The Wall Street Journal carried a story today on its front page entitled, “Banks Push Home Buyers to Put Down More Cash“. The key paragraph:
The median down payment in nine major U.S. cities rose to 22% last year on properties purchased through conventional mortgages, according to an analysis for The Wall Street Journal by real-estate portal Zillow.com. That percentage doubled in three years and represents the highest median down payment since the data were first tracked in 1997.
Last year, I predicted the end of the Homeownership Society as the result of a change in Federal housing policy. This news story confirms the trend that will sharply accelerate once some of the policy battles are fought and decided. I am working on a full report, but my initial impressions are as follows:
- The Federal support for residential mortgages will sunset. The remaining issue is one of timing and degree, not of the actual withdrawal.
- Private capital for residential mortgages will be more expensive (higher rates) and harder to get (higher down payment).
- Rentals will be the mainstay of Federal focus in the near future.
Consequences to the real estate industry are likely to be significant, although it is difficult to foresee all of the possibilities.
Reading Between the Lines
There are a couple of nuggets in the WSJ story that warrant some attention.
First, with the experience of the Bubble, banks have come to realize that the single biggest factor in predicting whether a borrower would walk away is the amount of equity he has in the property. Credit scores are meaningful, but nothing beats equity:
A 2009 Federal Reserve Bank of St. Louis study concluded buyers who made smaller down payments were more likely to default during “unfavorable economic circumstances, such as a housing market slowdown or job loss.”
Second, the resulting difficulty in qualifying for mortgages meant that FHA loans were absolutely crucial to the housing market over the last few years:
FHA-backed mortgages, which require 3.5% up front, made up about half of loans for home purchases last year, according to housing-research firm Zelman & Associates, but borrowers often pay higher interest rates and must pay private mortgage insurance, often driving their monthly payments higher.
Third, it appears that the banking industry is preparing for a future in which rentals figure in much, much larger than they do today:
“Many people will turn to the multifamily market,” [John Courson, President & CEO of Mortgage Bankers Association] said. “Or if you don’t have whatever is deemed to be the appropriate down payment, the alternative is to be a renter while you accumulate that. You can’t put a formula down that is going to fit every borrower’s profile.”
Taking Federal Plans Into Account
The above statements are not exactly news to real estate industry people. But there are two other seemingly unrelated recent stories we need to take into account.
First is the Obama Administration’s newly released proposal for housing finance reform. It straightforwardly puts forth the goal of eliminating Fannie Mae and Freddie Mac in their current form, significantly decreasing government support of residential homeownership, and supporting rental programs instead.
Second is the 2012 Obama Budget, which is being widely criticized by Republicans for its failure to deal with the enormous deficit problem. One item in the Budget that is starting to draw media attention is the proposal to limit the mortgage interest deduction:
Under his proposal, taxpayers in the 33% and 35% tax brackets would only be able to deduct their contributions and mortgage interest payments at the 28% rate. It would affect those with taxable income of $250,000 and up and bring in $321 billion over 10 years, according to the White House.
The media — or at least CNN — is in full support of killing the mortgage interest deduction. Here’s literally how that article on CNN Money starts:
President Obama’s plan to limit two popular deductions for wealthy taxpayers will hit a wall of resistance from entrenched special interests. (Emphasis mine)
At the same time that NAR and other members of the housing lobby are trying to position the fight against mortgage interest deduction as their looking out for average homeowners, the media will work to make sure their efforts fail: not just special interests, but entrenched special interests. Oh, by the way, the same day the “news” story was published, CNN ran this op/ed by a business professor:
This is a step in the right direction, but if the administration really wants to increase federal revenue and shrink the staggering national debt, it should go even further. It should eliminate the mortgage-interest deduction entirely.
Expect to see more such stories and more such op/ed’s in the near future.
In theory, Republicans might be convinced to oppose this as it is a form of a tax increase. But in reality, that outcome seems very unlikely given the politics of the nation at this time.
Third is the quite likely move by the Congressional Republicans to force the FHA to curtail its spending. Note that FHA loans, with their 3.5% down payment, constituted half of all mortgages in 2010. Given the Obama plans to reduce government involvement, it seems this will be one area where there will be bipartisan support. FHA loans are likely to get means-tested (require certain income levels) or lower the amount (to below median price) to target the low-income buyer.
Finally, there is the likely move by the Obama Treasury and HUD into multifamily finance. I’ve detailed what they’ve been saying, and what I think they’re going to do, over on Notorious ROB last year. The John Courson statement repeats the obvious, but I think it is significant because of the source: President and CEO of the Mortgage Bankers Association. My feeling right now is that the Obama Administration will split the housing finance lobby in half by dividing the banks from the builders and realtors by offering federal support for commercial multifamily mortgages. It’s the smart play, and what I would do if I were working for Obama’s Treasury.
Again, I need to work out some of these implications more fully. But none of them are good for the real estate brokerage industry in the short term. Both price and volume must fall, as buyer demand falls due to unavailability of financing. If only 20% of buyer demand evaporates due to the new mortgage landscape, and NAR’s baseline of 5 million homes for sale as the “normal” goes to 4 million as the “new normal”, what does that do to the industry?
That in turn should put major pressure on real estate agents and their brokerages. The Age of Less is a near-inevitability.
We live in interesting times of transitioning from Homeownership Society to Renter Nation. Let’s see what comes next, and look for a fuller report on these items in the next couple of weeks.