scores as low as 620, limited cash-out refinances, and down payments of just three percent.  FreddieMac punted the start of its own low-down payment program until March 23, requiring borrowers to first seek credit counseling and setting its own FICO floor at 660.  Meanwhile, FHA has lowered its MIP insurance for 30-year mortgages to just 0.85 percent that, when combined with low interest rates, provides the lowest-cost effective financing available in its 80-year history.

For home builders, these changes bode well for 2015, with NAHB’s Leading Markets Index moving up to .90 in the fourth quarter of 2014, which means that the national housing market is back to 90 percent of normal economic and housing activity.  Of the 360 metro areas tracked by this index, 80 percent saw increases during the quarter.  At the same time, NAHB’s Housing Opportunity Index also showed housing affordability rising to nearly 63 percent, due largely to lower interest rates and some lower-priced housing inventory.

Fortunately, construction lenders have also taken notice, with the stock of AD&C loans made by FDIC-insured institutions rising by 17 percent between the fourth quarters of 2013 and 2014.   Even with such lending still strongly subdued from the peak of 2008, this gradual thawing could help provide much-needed inventory for the first-time buyers waiting in the wings.

Is the lending faucet beginning to open?

According to a story in today's Wall Street Journal (via MarketWatch.com), the lending faucet may be finally squeaking open -- at least for certain commercial real estate projects. From the article:

An influx of fresh capital into U.S. commercial real estate is bringing some long-stalled development projects back to life and launching new construction of apartments, office buildings and shopping centers.

The moves show that the industry, in a deep slump just a year ago, has entered recovery mode—at least in the nation's largest and healthiest markets. Analysts say the improved economy is giving rise to pockets of demand for new commercial space, while low yields on other investments prompt investors to seek higher returns in real estate...

Of course, the U.S. still is dotted with thousands of stalled construction sites, ranging from struggling apartment projects on the Brooklyn, N.Y., waterfront to shells of buildings in suburban Sacramento, Calif. And it will take years to replace more than two million construction jobs, or about 30% of the 2006 peak, lost since the real-estate bubble popped...

But office buildings and other projects could help cushion the U.S. economy if public-sector building declines, as expected, due to government budget cuts and waning economic-stimulus aid...

Click here for entire article.

Lending for builders to remain tight until at least 2010

It's interesting these days to listen to economists or pundits who read through reams of data and declare, "There's plenty of credit -- just not at the price you want!" and then actually sit down with those who are trying to get deals done, and it's a very different story.

Yesterday some colleagues and I had lunch with a wealthy private investor (who claims to have access to $1.5 billion cash and another $500 million in other sources), and for people like him, the lack of credit -- which he doesn't need -- is providing him with some great opportunities, although he also remains on the sidelines because the spread between what sellers want and what buyers are offering is in the 25% range. For now, and likely through 2010, most buyers of land and many commercial properties will be families and groups of friends with money to invest, because credit is expected to remain tight for at least another 12 months. From a BuilderOnline.com story:

Builders immediately saw banks tighten up credit last fall, when the financial crisis began, and the government’s billion-dollar bailout to the banking industry seems to have had little effect. Builders can’t get money to buy land. They can’t get loans to develop lots. They can’t convince banks to joint-venture with them on partially finished developments, even when the bank already owns the land and would have minimal risk...

Unfortunately for builders, the current tight credit situation is likely to continue into 2010, according to experts interviewed by BUILDER in recent weeks. The reasons are myriad: a struggling economy, capital pressures, consumer credit problems, banking consolidation, and regulatory and accounting uncertainties, and of course, falling home prices...

Unfortunately for builders seeking capital, real estate loans represent a major factor in those losses.
Last year, banks reported net charge-off rates of 0.99% for all loans and 0.73% for real estate loans for the first quarter. This year, those figures doubled, to a net charge-off of 1.94% for all loans and 1.44% for real estate loans.

A similar trend occurred in noncurrent loans, which are at least 90 days past due. Overall, banks said 3.77% of all loans were noncurrent in the first quarter of this year, compared to 1.72% one year ago. A prime offender? Real estate, where the percentage of noncurrent loans jumped from 2.21% in 2008’s first quarter to 4.89% for 2009’s first quarter. Within that category, construction and development lending is the most troubled, with nearly 11% of such loans more than 90 days past due.

Even worse from the banks’ perspective, the bulk (61%) of the industry’s current $7.7 trillion in loans outstanding is in real estate loans, including $567 billion in construction and development lending...

Many banks, already weighed down by significant numbers of real estate owned (REO) properties, are wary of adding any additional land investments to their books, even in relatively low-risk joint ventures where the bank supplies the REO land and builders simply construct the homes.

Just like builders and homeowners, falling land values have eroded the value of banks’ land assets, forcing them to raise capital to protect against potential losses. In this declining market, they must also boost their reserves enough to satisfy bank examiners, who expressed worries about commercial real estate lending exposure at banks as early as 2006...

Accounting rules add another wrinkle. For accounting and financial risk reasons, regulators may not approve of a bank’s continued involvement in a real estate project and want the lender to realize any gains or losses as soon as possible. As a result, banks are doing everything they can to exit land deals quickly because if the project drags on (which is certainly likely in today’s weak market and struggling economy), bankers may need to account for that dirt differently due to its “troubled status,”...

Lack of resources may be another issue, particularly at smaller banks. At the same time as builders are begging and pleading for funding, lending institutions are dealing with a host of other challenges requiring time and resources—new credit card laws, personal and corporate bankruptcies, foreclosures, and mortgage modifications. They simply may not have the people, time, or expertise to carefully evaluate a builder’s proposal, no matter how promising.

Is private equity the answer to the lending squeeze?

With banks hoarding cash and other lending sources trying to remain afloat, some experts have suggested that private equity is the next likely source for development projects, as they've been tapped in the past. For now, however, much of that money remains on the sidelines as investors wait for a bottom that so far remains elusive. From a HousingZone.com story:

Reports have been surfacing that massive amounts of private equity funds are being pulled together to take advantage of the opportunity that the free fall of home and land values is providing. At the time this article was prepared, sources interviewed indicated that the majority of funds out there are sitting on the sidelines...

When these funds do come around, builders — as much as they want and need the cash to move forward with their developments — will want to be cautious. Private equity investors are not the same animal as the local community bank.

“There are different cultures. Builders are entrepreneurial. Financing people are bottom line. It's not like the good ol' days where things were done on trust...Finance people operate deal-by-deal. It's more black and white. Private equity firms are looking for a return, and there's a gap between what home builders have been used to and what these types of lenders are asking..."

Click here for full story.