Britt Miller

As the real estate markets continues to move through this current correction, the media continually apprises us of the status of defaults, foreclosures, lender tightening, Fannie Mae stimulus packages or lack there of, drop in sales volume and median home prices, mortgage & appraisal fraud, etc. There is definitely no shortage of information out there.

So what are we to make of all of this?

Over the past two years I have watched closely as the real estate ball started to unravel. Some of it was 100% anticipated, and some of it quite shocking. As I reflect back over this period, here are some of my personal take away’s that you might be able to benefit from:

Real estate is a LOCAL game - proximity to employment, available land, school test scores, diversified economy, type of neighborhood, access to transportation/airports, size of lot, size of home, number of bedrooms, quality of construction, etc., are all driving factors that effect real estate values. In the bay area, same zip codes can be dramatically affected based on test scores for grammar/high schools... just using one example. A broad brush approach does not apply when you drill down in real estate.

Core, well located, in fill markets are insulated from speculative home builders – Home builders buy land for a fraction of what individuals pay. Areas like Vacaville, Pittsburg, Antioch, Brentwood, Gilroy, and Salinas (to name just a few) saw huge run ups over the past four years because the economics and access to land made sense for builders and prices were attractive for buyers. When the tide turns, the builders still attempt to eek out a profit to the detriment of some initial buyers – when builders are buying land at $25k - $50k a lot, and building for $110 - $130/ft, you can see why the people who paid $300/ft (retail) for their house are vulnerable and sometimes walking away due to being completely upside down. Builders create an incredible wave on the way up, but when the tide turns they are "out".

Cash is King – Great buys are happening today for those that have cash. Lenders are rewarding people with strong reserves and highly motivated sellers are putting a huge premium on strong buyers – they are looking for certainty of execution.

Borrow when you don’t need to – there are a lot of people right now that need access to money. Unfortunately the rules of engagement have changed. No one has a crystal ball, but I can't tell you how many borrowers I have seen run their ARM down to the "last month or two" to preserve a rate. In a volatile market, the extra 30 – 60 days could cost you a refi or more realistically could cost you .5% in rate. Over the past 60 days, I have watched rates on ARMs go up .50% and lenders pull back from 85% - 75% LTV. Could be painful as you wait for the stars to align.

Don’t live beyond your means – this is pretty self explanatory. Our home is really the only visible asset to our friends/family/co-workers, etc – but don’t let it be your Achilles heel in pursuit of looking like you made it. Buy what you can truly afford.

Don’t buy based on terms, buy based on fundamentals – in the commercial world, an investor can pay a lot for a Jiffy Lube or a Walgreen’s because they have great credit which results in better than market terms from the lender. It's all great until Jiffy Lube becomes Al’s Oil Change and Walgreen's decides to move down the street and Bob's Pharmacy moves in. Don’t over pay for a property because you can get a teaser rate for 5.0% and all you care about is the monthly payment. Look at the fundamentals – how does it comp out. Time DOES NOT heal bad real estate buys – trust me.

If you can build your same house for less than what you paid for it, the headache could be worth it (contrary, if you can buy below "replace costs" you mitigate downside risk). This is a fundamental principle in real estate. We all put a premium on a turn key home. If you can buy a 2/1 for $725,000 on a 6,500 sqft lot, scrape it, and build a 2,500 sqft home for $600,000 ($1.325m total), DO NOT pay $1.55m for a inferior, older home, in the same market. You are economically disadvantaged the day you close. If you are okay with that, then just realize what you are getting into and you will have to find that "special buyer" when you sell. We all know it only takes one, just don’t be the "one".

HELOC's are the “bravado barometer” in the market – when lenders were giving out loans at 100% of the purchase price, the market was at its peak. In the future, let's be cognizant when HELOC's go to 100% LTV -- might be time to sell (or not if you plan on living in your home "forever").

Stated Income was the Hockey Stick – Look at values across the board in any market. The hockey stick effect was formed when stated income loans were introduced. Stated loans made up approximately 7% of loans originated in 2002 and the number ballooned to 45% in 2006. I personally don't think stated income loans will be back for many years unless you have an established banking relationship with a lender who really likes your liquidity and/or assets.

Lenders drive behavior – Sam Zell, a very prominent real estate investor out of Chicago, says liquidity drives value. Access to credit (i.e. credit cards), allows people to buy. Easy access to mortgage money, causes values go up. Very basic relationship.

ARM money – very appealing if rates make sense relative to longer term money (i.e. 30yr fixed) and a great solution if you foresee living in your home for 3-5 yrs. On the contrary, if the trade off between shorter term money (ARMs) and fixed rate (10yr, 15yr, 30 yr) is less than .25%, you should probably consider locking in longer term money especially if it's a residence you could live in for 5+ yrs.

LTV fuels appreciation – most borrowers would take more leverage/loan proceeds in lieu of higher interest rates. With the pull back in the lending market, buyers are being required to put down anywhere from 3% (conforming…up to $417k) to 20% (non conforming/jumbo) in equity.

Speculate in Vegas, invest in real estate – betting on "gut" only flies at the black jack table. Before you pull the trigger, do your homework!

Get comfortable with 6.25% - 7.0% money -- we are all reading about inflation. All indicators are pointing to higher rates over the next few years to offset a spike in inflation. Additionally, lenders are coming out of a seven year bull market by increasing their margins to price risk (short sales, foreclosures, defaults) into the interest rate equation.

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Overall, the market is going through a contraction and correction that was needed in order to bring everything back in line. There is risk in everything, and the day you are only buying and focusing on “the upside”, is the day we should probably hold off. The area that has surprised me the most, is the pull back in the secondary market for securitized residential loans. Wells, WAMU, Citi, and some of the other big institutional lenders, have priced their loan products where they have to make money.

While the indexes such as Libor, Treasury, MTA, COFI, are all down 30-35% from a year ago, lenders have priced the “new risk” into the margin – for example, if you want a 5yr, 6.5% interest rate on a jumbo loan at Wells Fargo, you have to be prepared to pay 3-5pts – this unfortunately is not a typo. Portfolio lenders such as Downey Savings and ING Direct, are able to utilize their deposits creating a pricing advantage in this market since they hold their loans on their books. i.e. 6.00% - 6.375% for the same loan.

In closing, here's to a great second half of the year and if you have any real estate questions or would like to review financing scenarios, please do not hesitate to call me or John Herndon (415-902-4188) who works with me.



Best Regards,
Britt Miller
Vice President
Steelhead Capital