US home prices have never been more unaffordable.
A little over a year ago, home prices finally surpassed their prior all-time highs, reached during the heyday of the housing bubble back in 2006.
But with home prices in 80% of US cities are growing twice as fast as wages, working-class families across the US are finding it increasingly difficult to support their families - let alone afford a home. But fortunately, this hasn't been a problem for institutional investors like Blackstone, which are presently enjoying the luxury of a controversial valuation assessment known as a Broker Price Opinion - or BPO.
As the Wall Street Journal explains, Congress prohibited the use of BPOs to underpin traditional mortgages as part of Dodd-Frank. But, fortunately for private-equity firms and their limited partners, that prohibition doesn't apply to investors buying tens of thousands of homes.
Blackstone and its lender, Deutsche Bank AG, settled on a sort of drive-by valuation done by real-estate agents that are more cursory and cost far less than traditional appraisals.
Congress outlawed the use of such assessments, called broker price opinions, or BPOs, to value properties for traditional mortgages. But the prohibition, enacted as part of postcrash financial regulation, doesn’t apply to investors buying tens of thousands of houses.
Now these perfunctory valuations abound, underpinning tens of billions of dollars of home deals. Sometimes the process is outsourced to India, where companies charge real-estate agents a few dollars to come up with U.S. home values by consulting Google Earth and real-estate websites.
That's right: Shoddy satellite photos and workers at call centers in India - thousands of miles away from the homes they're evaluating - are making up prices for homes that are then used to value collateral used in bond offerings. In fact, BPOs have been used to value collateral in the more than $20 billion of bonds sold by institutional landlord. They're also the fast-growing business of lending to individual house flippers. Banks request them when considering whether to foreclose or negotiate repayment plans with delinquent homeowners.
Their popularity shows how Wall Street is finding ways to adapt to government efforts to crack down on some of the excesses that contributed to the housing crisis. While authorities in Canada and Australia have passed laws to curb speculation in their respective housing markets, US regulators have been unwilling to challenge BPOs - though the SEC is investigating whether certain rental-home companies used these shoddy valuations to distort the value of bonds tied to the deal. Critics say BPOs are ill-suited to gauge home values and could leave debtholders with less collateral than they thought.
So what are the risks, exactly? Well, inaccurate pricing information could result in abrupt and unexpected losses for investors when a more thorough appraisal is sought.
“BPOs are a creature of financial institutions that want deals to close fast, and so they don’t have to use an appraiser,” said Donald Epley, a retired University of South Alabama professor who helped write national appraisal standards after the 1980s savings-and-loan collapse. “You’re just dumbing down the standards to make the loan.”
Some credit rating firms have realized that these valuations aren't reliable, and have stopped accepting them, or sought a second opinion.
When Fannie Mae last year guaranteed about $1 billion of Invitation Homes debt, it accepted BPOs for the 7,204 houses serving as collateral. Assuming a typical appraisal price of $450 and the $95 that Invitation Homes pays per BPO, the company saved about $2.6 million.
Credit-rating firms usually discount BPO values when grading rent-backed bonds. Kroll Bond Rating Agency has trimmed them by about 10% and uses the lower of the reduced BPOs and the amounts spent buying and renovating the homes.
“We’re never taking BPOs at face value,” said Kroll’s Daniel Tegen.
With many institutional investors expect, as Goldman Sachs put it, "a strong and synchronous global expansion" during the coming year, housing bears are difficult to come by. But Bloomberg managed to find one: James Stack, an investor who manages $1.3 billion for high net worth individuals, says that his "Housing Bubble Bellwether Barometer" is flashing red again. Stack predicted the housing crash back in 2005, just as home prices were reaching their peak.
His assessment of the market should send a chill down the spine of foreign investors who have poured money into New York City, San Francisco and other hot urban housing markets that have led the recovery in home valuations.
"It is 2005 all over again in terms of the valuation extreme, the psychological excess and the denial," said Stack, whose fireproof files of newspaper articles on bear markets date back to 1929. "People don’t believe housing is in a bubble and don’t want to hear talk about prices being a little bit bubblish."
Despite the torrid rally in home prices, Stack is one of the few real-estate market observers who foresee a sizable correction in prices. Indeed, as the vital spring selling season approaches, there are plenty of reasons for buyers to be optimistic - not the least of which is the "wealth effect" stemming from gains in equity prices. A backup in home building following the recession has left a paucity of inventory just as the housing needs of two generations - millennials who are buying their first homes and Baby Boomers who are downsizing in retirement - are shifting.
But there's a structural mismatch between different tiers of the housing market that are poised to create problems for homebuilders.
There are plenty of reasons to be optimistic. The housing needs of two massive generations - millennials aging into homeownership and baby boomers getting ready for retirement - are expected to fuel demand for years to come if employment remains strong. Sales in master-planned communities, many of which target buyers who are at least 55, reached a record last year, according to John Burns Real Estate Consulting. Last month, a gauge of confidence from the National Association of Home Builders/Wells Fargo rose to the highest level in 18 years, and starts of single-family homes in November were the strongest in a decade.
“As soon as homes are finished, they’re flying off the shelf,” said Matthew Pointon, Capital Economics Ltd.’s U.S. property economist.
Homebuilders, which have focused on pricier homes since the market bottomed in 2012, are now getting ready for a wave of first-time buyers left with little to choose from on the existing-home market. Investors are rushing to builders of starter homes, because lower-priced homes in the U.S. are in the shortest supply. Shares of LGI Homes Inc., which targets renters with ads that trumpet monthly payments instead of prices, rose 161 percent last year. D.R. Horton Inc., the biggest builder, powered by its fast-selling Express entry-level brand, gained 87 percent.
Homebuilder stocks rallied 75% last year, outpacing the S&P 500's best performance since the once-in-a-generation return in 2013. That gain made homebuilders one of the best-performing subsets of the market.
While demand for low-income homes remains robust, homebuilders have so far been fixated on housing stock for high-income earners - particularly in hot markets like San Francisco, New York City and Washington DC. Meanwhile, the SEC requested information in May from Radian Group about the BPOS it provided for rent-backed bonds.
Of course, its premature to say that this will have any kind of tangible impact on the market. But it should certainly make investors think twice about valuations.