Sunday, February 25, 2007

Impacts of the Subprime Implosion

by Osman Parvez
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By now, you probably know that there's been a rapid increase in the number of subprime lenders tightening standards or closing their doors. Novastar Financial (NFI) and New Century Financial (NEW) in particular (see charts below).

According to a new Credit Suisse report, nearly two dozen subprime lenders have ceased operations or have been acquired in the past year. Cumulative losses from subprime loans could exceed $10Bn over the next couple of years.

The question you're probably asking... what does it mean for the Boulder (and the regional) real estate market? Here's a few thoughts.

1. The most immediate change is that credit standards are tightening at the bottom end of the market. Those least qualified will find it more difficult to do so going forward. Those with stable work histories, money to put down, and solid credit will continue to find good rates as well capitalized, well established lenders compete for their business. It won't be impossible for lesser qualified individuals to buy, but they'll probably have to have to save some money first (which isn't such a bad idea, is it?).

For too long it's been far too easy for people to sign up for a mortgage. With their eyes on high profitability, subprime operators focused on selling mortgages to those least able to pay for them. And as always, the lower the credit quality the higher the expense of the mortgage (i.e. risk is related to return).

2. Some markets and neighborhoods will be impacted to a greater extent than others, and perhaps there is a silver lining. Just as when I first started posting research on real estate and talked about the downdraft of the bubble, some areas will see a major downturn (the former bubble markets) and other with strong, well established supply/demand trends and limited speculation will not.

To point, from Kiplinger's The Housing Market Puzzle (2/20/07),
Nationwide, total existing-home sales, including single-family homes and condos, were down 10% [last year] from the fourth quarter of 2005 (and nearly 18% in the West). On the other hand, nearly half of the markets gained ground in the past year, suggesting that plenty of metro areas are sidestepping the slump. Fourteen metro areas had double-digit increases, including Atlantic City, N.J. (where prices increased a robust 26%), Salt Lake City (up 23%), Trenton-Ewing, N.J. (19%) and Beaumont-Port Arthur, Tex. (15%), according to the Realtors
In the Denver Boulder region, neighborhoods with a heavy concentration of entry level homes, the same places now most impacted by foreclosures, are the ones that will also see lower demand as marginal buyers are removed from the market by tightened credit standards. And for those neighborhoods, it could be quite severe. Some predict that 20% of subprime originations in 2005 and 2006 will end up in foreclosure. The silver lining is that for a well financed investor, the next 12-18 months could represent extraordinary opportunity to purchase in select neighborhoods with carefully researched long term investment potential. If you're interested in leveraging that opportunity, call me for more details (303.746.6896).

Let's talk about Boulder. As you probably know, the median sale price in Boulder is well north of $500,000, so as a whole I expect there will be minimal impact from the implosion of subprime lenders. However, there are some neighborhoods and housing types that are at the low end of the market (yes, even in Boulder). The market for these homes and attached dwellings will probably be cooler this year, that means better for buyers and worse for sellers. I haven't published my usual price based market analysis for Boulder as yet this year, but when I do I expect it to show a cooling at the low end as compared to last year.

3. There is a vicious cycle when credit standards tighten, foreclosures mushroom, and jobs in key sectors like housing construction are lost. A classic vicious cycle means that negative factors beget more of the same, the situation spirals downward and the trend is difficult to break. Here's a new story from USNews on Denver's Montbello neighborhood where bank owned homes represent 80% of current inventory. If you're following foreclosures in Denver, you might want to watch the recorded sessions from Denver's newly formed Foreclosure Task Force. It's the city's attempt to try to deal with the problem.

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For more information, read the WSJ's Home Lenders Cut the Flow of Risky Loans. See the mortgage lender implode-o-meter, Denver Post's "Zero-Down Lenders Folding," the many posts on the subject by Mish, and Bill "Love the Hair" Fleckenstein's latest, "Subprime Housing Game is Overl"

For an example of how local lenders are tightening standards, see below. It's from an email I received regarding one local lender's newly updated policy on "stated income and stand alones".

· The minimum Experian score requirement for stated income on term loans secured by a Primary Residence increased from 640 to 660 (Piggybacks and Stand Alones). HELOC guidelines remain at 680 Experian.

· The max loan amount for stated income on term loans secured by a Primary Residence decreased from $150k to $100k (Piggybacks and Stand Alones)

· The max loan amount for stated income on 2nd homes decreased from $100k to $50k (Piggybacks and Stand Alones))

· The max loan amount for stated income on Investment Properties decreased from $100k to $50k (Piggybacks--we don't do Stand Alones on NOO).

Stated W-2 employees must have a minimum of 2 years in the same line of work and income must be reasonable

for their job description. Self-employed borrowers must be self-employed at the same company for a minimum of 2 years.
Here's the 1 year chart for NFI:














Here's the 1 year chart for NEW:














Image credits:bigcharts.com, brian u



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15 comments:

  1. I'm all about tighter reigns on credit scores. We worked our asses off to get ours to a nice place...I get irritated when i see people getting similar or better loans, even if they are kinda shady. I guess I Just have to hope that karma will get them in the end. :) And I agree...something HAS to be done about all the foreclosures in Longmont. Eek.

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  2. I'm all about tighter reigns on credit scores.

    I agree. It is sad that people with crappy credit are bidding up prices.

    It will be interesting to see whether the price drop on the low end occurs quickly or after significant numbers of properties go back to the bank.

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  3. As much as we all like to hate on Subprime, when standards tighten there are going to be a lot less buyers for the homes and prices we all now enjoy. Many people bought their $500,000+ homes with these loans, I have a feeling this is going to get ugly and not just in Longmont, imho..

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  4. So how do you reconcile Boulder's median house price of ~500K and the Boulder's median income ~ 80K.

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  5. Across the country but particularly in major cities you'll have trouble reconciling median income and median home prices. Renting is one problem.

    According to the census, the homeownership rate in Boulder is 49.5%. If you remove renters from the sample, you'll find the median income of owners is probably much higher on average. Renters tend to be younger, less established in their chosen careers, and tend to bring median income lower in a sample set.

    The other factor you'd need to account for in order to reconcile is assets of the borrower. I imagine if you took a random set of Boulder home buyers and compared them to a random set of buyers elsewhere, you'd find Boulder buyers have relatively stronger balance sheets. In other words, they're probably capable of putting down more than 20% and have diversified investment portfolios.

    With all of that said, let me reiterate. I didn't say that we wouldn't feel *any* impact from the subprime lender implosion. I think it will indeed show up at the low end of Boulder's market but home buyers closer to median prices are usually in better financial shape and less likely to have needed a dodgy loan to acquire the property.

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  6. I think it will indeed show up at the low end of Boulder's market but home buyers closer to median prices are usually in better financial shape

    I don't think it's possible for one price range to be affected without affecting all price ranges. If you compress the bottom end, then people purchasing near the middle range will be diverted ("We'd like that bigger house, but it just wasn't worth $200K"). Likewise, that has an effect on the top end.

    It's all related.

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  7. Good explaination.

    So since the majority of Boulder's residents are unable to afford a home, only a small portion of residents are relevant to the housing market.

    Indeed, I expect over half the houses in Boulder i.e. >500K are affordable to less than quarter of Boulder's population.

    So Boulder's housing market stability rests on its exclusion of the middle class.

    Only one problem, its not clear to me that middle class earnings and credit access are less volatile than the incomes and credit access required to afford the median home in Boulder.

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  8. "I guess I Just have to hope that karma will get them in the end." Blame also the lenders as well - not just "those people" who happen to be poor, financially strapped, burdened by health care costs / family tragedy, etc etc. What do you know about the working folks in America? What gives you the right to judge those you don't know anything about? We can pontificate all we want about Boulder's market, but guess what - Boulder's market is an anomaly in the region and when compared to 99% of the country. Put it in there with SF and NYC. Boulder Real Estate is a luxury item - you pay for the perception of prestige and status as much as anything. A very interesting article by Joel Kotkin from the Wall St. Journal Feb 13, 2007. It begins "These seem the best of times for America's elite cities." 'Nuff said. Osman, I appreciate your eternal optimism for Boulder, and I love it here too, but remember the laws of physics my friend. A great many people have been forced to sit on the sidelines while prices escalate - or to deal with the devil in subprime land - and they are now paying the piper. I think it sucks that the great "American Dream" of owning a home is so far out of reach these days. Oh Japan 1980s.....

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  9. Couple of additional thoughts.

    First, thanks for the comments. I'd like this blog to a place where people share ideas. I appreciate your thoughts, even if I don't always agree.

    As for whether changes in supply and demand at the low end will impact other price points, perhaps I'm being overly bullish. The implosion of subprime lenders, Freddy's announcement on a change in policy regarding purchasing subprime mortgages, and this week's global equities market shakedown may have marked the beginning of the long expected turn in the economic cycle. If it's true, it will impact housing (among many other industries) across the spectrum.

    With that said, long term trends in supply and demand, much of it driven by the incredible quality of life in Boulder, will show our community whethering the downturn better than others and enjoying more of an upside. That's already happening.

    Now.. on the issues affecting the middle class and the working poor. They're serious problems. I have strong feelings on this and could go on quite a ramble covering universal health care, education that fails to engender independent thought, complicity and apathy in our citizenry, our government's unfunded implicit liabilities, and on and on... but before I start frothing at the mouth, I'll cut it short. From what I've seen, Boulder is taking affordable housing very seriously. Before you judge, compare our City's programs to other high value small cities around the country. And if affordable housing programs don't work for you (they frequently don't work for my clients), there are more affordable homes in great communities only 15 to 30 minutes away.

    Buy me a beer sometime and I'll treat you to the full ramble.

    p.s. Thanks for that Joel Kotkin article. Interesting stuff and a counter point to Richard Florida's recent piece in the Atlantic Monthly (a few months ago).

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  10. And if affordable housing programs don't work for you (they frequently don't work for my clients), there are more affordable homes in great communities only 15 to 30 minutes away.

    Let's rephrase that:

    If you can't afford a million dollar home, we don't want you owning in Boulder. But, don't move too far away, because we need you to come into town from time to time so you can spend your money here, mop our floors, pick up our garbage and ETC. . .

    Oh yeah -- Peace, love, and liberalism! And no, none of us are hippocrates.


    Sorry, this comment might need be completely fair, but the thread just seemed like it was begging for it.

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  11. The implosion of subprime lenders, Freddy's announcement on a change

    Speaking of the GSEs it has been over half decade since Fannie Mae produced a credible financial statement. While Boulder's median value is well above FNM's cap, I can't help but think turnmoil in the secondary mortgage market will spill over into the real estate market.

    long term trends in supply and demand, much of it driven by the incredible quality of life in Boulder, will show our community whethering the downturn better than others and enjoying more of an upside.

    The community or the homeowner/landlord minority?

    In the event of serious turmoil at the GSEs (See the OFHEO systemic risk report), I would expect a severe credit drought for most Americans. This should further exacerbate the affordability issue in Boulder, regardless of politicians in the lip service industy.

    Boulder, would again, not be directly exposed due to the high valuations but I would think the market would become entirely dependent on high net worth individuals.

    Can one live on a diet of caviar and merlot alone? I suppose the example of Aspen provides a decisive answer of "Yes".

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  12. Osman, you neglected to mention the details of Boulder's "Affordable Housing" schemes. All units sold under these provisions are Deed Restricted, must be sold to another qualified ("low-income" - i.e. less than 50K or so per yr !) candidate, and cannot appreciate more than the LESSER of two or three benchmarks. While better than renting, for sure, virtually none of these are single family houses - mostly basement condos and such. And to limit the potential gains of 4-6% (or more) per yr to 2-3% or less is quite unfair to the lowest income community. They will need to leave in order to gain living space as their families grow. As for Glasser's comment - right on the money. How can a community be worth a damn when there is no diversity - economic, social, or otherwise. Trails and parks and "quality of life" (WTF?) be damned, give me some diversity of culture.

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  13. And to limit the potential gains of 4-6% (or more) per yr to 2-3% or less is quite unfair to the lowest income community.

    While low income housing is prohibited from enjoying the same appreciation rate as real Boulder homeowners, they are not prohibited from suffering drops in the market value of their homes.

    As for Glasser's comment - right on the money. How can a community be worth a damn when there is no diversity - economic, social, or otherwise.

    I wasn't saying that at all. In fact, I would argue racial and economic homogenity are Boulder's strongest attractions to the homeowning minority.

    I'm just asking if Boulder's economic approach of divorcing itself from the middle class will result in less volatility in the real estate market.

    I'm not so sure. The highest income brackets tend to be quite volatile. It is easy to consistently earn the median income. Earning 3X or 4x *consistently* is tricky.

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  14. Egyptian Real estate Agent3/13/2007 05:08:00 AM

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