Published on: February 4, 2019
Unconventional loans are back. Offered to borrowers who can’t document their income through traditional means, because they are self- employed, for example, the loans were wildly popular during the ‘anything goes’ days preceding the 2007-2009 financial meltdown, when they were known as low-doc, no-doc or (more disparagingly) “liar loans.” A slowing home sales and rising interest rates are renewing their popularity today, as lenders seek to gain or preserve market share in a diminishing and increasingly competitive market.
The Wall Street Journal reports that lenders originated $34 billion in non-traditional loans in the first three quarters of last year, 24 percent more than in the same period a year ago. Although they represent a small segment of the market (less than 3 percent, according to statistics compiled by Inside Mortgage Finance), the trend is “notable,” the Journal suggests, because originations of conventional loans declined during that period and posted a year-over-year decline for the year. Lenders are finding an enthusiastic purchase market for the loans they originate: Investors, anxious for higher returns than the bumpy stock market has been offering, have been enthusiastically purchasing bonds backed by the loans, sales of which nearly quadrupled last year, the Journal reports.
Industry executives say the loans are being underwritten more carefully today, with closer attention to a borrower’s ability to repay. But critics are skeptical of those assurances and concerned that increasing competition and declining mortgage demand will erode any improvements in underwriting standards.
“While they might not be as toxic as some of the loans pre-crisis, you still have a host of affordability concerns,” Scott Astrada, director of federal advocacy at the Center for Responsible Lending, told the Journal.
Guy Cecala, chief executive of Inside Mortgage Finance, echoed that warning, noting signs that lenders are becoming more aggressive and less cautious. “It’s definitely starting to swing,” he told the Journal. “As more companies enter the space, you’re going to see more completion,” he warned, “and with more competition, you’re going to see loosening of underwriting standards.”
FINDING THE RIGHT WORDS
Existing home sales cratered in December. That may sound extreme, but the terms that have described this slowing trend since May – “fell,” “slipped,” “dipped” and “declined” ─ don’t convey the 10 percent year-over year difference in sales for the final month of the year. The annualized pace of just under 5 million units was the slowest in nearly three years. Sales for the year also were more than 3 percent below the 2017 total – also the weakest performance since 2015. Median sales prices were a scant 1.2 percent higher than the December 2017 rate – the smallest gain since the housing recovery began in 2012.
But Redfin Chief Economist Daryl Fairweather cautions against reading too much negative news in the slowing appreciation rate. “December may feel like a foot on the brake, but the housing market was going over the speed limit,” he told National Mortgage Professional. Home prices, he noted, have been outpacing wage gains for most of the past decade, “and that can’t go on forever.” A slower appreciation rate, he suggests, will give incomes a chance to catch up with home prices, giving affordability-strapped buyers more purchasing power. Lagging sales, meanwhile, will shift the negotiating balance in favor of buyers, who will have more options from which to choose and feel less pressure to offer whatever sellers demand, the Redfin analyst reasons.
While Fairweather is more upbeat than many analysts about the near-term housing outlook, he remains concerned about longer-term trends, which are pushing housing affordability beyond reach for a larger and growing segment of the middle class. A Redfin analysis found that the number of homes affordable to middle-income buyers declined in 86 percent of the major housing markets the study covered, even though the number of homes available for sale in many of those markets increased.
Rising incomes, fueled by a growing economy, have begun to bring more first-time buyers into the market. “But they have missed the boat on affordable deals,” Fairweather told the Washington Post. And if current conditions persist, he added, many of these would-be buyers “may be forced to [continue renting] instead.”
FLOOD INSURANCE GAP
As climate change increases both the frequency of devastating flooding and the number of the areas deemed to be at risk, the flood insurance protection gap – the gap between the number of homes that need the insurance and the number that actually have it – is growing. The National Associating of Insurance Commissioners has calculated that half of U.S. flood losses occur outside of designated flood hazard areas, where flood insurance is required by mortgage lenders; but according to a Lloyd’s of London analysis, only 1 percent of properties in those areas have flood insurance.
Proponents of flood insurance reform have been urging changes that would encourage more private insurance companies to offer flood coverage, but the structure of the market has thus far discouraged private participation, panelists at a recent conference observed. While high private insurance premiums, the lack of private flood risk models have been problematic, the panelists said, the biggest obstacle, they agreed, is the dominance of the National Flood Insurance Program managed by FEMA.
The federal government, through FEMA, is providing “subsidized, cheaper insurance,” at rates that have proven inadequate to cover flooding risks, one of the panelists, Robert Muir-Wood, chief research officer for the catastrophe modeling company RMS, said. Private insurers, he noted, can’t compete with those subsidized rates, which is why the private market currently is so small. Until the NFIP’s pricing actually reflects the risk,”” he said, “it will be very hard for insurers to complete against it.”
A WIN FOR AIRBNB
Airbnb won a round recently in its ongoing battles with local governments seeking to curb short-term rentals of single-family residences. A federal district judge in New York temporarily blocked an ordinance requiring companies hosting short-term rental platforms to disclose the names and addresses of those listing their properties for rental on the sites.
HomeAway joined Airbnb in challenging the ordinance, arguing that it violated users’ privacy rights. The companies also argued that the hotel industry has engaged in an anti-competitive national lobbying campaign “aimed at hobbling [the ability of] home-sharing platforms to compete with traditional hotels” Defending the city’s ordinance, Mayor Bill de Blasio insisted that it is a reasonable and necessary “to stop landlords from creating de facto hotels,” which, he told reporters “is unfair and illegal.”
Airbnb, meanwhile, said the preliminary ruling represents “a huge win for Airbnb and its users, including the thousands of New Yorkers at risk of illegal surveillance who use [short-term rentals platforms] to help make ends meet. The court recognized the fundamental importance of New Yorkers’ constitutional rights to privacy and the sanctity of their own homes,” the company added in a press statement.
A Boston ordinance restricting short-term rentals that took effect in January, also imposes some disclosure and enforcement requirements on platform hosts, requiring them to submit annual reports identifying the location, nature of the rental and number days rental units were occupied. Booking agents that refuse to accept these enforcement obligations won’t be allowed to operate in the city.
Speaking of Boston (see item above), the City Council has approved an ordinance that would impose a six percent tax on “flipping” transactions involving properties valued at $2 million or more. In addition to that tax, which would be split between the buyer and the seller, the ordinance would require sellers to pay a fee equal to 25 percent of the property value if it is sold within two years of purchase.
The ordinance would not apply to owner-occupied dwellings and transfers involving family members. The revenue generated by the taxes and fees on flip transactions, estimated at between $175 million and $350 million annually, would be used to subsidize the production of affordable housing.
“We settled on [$2 million] because we felt it was high enough that we were getting to the investor and commercial class of property owners,” City Councilor Lydia Edwards, one of the measure’s co-sponsors, told Banker & Tradesman. “We want to make sure families can get wealth from the homes. This is for a special class of the market who we feel are speculative and come here just to make money,” she added. “They’re not folks dedicated to housing Bostonians.”
The ordinance would have to be approved by both the state Legislature and Boston Mayor Marty Walsh, who has previously questioned the effectiveness of transfer taxes as a mechanism for financing affordable housing. Separately a recent analysis by ATTOM Data found that investor interest in home flipping has declined as the pool of distressed properties yielding high flipping returns has declined.
“Fewer distressed sales are limiting the ability of home flippers to find deep discounts even while rising interest rates are shrinking the pool of potential buyers for flipped homes,” Daren Blomquist, ATTOM’s senior vice president, told National Mortgage Professional. “These two forces are squeezing average home flipping returns, pushing investors to leverage financing or migrate to markets with more distressed discounts available to achieve more favorable returns.”
IN CASE YOU MISSED THIS
The nonpartisan Congressional Budget Office estimates that the 35-day government shutdown will shave $3 billion ─ nearly half-a-percent ─ from annualized gross domestic product growth in the first quarter of this year.
Homeowners are staying put for more than seven years before selling – almost double the traditional home ownership tenure, and a major reason for the scant supply of listings in many markets.
The U.S. Supreme Court has refused to consider a law suit challenging the constitutionality of the Consumer Financial Protection Bureau. The D.C. Court of Appeals found that the agency’s organizational structure does not violate the Constitution’s separation-of-powers principle.
Renting a dwelling is less costly than buying one in more than half of the nation’s major housing markets, a recent study has found.
Business executives are becoming less optimistic about the economic outlook. More than half of those responding to a recent survey said they expect their corporate earnings this year to be poorer than last year.
A KNOTTY PROBLEM
A constrictor knot is known as one of the strongest of all knots. Wikipedia describes it as “virtually impossible to untie once it has been tightened.” That description also applies to key provisions of this Texas condominium’s governing documents, which completely tied the hands of the condominium association when it tried to pursue a construction defect claim against the developer. (Mosaic residential North Condominium Association, Inc. v. 5925 Almeda North Tower, L.P.)
About a year after this Texas high-rise condominium community was completed in 2007, some of the windows in one of its two residential towers began to leak. When initial efforts to repair the windows proved unsuccessful, and when more leaks developed, the association commissioned a study by an engineering firm, which concluded that the problems resulted from structural defects in the building’s window systems. Replacing them, which the study recommended, would cost an estimated $9 million. The association sued the developer, the contractor and the company that had installed the windows. The trial court granted summary judgment to the defendants, agreeing with them that the association lacked standing to pursue the claim. The Appeals Court upheld that decision.
The association argued that it had standing based on the state condominium law; common law; and the common law doctrine of associational standing. Taking those arguments in order:
The Texas condominium law authorizes associations to initiate legal action on its own behalf or on behalf of two or more unit owners, “unless otherwise provided by the declaration.” The problem was, the association’s declaration did provide otherwise, stating that: “The Association shall not be entitled to institute any legal action on behalf of any or all of the Owners which is based on any alleged defect in any Unit or the Common Elements, or any damage allegedly sustained by any Owner by reason thereof, but rather, all such actions shall be instituted by the Person(s) owning such Units or served by such Common Elements or allegedly sustaining such damage.”
The association argued that the statute should be read as “clarifying” rather than limiting the association’s rights: “The better reading,” the association suggested, is that the statutory rights “are not exhaustive and the declaration may confer additional rights” on the association. To construe the statute as precluding standing, the association contended, “would allow the developer of property to completely undermine the functioning of a homeowner’s association by permitting a declarant to unilaterally abrogate all of an association’s statutory rights.”
But the Appeals Court said the statutory language should be interpreted to mean what it clearly said, and what it said, the court asserted, was that associations could not file suit on behalf of owners if their governing documents created that barrier. “In construing a statute, we presume that the legislature ‘acted with knowledge of the background law and with reference to it,’ the court noted, quoting from a previous decision. “The association does not identify any irregularity that would justify reexamination of the legislature’s decision to limit the powers granted [in the statute],” the court continued, adding, “We apply the statute as written,” to mean that the association lacks statutory standing to sue on behalf of its members.
The association also lacks standing to initiate action on its own behalf for common area claims, the court reasoned, because the association consists of unit owners, and the declaration authorizes actions only by unit owners “served by the common elements or actually sustaining” damage. “To also construe the [declaration] in a manner that grants the Association, which ‘exclusively’ consists of ‘all the unit owners,’ standing to bring such suits ‘on its own behalf’ would render [that provision] meaningless,” the court said, because it would allow the association to initiate legal actions “on its own behalf” for defects in individua units. “We will not interpret an instrument in a manner that produces an absurd result,” the court stated.
The trial court ruled that the association lacked standing under common law, because it did not own and had no separate interest in the units or common areas and had not suffered any injury from the alleged construction defects. The association countered that its injury derived from the requirement to pay for the repair and replacement of the windows, which it was obligated to maintain.
The Appeals Court disagreed. The association’s maintenance obligations apply only to common areas, the court noted; they do not apply to elements located within the boundaries of individual units. And the association’s declaration defines the unit boundaries to include: “The glass wall system, or other material comprising the walls of the Unit.,” as well as “entry doors and exterior glass surfaces, including but not limited to, windows and glass doors, serving the Unit…. Even were we to conclude that portions of the glass wall system lie outside the units,” making them part of the common area, the court stated, the association would still lack standing to sue, because the declaration also bars claims based on alleged defect in “any unit or the common elements.”
The court also rejected the association’s argument that the obligation to repair the windows created the injury required to establish standing. Those obligations, the court noted, “are expressly limited to ‘periodic painting, staining and/or cleaning’ and ‘periodic cleaning and maintenance of the exterior glass.’ Nothing in the term ‘periodic’ maintenance… invokes a duty to perform an expansive replacement of window systems or to repair water damage on the interiors of individual units,” the court reasoned.
“The Association seems to argue that it has standing simply because, notwithstanding whether it has any such duty under the North Declaration, it has already performed certain repairs or replacements,” the court continued. “[But] the Association does not direct us to any authority supporting such proposition. Further, standing cannot be conferred by agreement. “
To establish standing under this common law doctrine requires a showing that:
- An association’s members would have standing to sue on their own;
- The association is acting to protect interests “germane” to is purpose; and
- Neither the claim asserted nor the relief requested requires individual members to participate in the litigation.
The defendants had argued that the association failed to meet the second and third of these prongs; the Appeals Court ruled that because the association failed the third test, the court did not have to rule on the second. The problem with the third test, the court said, is that the damages suffered by individual owners varied, depending on the number of windows in their units, the number that were actually defective, and the extent to which the leaks caused water damage in the interiors of their units.
“Because the relief that the Association seeks necessitates that each member prove his distinct injury,” the court ruled, “the Association lacks associational standing to assert its claims.”
The association argued that there was no need to establish individual proof of damages to members, because any judgment awarded would go to the association, not to individual owners. But that actually precluded standing, the court said, because “prudential concerns are advanced only when the remedy sought, if granted, will inure to the benefit” of association members who have been injured.
Leaving the constrictor knot the developer had tied firmly in place, the court upheld the trial court’s decision granting summary judgment to the developer and the other defendants.
“Social frictions remain a challenge for democracies around the world, and we wonder when investors might take more notice of this.” ─ Seth Klarman, heads of the Baupost Group, one of the world’s largest hedge funds.