Bulls & Blogs

Property flipping, through which a real estate investor buys and resells a property in a short period of time, is a popular way to achieve elevated returns on investment properties. Unfortunately, it also was a preferred means of committing fraud in the lead up to the financial meltdown. (Fraudsters often would conspire with appraisers who would inflate a property's value, thus enabling the fraud.)

As a result, HUD prohibited the use of the FHA loan program for properties that had been owned for less than 90 days. The FHA loan is a favorite of first-time homebuyers because of its lenient down payment and lower credit score requirements, and a large share of property flips are lower-priced homes, which tend to attract these same homebuyers. The result of the prohibition was that investors often had to hold properties for 90 days before they could sell for no reason other than to satisfy the regulation. This made the economics of purchasing distressed and foreclosed properties much less appealing.

With the number of foreclosures rising dramatically, HUD on Feb 1st waived this regulation under certain conditions. This is a huge deal for property investors because it means they can purchase a foreclosure at auction and immediately market the property for sale at an elevated price. There's only one problem: Most lenders are not applying the waiver to sales by private individuals. I did say most, not all. I know of at least one lender that is applying the waiver as HUD intended.

Check your excitement until you review the conditions. (This is only a summary. Drop me an email if you want the full text.)

• The seller must hold title to the property, so contract assignments may not pass muster.

• It must be an arms-length transaction with no identity of interest. The property should be marketed "openly and fairly."

• The property's title report cannot show a pattern of flipping.

• If the sales price of the property is 20% or more higher than the seller's acquisition cost, the waiver will apply only if:

  • A second appraisal verifies that the seller has completed repairs to increase the property value or explains why the increased value is justified absent repairs;
  • A thorough property inspection, performed by an independent inspector, must be provided to the buyer.

(Actually, the waiver allows the lender to justify the increased value without a second appraisal, but I don't know any lenders willing to do that.)

Getting the waiver will add some time to the loan process. Additionally, the lender cannot request a waiver until the first appraisal has been completed. Thus, the buyer may have to eat the appraisal cost if HUD rejects the waiver request.

If you want more information, or if you have a transaction you want me to review, don't hesitate to drop me an email.

Today was the last day of the Federal Reserve's direct intervention in the mortgage market. To recap, the Fed allocated $1.25 trillion in Jan 2009 to purchase mortgage based securities (MBS). The goal of this program was to support the mortgage and housing markets and to foster improved market conditions. The question is what happens now?

Mortgage rates clearly have benefited from the Fed's involvement. In very simple terms, markets set interest rates to earn a certain spread above what they consider a risk-free investment, the 10-year treasury bond. When the Fed began the MBS purchase program, this spread was 170 basis points (1.70%). Within about a month, the spread had tightened to 120 bp and has continued to tighten to roughly 65 bp today.

There are many reasons why spreads increase and decrease. One big reason is supply and demand. With the Fed ending its purchases, who will step in to provide the demand for MBS? First, be clear that the Fed was buying AND selling MBS (though it certainly was a net buyer). There are other buyers in the market. Domestic and foreign banks also were net buyers. Hedge funds and money managers, on the other hand, were net sellers.

The Director of the FHFA (conservator of Fannie and Freddie) has made it clear that Fannie and Freddie are not going to hold the MBS on their books. Thus, they will be net sellers.

For the short term, it appears supply and demand may be out of balance. In order to draw private investors to soak up excess supply it's likely mortgage rates will rise. The most believable predictions I've seen estimate that spreads will rise to as much as 100 basis points. If the 10-year treasury hits 4.0%, this would equate to a 30-year fixed mortgage rate of 5.5%. (The extra 50 basis points is eaten in servicing and guarantee fees.) It's unlikely this will happen all at once. Instead, rates probably will be volatile as the market seeks out a new equilibrium.

Will the higher rates dampen the housing market? That's the big question. Mortgage application volumes are still depressed, which may help keep the spread tighter (because of less supply entering the market).

One last question: What will happen to the MBS the Fed purchased? Will it flood the market and put further pressure on rates? The Fed says it plans to hold the securities on its books for an extended period of time and sell them only as market conditions allow.