Here is a simple way to test if the last year of housing market gains have been due to a real, fundamental, consumer-led recovery, or nothing but the latest iteration of the Fed's money bubble machine manifesting itself in the place of least du jour resistance - houses: Assume rising interest rates.
That's right - the oldest economic joke in the book is also the best way to approximate real marginal demand, especially by those whom even the NYT earlier today identified as the primary beneficiary of cheap credit which they have subsequently transformed into an ubiquitous landlord industry, buying up homes by the tens of thousands with the intention of quickly converting them to rentals.
So if, indeed, it is the smart money that defines the marginal price, and since said money is "smart" and realizes that either the US consumer is tapped out and unable to satisfy a priori modeled cash flow demands or it anticipates a rise in interest rates (not due to a pick up in the economy but due to a tapering of Fed purchases - two very, very different things: note the pick up in yields at the end of QE1 and QE2 which signaled not an economic recovery but simply more QE a few months down the line) which contrary to the propaganda on TV would have a devastating impact on the housing market and also the economy, then we would promptly see the imminent pop of the second coming of the housing bubble.
One can make the argument that some have already felt the early tremors: late last year it was Och-Ziff, one of the original entrants in the REO-to-Rent business who called it quits as the returns it was generating from rental income were "less than expected." Then just last week we wrote about Carrington, an early landlord investor backed by OakTree, which too decided to quietly slip out the back exit. Carrington's memorable quote still haunts us: "There’s a lot of -- bluntly -- stupid money that jumped into the trade."
Yes there is.
Which brings us to tonight's news. Because while pulling out on one's terms as OZ and Carrington have done, is never sufficient and necessary grounds for others to follow suit, being forced to do so can quickly send all the other remaining marginal players stampeding in a accelerated prisoners dilemma where nobody wants to be the last to defect, or translated, he who sells next, sells much better than he who sells last (especially since by then the market will be bidless).
Moments ago the WSJ reported that one of the companies at the vanguard of the second housing own-to-rent bubble, Colony American Homes, has just pulled its IPO due to, you guessed it, market conditions. Because the market being a whopping 4% off its all time highs truly qualifies as a force majeur in the IPO world. Only that's not it. What is "it" is the recent pounding all related housing REITs have experienced on nothing more than the mere concern that rates may, at some point rise (even despite the simple math conducted by Jeff Gundlach today demonstrating how a return to 5% interest rates would promptly destroy the US balance sheet in a few short years time).
Sure enough, suddenly all companies that did not have to concern themselves with plunging and uneconomical cash flows simply because their cost of capital would be laughably low no matter the asset side of the balance sheet, are in near panic mode. Such as Colony.
Colony American Homes Inc. postponed the pricing of its initial public offering Tuesday, citing market conditions, according to a person familiar with the matter.
The Scottsdale, Ariz.-based firm has projected its IPO of 20 million shares to be priced between $11.50 and $13 each.
Colony American’s postponement follows a selloff in shares of real-estate investment trusts the past two weeks, as the prospect of interest rates’ eventual rise has dulled the shine of high-dividend-paying stocks. REITs, property-owning companies that pay most of their taxable income to shareholders as dividends, had gained appeal as an alternative to bonds in recent years, as historically low interest rates left investors searching for income.
The single-family landlord would be the latest in a new class of REITs that have gotten a tepid reception from investors: those formed to buy single-family houses, rather than larger buildings like apartment complexes or office towers.
Colony American Homes was formed last year and seeks to buy houses in mid- and upscale neighborhoods with low crime and good school districts. As of April 30, the company owned at least partial shares in 9,931 homes in nine states, including California and Georgia. Veteran real-estate investor Thomas Barrack, founder of private equity real estate firm Colony Capital LLC, serves as chairman of Colony American.
However, Colony was not alone. Also after the close today, another rental REIT, the hilariously named American Homes 4 Rent also scrambled to file its own IPO prospectus, realizing the game is almost up. And while we will let readers delve into the financials of the massively unprofitable rental REIT on their own (S-11 link here), the firm which has already invested $2.5 billion to purchase some 14,210 properties across the US, which in an ideal world would generate an average of $15,755 in cash rent per property (and a solid 9% cap rate if only on paper) suddenly also appears very worried about the rate compression between its assets and liabilities and can't seem to wait to cash out.
But what is most curious about the AH4R IPO is that it was only in November of last year that none other than Blue Mountain - the hedge fund located on the fifth floor of the JPM HQ best known for first raping then rescuing the JPM London Whale: one wonders just how much Andrew Feldstein might have overheard at the 48th Street Starbucks but we digress) invested over $70 million in the rental company. Six months later it is perfectly happy to be classified as a "selling shareholder."
Translation: the hedge funds that bought in barely six months ago into what everyone knew would be the easiest and most levered wave to ride the accelerated housing bubble, are now rushing to get out before the emperor's lack of clothes is obvious for all to see. If they can that is: for those who are forced to pull their IPOs, the sad housing reality summarized so aptly by Carrington is about to unfold.
But the best news for everyone, is that very soon we will have the answer if the past 18 months in rising prices were nothing but a transitory mirage created by Bernanke's printer. If the "smart money" is any indication, we are quite confident we know the answer already.
And just in case the less than smart money, i.e., reporters with an agenda and such, are confused by what is going on, here once more is Mark Hanson explaining just why the so much desired rising interest rates are nothing but a fast and anything but painless suicide for the housing sector.
Mainstream analysts have already forgotten that the bubble from 2003-2007 was all about "leverage-in-finance", I.e.: popular, exotic loan products of each period, terms, allowable DTI, documentation type, start/qualifying interest rates etc. For example, from 2003 to '05 a 5/1 interest only loan allowed 50% DTI qualifying at interest only payments. From 2006 to '07 Pay Option ARMs allowed 55% DTI at a 1.25% start rate. This made the "cost" of buying a house HALF of what it is today. Then when the leverage-in-finance all went away during a short period of time from late-2007 to mid-2008 house prices quickly "reset" to what people could afford to pay on a fundamental basis...30-year fixed mortgages, fully documented, 45% DTI, at a 6% interest rate.
Because 70%+ of homebuyers use mortgage loans -- and the monthly payment trumps the "purchase price" of the house with respect to purchase ability and decisioning -- then it stands to reason that the monthly payment rate of popular loan types of each period relative to house prices would determine whether or not house prices are once again bubbly.
Bottom Line: the popular loan programs during the bubble years -- which allowed for rapid and large house price appreciation -- were not 30-year fixed loans like today. Rather, exotic interest only loans, negative amortizing Pay Option ARMs and high CLTV HELOCs. Thus, comparing the "affordability" of houses using today's 30-year rates and program guidelines vs 30-year rates and guidelines from 2003 to 2007 is apples to oranges.
Based on "cost of ownership" for the 70% who need a mortgage loan to buy, CA houses are more expensive today than from 2003 to 2007.
This is why first-timer buyer volume has plunged to 4-year lows recently. And if not for the incremental buyer & price pusher -- the institutional "buy and rent or flip "investor" that routinely pays 10% to 20% over the purchase price / appraised value treating a house like a high-yield bond -- present house prices cannot be supported.
Bottom line: Back in 2006 a $556k house "cost" as much as a $324k house does today.
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After 5 years of interest rates being forced incrementally lower each year -- and everybody that qualifies refinancing over and over again allowing the banks to originate and earn several points off of each gov't loan churn -- the jig is up for a while at least. The mortgage market is now so efficient -- and rates have been at historic lows for so long -- there is simply nobody on the proverbial "fence".
This morning I was made aware that three large private mortgage bankers I follow closely for trends in mortgage finance ALL had mass layoffs last Friday and yesterday to the tune of 25% to 50% of their operations staff (intake, processing, underwriting, document drawing, funding, post-closing). This obviously means that my reports of refi apps being down 65% to 90% in the past 3 weeks are far more accurate than the lagging MBA index, which is likely on its' way to print multi-year lows in the next month.
As I stress in the note below, the "refi capital conveyor belt" is a quiet, yet powerful economic driver. Not only do refi's grease homeowners balance sheets and have been responsible for the lions'' share of mortgage-centric US banks' earnings over the past few years but they are huge for the labor market.
With respect to jobs, well over 100 individuals touch one refi from loan application printing/shipping, up-front processing (appraisal, credit, bank/job verifications, title, escrow etc), to lender underwriting, document drawing, and funding, and through post-closing including securitization and trustee services. So when the refi door slams shut it's a macro headwind for which few account. In fact, many model the exact opposite...that rising rates is great for banks and the economy.
Naturally, Ben is aware of all of the above. Which is why it is only a matter of time before we get yet another "capital reallocation" catalyst event, which forces speculators out of stocks and right back into the "safety" of bonds where they can hibernate until 2014, when the "Great Rotation" charade that has repeated itself every year for the past four, can resume once more even as the even greater charade, Quantitative Easing, which is merely a wealth transfer mechanism from the middle to the upper class, is here to stay.
Assume rising interest rates indeed... Then promptly run for the hills.