Before the Covid-19 crisis mortgage interest rates were close to historic lows. Refi’s were happening and while the housing market may have been in a seasonal slowdown it was and still is a seller’s market. However, Chase the country’s largest lender by asset and the nation’s 4th largest mortgage lender in 2019 is raising borrowing standards this week for most new home loans as the bank moves to mitigate lending risk stemming from the novel coronavirus disruption.
- Beginning on April 14th, 2020 those applying for a mortgage through Chase will have to have a credit score of at least 700 AND provide a down payment of at least 20% of the home’s value. Of note the average down payment across the housing market is around 10%, according to the Mortgage Bankers Association.
While on the surface this may seem Draconian in fact it is a smart move on the part of Chase and I assume other lenders will follow. Consider the following:
- Within the past few weeks 16M+ workers have become unemployed.
- Economic uncertainty is an issue; while the equity markets have gained back some value lost over the last month, we are still enduring 20% losses across most major indexes.
- Chase’ decision will reduce their exposure to borrowers who unexpectedly lose their job, suffer a decline in wages, or whose homes lose value.
- Shifting staff to refi’s is profitable i.e. collection of fees and lower risk i.e. underlying asset usually has higher percentage of equity.
- The residential mortgage market is already under strain after borrower requests to delay mortgage payments rose 1,900% in the second half of March.
While Chase let the way, according to Forbes, others are jumping on the wagon: Mortgage Loans Get Harder to Come By As Lenders Tighten Standards
As prospective buyers, sellers, real estate brokers and others associated with the industry should we be concerned?
- Last month the National Association of Realtors said home sales could fall by around 10% in the short-term, compared to historical sales for this time of year.
- A Federal Reserve March consumer survey said home prices were expected grow 1.32% over the year, the lowest reading since the survey began in 2013.
- Until the real estate business returns to some sort of normalcy i.e. showings, in-person closing and related I assume the housing market will be sluggish.
As a broker who has been in the industry for almost three decades, I too have found the events of the last month unprecedented. However, history usually has lessons that can be applied to recent events.
Colorado Regional Recession (mid to late 1980’s): A downturn in oil prices and an exodus of oil related businesses from Denver consolidating to Calgary and Houston there was an outflow of population and employment throughout the state. In Metro Denver housing prices peaked in 1983/84 and bottomed between 1987/88. Of note the home I purchase in the Fall of 1987 for $140,000 previously sold as new construction three years earlier for $200,000. The drop-in value 30%.
Fall 2008 Financial Crisis: The collapse of Lehman Brothers would be the catalyst for the Great Recession. Coupled with housing considered a commodity and purchased with leverage the result a drastic downdraft in values beginning in 2009 and not showing positive activity until 2012.
Concerning the Denver Market while our economy has diversified and we may truly believe there is a housing shortage I believe we may be in for some challenging months ahead.
- There will be job losses as some businesses will not re-open and others will experience contractions of their business.
- The existing glut of deluxe and luxury rentals will be exacerbated due to employment relocations i.e. out-migration and job losses.
- Demand will continue for starter homes; I believe we will see more requests for modifications and pre-foreclosures in the middle and upper-markets where some owners were already on the margins concerning debt-to-income ratios.
- While not immediate, I do believe there will be job losses in our economy. While demand will be sustained concerning starter homes, I feel we already have a glut of high-end rentals which will lead to an increase in vacancy.
- Home values will not necessarily drop immediately and even though the equity markets may stage a rally I believe the impact on small and medium sized businesses and loss of the wealth effect (doe to equity markets and loss of values of homes) will lead to a retrenchment in asking prices and may move the overall real estate market back to equilibrium.
- Real Estates Taxes in Denver and surrounding counties have increased due to underlying home values. However, I believe there will be a short fall in sales tax collection and if home values decrease will lead to a contraction of real estate taxes collected which could result in budget shortfalls and/or increased borrowing.
Concerning Luxury Real Estate: The wealthy are still wealthy. However, in top-tier markets with a glut of luxury real estate i.e. $50M+ spec homes in West Los Angeles, Billionaires Row in Midtown Manhattan I do forecast price drops, concessions and opportunities for long-term appreciation reminiscent of 2010-2013.
Where do I see opportunities?
- Commercial/Business Real Estate: If one has the three L’s coupled with a financially strong tenant and or owner/user, I believe opportunity is there for rental income and equity appreciation longer-term.
- 2nd Homes: Usually one of the first markets to show signs of stress. Add to this so many properties that were placed on the transient rental market i.e. Airbnb. VRBO, Professional Management and so forth. With travel and tourism challenged for the foreseeable future coupled with a loss of rental income do not be surprised to see inventory increase and prices fall in resort/2nd home communities.
- Overall Entrepreneurial Opportunities: While Recessions are painful one bright spot is invention and innovation. I believe we will see opportunities concerning small businesses including franchise sales. Personally, I see opportunity in aspirational businesses and those offering affordability. Thus, I am a fan of Dunkin, Wal-Mart, Family Dollar and other consumer staples that are necessities versus luxury.
I do hope fiscal stimulus works yet I believe it is a short-term bandage on a larger structural issue. The world economy has been expanding due to expansionist fiscal policies i.e. cheap to borrow money coupled with tax cuts. While I am not here to debate of austerity versus capital spending (OK, I am for the latter), the reality is Covid-19 may be an economic reset both short and long-term and the decisions we make today will impact our future.
Finally to answer the question in the visual posted; I believe it is a good thing as tightening of credit channels I believe in the long-term is a positive HOWEVER during times of fiscal crisis and uncertainty I do feel the spigots need to be opened up to spur and sustain economic activity.