Lender Lounge with Kevin Kim Special Episode: Mid-Year Outlook

Kevin Kim:

All right. I think we're live guys. All right. Well everyone, welcome to a special edition of Lender Lounge with yours, truly, Kevin Kim. We're going to change it up this time. As for those of you who've been watching the podcast and listening in, we've been doing a lot of these midyear midseason live streams and up until now they've been kind of random ones where it's kind of fun and games. But right now in the year that we've been having, I think it was a good idea to have a little more of a serious discussion, have a little bit more of a impactful discussion. So being that we're close to the middle of the year, there's been a lot of uncertainty and volatility in the private lending industry and the economy at large, and we hear at Geraci felt like it would be a great opportunity to ask two of our favorite economists and data junkies that serve the private lending industry to join us here on the podcast. So gentlemen, why don't you go ahead and introduce yourselves and what you do and who you work for. Rick, why don't we start with you?

Rick Sharga:

I was going to say we should go alphabetically and let Darren do it. So thank you for reversing the order. He's like

Kevin Kim:

To my left, to my right, whoever goes first, right? No,

Rick Sharga:

It's all good. Thanks. Thank you to Kevin and the team for inviting me to participate today. My name is Rick Sharga, I'm the Executive Vice President of Market Intelligence at ATTOM. For those of you not familiar with ATTOM, we're one of the nation's leading providers of real estate and mortgage data to the real estate financial services, insurance and home services industries, as well as government agencies and educational institutions. So delighted to be here with my longtime friend, Mr. Bloomquist.

Kevin Kim:

Alright,

Darren Blomquist:

Yes, thank you. Yeah, honored to be here as well. My name is Darren Bloomquist. I am Vice President of Market Economics at auction.com. And I didn't do a good job of branding as Rick should have did teach me. I didn't put my name of auction.com up there with my name, but with auction.com, we are the largest marketplace for selling distressed properties in terms of specifically for at foreclosure auction and bank owned auction, we account for about 40 to 50% of that market of the transactions that occur there. And certainly I paid close attention to that distress market, but the retail market matters a lot to us and our sellers as well as our buyers who are real estate investors out there on the front lines of the housing market.

Kevin Kim:

Alright, well I want to kind of do an opening segment and more general of a discussion for those of our listeners who are watching things. I mean it's all over the news. Everyone's talking about this issue as it pertains both on the politics side but on the industry side as well is that there has been a lot of concern and volatility. We've got record inflation, we've got rate hikes we never seen, haven't seen in 10 years, mortgage rates up the roof, a lot of uncertainty, a lot of concern. I talked about this with some friends and shades of the 1980s. So first things first, I like you gentlemen to open up and give us your thoughts on current general outlook and then let me know. We have the slides here for you guys ready for your use as well. So

Rick Sharga:

You want to talk economic outlook or housing market outlook or

Kevin Kim:

Let's start with economic outlook for now. General economic outlook is kind of one of the first things I'd start with because broad impact right now is a lot of concern generally speaking from a lot of our clients, but haven't gotten thoughts from folks like yourself who live and breathe this stuff.

Rick Sharga:

Darren, I'm going to let you go first since I got to introduce myself first.

Kevin Kim:

There you go, gentleman.

Darren Blomquist:

Oh wow. Look at that. And actually I do think there might be another opportunity for this slide, but this slide that where that has just tons of data on it.

Kevin Kim:

Yeah lemme get it for you. This one right here?

Darren Blomquist:

Yes, that one. All right. The last couple of recessions, I could have gone back further, but I think the main point in reference to your question, and this maybe steals some thunder about what we're going to talk about later too, but the main point is if you look at the gray lines and the gray bars, the gray bars, there are the last three recessions including the pandemic recession, which was extremely short. And then the gray lines, which are the federal funds effective rate. It's not guaranteed, it's not quite death in taxes, but when the Fed raises its rates, they're not intending to cause a recession. They're intending to cool the economy off. But when they do, we typically do see a recession following that. And we've seen that the last three times. And if we went back further in time, we'd see it very consistently over the recessions. And so I think in terms of an economic outlook, broad outlook, I think there is a very high risk for a recession given the anticipated fed rate rise increases that are coming. We've already seen one and it looks very small there on the right hand side of your screen, but if those continue as are expected, we would see something more like what you saw leading up to the 2020 recession as well as the 2008 recession as well as the 2001 recession, more of a trapezoidal type of shape there. And so my answer would be that

Rick Sharga:

Did you say trapezoidal?

Darren Blomquist:

No. If I did, that was a Freudian slip. Trapezoidal, I don't know if that's a word, but so I think there's a very high risk of recession. People who are smarter than me have looked at this longer than me are predicting a recession. It's not guaranteed, but I think that in terms of economic outlook is coming, you could argue there was actually a decrease in the GDP in the first quarter. So we may be closer than we think.

Kevin Kim:

The initial first signs. And that was all of the news as well. Rick, give your insights to us and we'll get into the weeds a little bit on this stuff on the housing side.

Rick Sharga:

Yeah, I tend to agree with Darren on his outlook right now, although I don't have quite as many data points on a chart. If you look at the last, the history of Fed involvement in trying to prevent the economy from overheating trying to get inflation under control. 8 of the last 11 times they have tried to do that. They've overcorrected and the country has gone into a recession probably worse than that. The three times they successfully executed a soft landing, they did it by raising rates proactively before inflation got terribly high. Those three times they successfully executed a soft landing every other time when they started to take action after inflation spiked up, we entered into a recession. And to Darren's point, the technical definition of a recession economists use is two consecutive quarters of negative GDP growth. We've had a negative quarter in Q1 down by about 1.4% after phenomenal growth since the month or the one quarter dropoff when Covid was first declared.

I was talking to Lawrence Young, who's the, and Darren actually was on this panel as well, who's the chief economist for the National Association of Realtors. And he said something really interesting about a coming recession. He said, we are probably going to have one, but it may not matter. And that wasn't as cavalier as he made it sound. What he meant was technically from an economic standpoint, we might actually have a recession, but the fallout from the recession may be so minuscule that we almost don't notice it. And I would point to this current quarter. This past quarter as an example of that, we were in negative territory, 1.4% minus growth, but job growth continued unemployment didn't go up. Consumer spending continued to be strong. So even though technically we were in a negative quarter, it kind of didn't feel like a bad recession. The reality is that there are a lot of things that are contributing to what's happening right now.

 

It seems to me almost impossible to imagine that the government and the Fed activity combined could pour $11 trillion into the economy in 18 months and not have some inflationary impact and perhaps a rebound that leads to a recession. The other thing to factor into this, and then I'll stop talking so we can have a conversation, is consumer confidence right now is the lowest it's been in decades. The trend line has been down. There's a disconnect right now between consumer spending, which represents about 70% of the gross domestic product and consumer confidence, which is continually getting lower. That disconnect historically just doesn't happen for long periods of time. And consumers could get worried enough between inflation, the war in Ukraine, another wave of Covid that they do clamp down on spending. And that could all by itself lead us into a recession. So I don't really think it's much of a question if I think the questions really are when and how bad it'll be. And right now I'm thinking mid next year and fairly mild as US recessions go.

Kevin Kim:

So I'm hearing a fairly mild outlook, nothing, nothing too crazy to worry about and kind of echoes some of the other panels I've been on and discussions I've had with other industry folks, more folks on the lending side who've kind of had the general sense that the parties not over, but we should probably start thinking a little bit more conservatively and let's try and put this over to housing because I mean that's what everyone in our industry is watching like a hawk. And this is one of the most material, I guess, factors when it comes to the private lending industry because hell we're making loans on houses, right? So let's talk about that. So one of the things that Darren's slide here is showing is the correlation to some housing stats that are pretty interesting. I was reading this slide, Darren, there seems to be some pretty interesting, I guess predictors that are we headed toward a pretty bad situation on the housing side because there's a lot of corollaries 2008.

And so everyone I've talked to so far and my kind of just sense doesn't feel like we're headed toward 2008 part. And everyone seems to be justifying that based off of the inventory issue. We talk about inventory, inventory, inventory, the demand side is so high and the supply side is so low that that's going to be kind of our saving grace to some degree. But based off what I'm seeing here and some other kind of conversations I've had with you and other folks, that may not be the case. So I mean, let's open up that and then see what you guys think. I think you're on mute there, Darren. There you go.

Darren Blomquist:

There we go. Can we hear me all right? Yeah, I had to take a cough break while Rick was talking. He gets me emotionally. But anyway, so the point is actually the parallel, trying to parallel maybe what we've been through over the last couple of years, a little bit more to the recession in 2001, my theory is that we were headed toward a recession anyway. The recession signals were flashing in 2019 and nobody was foreseeing a pandemic at that point. And we were actually headed toward what you might call a soft landing in the housing market interest rates. The Fed had been raising interest rates, as you can see there with both the gray line and the blue line and home price depreciation was slowing down. In fact, the data we use, which is actually the public record data from Adam shows, there was one month where home price depreciation was as low as 1%, actually a little bit under 1% as interest rates rose there for an extended period of time above four.

And so above four and a half actually. And so we were headed in that direction, and what the pandemic did was actually saved us from that soft landing maybe potentially, and what would've been a recession anyway. And all the stimulus thrown at the economy during the pandemic helped to save us from that and maybe a softening of home prices. And what it did is, as you can see there with the green lines, it created a huge increase in home price appreciation, acceleration of home price appreciation, or it helped contribute to that. So I think we saw a somewhat similar scenario back in 2001, fed lowered interest rates as that recession hit and that stimulated home price appreciation. But what happened is it may be overstimulated home price appreciation to a point where a correction almost was needed once the second recession hit. And so I think, I don't want to say we're going to see another 2008 at all. I would get lambasted by Rick for that, I think,

And I don't think that's the case. There's a lot of different, the inventory that you talk about is a huge piece of it and the quality of loans that we have. But I do think there is a risk of at least a correction in home prices given all of this. And I think when we just surveyed our buyers, who I like to say are on the front lines of the housing market, they're thinking six months ahead, they're the borrowers of the private lending community and they're always thinking in six months cycles, what's going to happen after I buy this property and auction.com and renovate it and then resell it down to the road in six to 12 months? What they said, 55% of them were saying that they think they described their market as overvalued with a correction possible. And that was up from 40% a year ago. And how

Kevin Kim:

Current was that? Was that recent or

Darren Blomquist:

That We did the survey in March, so a couple of months ago, and that was even before we saw some of the increase in interest rates, right?

Kevin Kim:

I mean, the record increased recently right up to 6%. I mean, it seems to be what I've only heard anecdotally speaking, nothing data wise that seems to indicate HPA is now stabilizing or on the decline. We're not. I mean, I've personally seen it on homes that I watch and stuff like that in communities that I live in, but it's not been validated by anyone. I mean on your guys' end, even though rates were climbing, climbing, climbing over the past five months, mortgage rates that is didn't seem to have an impact on home price too much.

Darren Blomquist:

The consumer has been extremely resilient. The home buyer has been extremely resilient in the face of rising rates. But I do think that risk is continuing to increase. The more that we see double digit home price growth continue, the greater the risks for a correction down the road. But when I say correction, I'm not saying 30 to 50% decrease in home prices like we saw in 2008.

Kevin Kim:

Yeah.

Rick Sharga:

Can I,

Kevin Kim:

Yeah, Rick, go ahead.

Rick Sharga:

Can I please put the, we're looking at 2008 all over again, meme to bed once and for all.

Kevin Kim:

I'm glad you bringing that up. Yeah, please.

Rick Sharga:

The market dynamics this time compared to then could not, if you wrote a script and said, do a Jerry Seinfeld opposite day episode, that's what we'd be looking at right now. Darren touched on a number of the points, but just to put a little bit more granularity into what he was saying, we've seen inventory start to improve a little bit. Now we're up to about 1.8 months supply of homes available for sale. We have less. We have, I believe, 0.6 month supply of new homes that are completed and available for sale in a normal market. We're usually somewhere between four and six months supply. So even with the modest improvements we've seen lately, we're way, way off where we'd normally be. If you look at inventory leading into the financial crisis, we had 13 months of supply. So the builders never got the memo. They kept building once some of those bad loans started to go bad, we had foreclosure inventory coming into the market.

The lenders clamped down on credit demands for what they were going to allow in terms of their loan portfolio. So nobody could get a loan at precisely the same time as we had more than twice as much inventory as a healthy market would support. So the inventory thing that we kind of glibly refer to is really much more real than most people give it credence for. The other thing is Darren mentioned loan quality. There are a lot of borrowers who are buying on spec, speculative borrowing going on, people getting 125 LTV loans, 133 LTV loans, negative amortization loans, pick a pay option loans. The only way they were able to afford a house they bought was to get in on a teaser rate because they didn't understand that when an interest rate went from two to four, it didn't represent a 2% increase. It represented a hundred percent increase in their interest payments.

There was a story about a woman here in Orange County where I think all of us are located during that period who was losing eight homes to foreclosure. She was a cleaning woman who made about $40,000 a year and had eight mortgages on individual properties that she bought as investments. You have to wonder what the loan officer around loan six or seven or eight must have been thinking in order to approve yet another loan on these properties. So we don't have that kind of speculative buying going on today. We have owner occupants who for the last couple of years were driven by a desire to move from renter to homeowner. They were getting to that prime home buying age.

They very often were putting a lot of cash down. In fact, 34% of purchases in the last quarter of residential properties were cash purchases. A lot of those by owner occupants and wall prices has been going up. We've seen equity levels go to record numbers. Last published number I saw was 27 trillion in homeowner equity. 90% of borrowers currently in foreclosure have positive equity. And if you juxtapose that with 2008 when a third of all homeowners were underwater on their, again, it's just that the conditions couldn't be more different. Having said all that, I tend to agree with Darren. I'm probably a little more selective. I don't know that the entire housing market is due for a correction, but I do know there have been some regions, some markets and some price tiers that are definitely overpriced. And we're already starting to see list price reductions. So Bay area of California, Pacific Northwest, maybe some markets like Austin or Phoenix or Boise or

Kevin Kim:

Overheated areas that were mean Phoenix is supposed to be one of the most highest increase in home value in the country. As recently,

Rick Sharga:

Well last year Boise was at 45%. Now guarantee

Kevin Kim:

Here down Orange County, it's terrible too. So that's interesting part.

Rick Sharga:

I think the median price in Orange County is either a million dollars or very close to it right now, which is just, it's insane. But there's nothing available for people to buy and there's people that still buy that.

Kevin Kim:

And that raises the interesting question. You mentioned earlier, just the equity amount, right? So it sounds like, I hate to say this, but the A TR requirements of the conventional programs seem to have given us a little bit of extra protection in the sense that there's not as many speculative owner occupant borrowers. But when we look at our market on the private lending side, there has been a significant increase in amount of leverage that's being offered to both flips, construction, those types of short-term loans, but also on the term rental programs. Before we transition into the impact on the industry of private lending, I kind of want to ask the impact associated with certain phenomenon I guess you can call within in the home buying industry as a whole. One of the things that everyone seems to have been complaining about was these cash buyers and they're causing challenges. But you mentioned something Rick that was kind of interesting there. You're saying that the cash buyers that you've been tracking have been actual owner occupants, right? So it's not as many I buyers as we think there are. Is that the case or?

Rick Sharga:

Well, we're actually crunching the numbers right now. I can't give you a percentage, but I'll promise you that there's a higher percentage of owner occupants using cash to buy homes today than anytime since I've been in the industry. I don't know the exact percentage. The IBU muddy the waters a little bit because they are coming in and buying properties with cash. But you're talking about collectively tens of thousands of acquisitions a year in a market where 6 million properties were sold. There's another category called power buyers companies like Ribbon and Knock who will effectively make a consumer a cash buyer by fronting them the money to buy a property while they're trying to sell their home. But the other point that's important here, I mentioned Boise a couple seconds ago, is you're seeing people tap into the equity they've acquired to then use that to buy property with cash.

So there was nothing organic about the Boise economy that justified a 40% increase in home prices. It was buyers coming in from the Bay Area who sold a house in San Jose because they can now work from home. They took the $600,000 in profit, moved to Boise, bought a home for 400,000 that have been listed at 300,000, kept the other 200,000 in the bank and property values inflated. So you're seeing an awful lot of that. And it's important for people to understand that most of the buying today, a higher percentage of buying today among consumer buyers is move up versus first time buyer. So those really expensive houses they're buying, they're using all that equity they've built up to make a significant down payment, keep their monthly payment within boundaries. So again, it's not the kind of risky buying that we saw back in 2008, but normally first time buyers account for about 40% ish of the market. Last numbers from the NAR was about 25%. So there's very little inventory available for first timers. They're not able to afford a lot of the inventory that's out there. And so a lot of this is people tapping their equity.

Interesting.

Darren Blomquist:

Yeah, just a couple comments. One of the things on the inventory side, I agree on the inventory side, but I guess I view it a little bit differently than Rick. I mean, when I look at the new home inventory as of March 407,000, that's the highest it's been since, sorry, I'm looking at my spreadsheet since August of 2008 and we have now

Rick Sharga:

Seen, doesn't that include homes currently under construction?

Darren Blomquist:

It probably does.

Rick Sharga:

Okay. So I don't actually disagree with you. I was talking about the ones that are completed, but a lot of these are being sold while they're being built. So you're,

Kevin Kim:

And actually raises a question I wanted to ask, and Darren, it sounds like it's a good topic on construction. It's because I've actually been challenged on the inventory topic and there's data that backs up the argument that there is an inventory shortage. But a lot of our clients are saying from a lender's perspective, is there really a shortage? Because construction lending is through the roof right now, right? New construction, there's a lot of people that make the argument that fixed income flip is dead and it's all construction loans. Now is that producing sufficient? And that's one piece of the puzzle, but compare that with also the massive, massive plan communities that are being built. I mean, drive around Orange County, they're being built everywhere too. So talk about the construction you're looking at there.

Darren Blomquist:

Well, I think that we're on, if this trend continues, it could quickly flip. And home builders are notoriously and partly just because of the industry are behind the times because you can't immediately have a house. You can't create a house overnight. And so that, I think there is some risk of builders getting behind the curve. And we did see housing starts at a nearly 16 year high in March as well. And so there are some signs that inventory is coming back. We're also seeing inventory. It's a smaller part of the puzzle, but we're seeing some of the inventory held back by the foreclosure moratorium come back as well. And so that all coalescing could, I think fairly quickly shift the tide. And certainly on the existing home sales side, the inventory is just razor thin, but it's more on the new homes that I see. Some of

Kevin Kim:

Those signs about that though, because there's a lot of construction going on. True. But a lot of our clients really doubled down when term rental became a great product for them from a capital market standpoint. They were able to originate and sell those loans on volume, a big piece of the private lending industry. But one of the fascinating things that came from that I noticed was this whole built to rent phenomenon. And it seems to be that they're not building, they're building to hold these things and rent 'em out and whole communities. And it raises an interesting question from an inventory standpoint for supply, which ultimately impacts values is how much of that is being factored into this analysis. It worries me when I hear about master plan communities that are being built solely for built to rent, and that may not be a thing with as rates climb, but I do want to bring it up and get your guys' thoughts on that.

Rick Sharga:

That could even be more of a theme as rates climb. Darren and I pretend to disagree, but we're actually really, really close in terms of our perspectives. Just little different dots on the continuum. I've seen indications, I'm sure Darren has as well, that we may have peaked in terms of demand at this point. If you look at some of the statistics out there, we've had eight consecutive months now where existing home sales are lower than they were the prior year. We've had 10 consecutive months where pending home sales are lower than they were the prior year. The mortgage bankers association's purchase loan application index, which tracks a number of loan applications for people looking to buy houses is trailing both 2021 and 2019. You have to kind of throw out 2020 because it was a weird year. So you look at all those things and California, which a lot of people look at as bellwether state when it comes to real estate trends, home sales are off 7% year over year at this point in the year.

So I think inventory is one of the issues. I think the other issue that really becomes a huge, huge factor is affordability. And if you just look at the fact that interest rates have virtually doubled for a 30 year fixed rate loan in the last year, home prices have continued to go up 17 to 20% depending on where you're looking. That average monthly payment is 25 to 30% more expensive than it was a year ago. And that just wipes a lot of buyers out of the market. So as those rates go up, as home prices go up, and we may get to this later, but I am of the belief that as we hit this affordability wall, you'll start to see home prices plateau and home price appreciation get much, much lower as we get toward the end of the year. But that could actually drive more people into renting these single family units that a lot of private lenders are funding the development of because they just can't justify spending as much as it costs them to get into the owner occupant market right now, but they'd maybe still like to be in a house.

So I think that becomes an opportunity for the investment community, people that are buying and handling these single family rental units

Kevin Kim:

And absent a sharp decline that support the argument. And one of the debates that I've had on the show and questions I've asked our guests is like, is the whole idea of the next generation being a generation of renters, there's a lot of, if you go to a rental show, I remember all the panelists like, oh, gen Z and millennials love the rent they don't want to buy. And then compare that to record home buying demand. So

Rick Sharga:

If you go to an ostrich farmer's conference, they will tell you that ostrich is the up and coming meat.

Kevin Kim:

You

Rick Sharga:

Have to be a little careful where you get

Kevin Kim:

These sources. It's kind of funny because the industry, those events are full of folks who are doing fix and flip and rental and bridge and construction, and they would rather someone buy the home than rent it. But the interesting part of that is my perspective is there's a lot of conflicting arguments on this front, but there seems to be kind of supporting data on both sides of it.

Darren Blomquist:

I actually kind of think it's a little bit of both because the millennial, we'll talk about the millennial generation, which is in their prime. Home buying is so big that if you look at home ownership rates among those millennials, it's still the furthest among generally millennials. The under 35 age bucket from the Census Bureau, it's still the furthest below that homeownership rate is still the furthest below its 2004 peak of any age group. So they've been the slowest to become homeowners in some ways of any generation, but they've also seen the biggest increase since 2016 in home ownership rates. So there's kind of room for both trends to be happening. They're increasing their home ownership rates, but they have more runway to increase their home ownership rates or stay renters at the same time. So I think there may be a little bit of both there because just the sheer size of, to

Kevin Kim:

Me, it would benefit a lot of us to see an increase in, I guess demand, but make it a little more affordable. But one of the questions becomes, and I want to bring this up because California announced they have this, the California Housing Finance Agency is offering this type of forgivable equity builder loan, and they're offering for first time home buyers that meet a certain income threshold effectively sounds like it's a forgivable loan as a second. So you can put it down payment on the house and kind of similar to what those for-profit agencies are doing. But where do we land on this? I mean, this seems to be kind of an artificial attempt from my perspective, at least artificial attempt to increase demand. But I mean, at the end of the day, if your income bracket isn't there, you can't afford the average house against in where you're trying to live. So do you guys, what do you guys think about that?

Rick Sharga:

How down payment assistance programs aren't new? There have been not-for-profits that have offered those over the years. And by the way, according to research from the Urban Institute, there's been no indication that properly qualified borrowers with down payment assistance foreclose at any higher rate than anybody else does. So the key there is, so the problem they're trying to solve is certainly not lack of demand, it's lack of affordability for underserved communities and for households at the low end of the wage spectrum. The key to making this work the right way is to make sure that if the down payment is the only thing preventing successful homeownership by that family, that down payment no longer becomes an issue. But you, well, my

Kevin Kim:

Concern with that though is the a r analysis may not if they require any area median income as kind of the qualifier, do you meet the a r analysis to actually own the take down the mortgage?

Rick Sharga:

You and I are saying the same thing, Kevin. If they vet the borrower properly and say that once we get past the down payment, they can absolutely afford that monthly payment. And they have adequate cash reserves so that when the water heater blows up, they don't go into foreclosure. But if they just start doling out down payment assistance to get somebody into a house, without doing that careful qualification, you're basically setting a lot of people up for failure because those typically are borrowers who have no margin for error, very little wiggle room. And so putting them in a spot where they have that kind of financial responsibility and maybe aren't ready for it is just really not good for anybody.

Darren Blomquist:

And I see it as solving the wrong problem, which is stimulating demand. We already have plenty of demand. We need more affordable housing, more supply. I mean, even though I've just talked about some issues on the supply side, but I do see that as potentially simulating demand. I mean, if you look back, actually, you might be able to see it on this graph here. You see the first time home buyer tax credit. I know the numbers are really small there. First time home buyer tax credit was a policy put into place to try to,

Kevin Kim:

There we go a little bit better.

Darren Blomquist:

Yeah, I think it went into effect January, 2009 to try to stimulate demand coming out of the recession. You actually see there was a few months in 2009, maybe into 2010, where we saw home prices go positive. But then once that home buyer tax credit went away, the home price appreciation went back negative again. And we're not in a scenario where we're trying to actually, that was a scenario where you did want to stimulate demand. We're not even in a scenario where we want to stimulate demand. So

Kevin Kim:

They're trying to solve for the affordability problem, but they're really impact, they're really just increasing demand,

Darren Blomquist:

Which is going to exacerbate the affordability problem, in my view. And so I think more supply, and I do think that the folks that this industry, the private lending industry is lending to are one piece of the puzzle in helping with that provide affordable housing supply.

Kevin Kim:

Exactly.

Darren Blomquist:

Yeah, I want

Kevin Kim:

To talk about that now because I'm transitioning over to the industry specific issues. One of the things that we're all watching like a haw is foreclosures and Darren Auction is one of the best places to get this information. But the interesting part is I've anecdotally, I've gotten information from clients in New York and all the country that say foreclosure moratoriums not as much of a concern anymore, but they're all kind of worried about incoming disruption from legislation. We have it in California. We have that, I call it the sniper bill, right? Someone sniping and take your foreclosure off from underneath you, but give us some intel as to whether it's become kind of a national thing. Are we going to start seeing this trend across the country and disrupting foreclosures? Because now the more to are over, our clients can go to auction, our clients' borrowers can go to auction and buy these properties. But are we going to have a stall because of the things similar that we have in California?

Darren Blomquist:

Yeah, I think there's some well-intentioned policies, and we are seeing a trend, and as Rick said earlier, California's a bellwether state in more ways than one. And when it comes to legislation, we are seeing a trend in that, okay, these foreclosures are coming back. Let's get them into the hands of they're affordable. They tend to be on the affordable end of the spectrum. Let's get 'em into the hands of owner occupants. And I think that's very well intentioned that the bill in California does that by saying, after the foreclosure auction is ended, owner occupant or a nonprofit can come in and make an upset bid of that. And we've seen that. We're tracking that in our data. We've seen that happen to a certain extent. There hasn't been a lot of that going on, but that has been happening and it disrupts the process. It creates unknowns for the buyers at the first foreclosure auction, I guess the real foreclosure auction for a lack of a better way of saying it, about they put that cash out and they have to wait 45 days before they actually know if they take possession of the property.

So there's uncertainty around it. And we've seen some potential abuse in terms of nonprofits coming in and claiming to be, I mean, they are nonprofits, but really just buying up those homes and not renovating them and doing quick flips. So I think the problem with some of this type of legislation is it's got good intentions, but you've got to think about human nature unfortunately. And so I think that the other trend that we're seeing that I think is more helpful, although it is not going to be a silver bullet, is a first look after the foreclosure auction has taken place, a first look opportunity for owner occupants and nonprofits in the what's called the second chance auction, which happens with HUD properties where it's an REO, it hasn't been renovated. We put it up for auction on auction.com, and there's other places as well. And HUD has just recently announced that they, they've expanded that first look period to 30 days.

So owner occupants and nonprofits have 30 days to go in and make a bid where other bidders are not allowed to participate. And that may have some lift. But the other issue, and we actually did a joint study with the Urban Institute looking at this, why don't more people buy it at auction, at foreclosure auction and REO auction? And the conclusion is, as you guys probably know, these properties are in very poor condition. They're often not financeable, and they require major renovations that an owner occupant is not prepared to handle, and about half the time they're occupied. So if you're an owner occupant, you take on the task of evicting the current occupant, and that's not something a lot of owner occupants are ready to do. So it gets a little thornier when you look at this. And when we look at some of our data, this is something we're looking very closely at. The property's bought on our platform when they're resold after about 200, 250 days, 71% of them are going to owner occupants after they've been renovated. And so we think, Hey, the market's actually doing a pretty good job. There's some incremental things we could do to increase that eventual ultimate owner occupancy rate, but the market's actually doing a decent job of that. And I could go on and on

Kevin Kim:

About fixed infl model in general, right? The rehab fixed infl model in general, the data itself is showing that because it takes a professional to do that kind of stuff, I don't want to buy it. I don't want to do that. I'm your exact person. I don't want to do that kind of stuff. I can't be bothered to go in and do a full reno on an REO or evict a tenant or I don't have time for that. And I think that's ringing pretty true across the board.

Rick Sharga:

Your lenders will probably agree with this that the two biggest mistakes investors make when they're buying one of these properties are they tend to either overvalue it and so they pay too much in its current condition, or they underestimate the cost involved in bringing it to move in ready condition. If investors make those mistakes from time to time, imagine the likelihood of a first time home buyer looking at one of those properties and being able to accurately gauge how much to spend and how much it's going to cost to fix. And to Darren's point, a lot of these properties are in such bad shape that they're not even, you're not going to be able to get financing on 'em. So it's, as Darren said, very well intentioned. I think everybody's in the right place, but I'm even more opposed to this than what Darren was because again, I think you're inadvertently setting a lot of people up for failure trying to do the right thing, but completely ignoring the value add role that investors play in these markets, in doing what they do to improve the value of a community of a neighborhood, bring properties onto the market that are ready for people to move in and still doing it at a relatively affordable price.

You asked about other things that we're hearing two things worth mentioning. One is that I have heard there's another one of these sniper bills in consideration in Ohio where they're looking at a similar program to what we've seen in California on that sniping after the auction piece. There is a letter that was published by the Consumer Finance Protection Bureau last week that was warning servicers not to execute foreclosure proceedings on a borrower who might qualify for their state's homeowner assistance funds. So right now, if you're a servicer and a borrower calls you and says, Hey, I know I haven't made any payments in six months and I'm out of forbearance now, but I might qualify for half from the state capital, you probably don't want to put them into foreclosure right now. So that's going to keep some of these properties from getting to the market anytime soon. And one last point, the Biden administration for a while had been considering its own 15% down payment program that would be available nationally, the first time buyers who met certain financial thresholds. So again, to Darren's point, last thing we need to do right now is stimulate more demand, which would actually drive more

Kevin Kim:

In the economy. I mean, there's a lot of money out there. So the Fed tap ran, it's kind of counter to what the Fed wants to do. Alright, so I want to transition to now industry specific issues and metrics and what you guys have been seeing as it pertains to fix and flip loans, construction loans and term rental loans. The three kind of big products that our industry is focused on bridge, which we classify bridges, fix and flip construction on residential for investor properties. And then the term rental product has become, which was this massively popular product when rates were at record lows and has become a very hot issue as of late with rates being what they are. So Darren, I think your second slide has this information on it, so I want to see what you, give me your guys' perspective on things. How have things been going on the investor front, how are things going from your perspective as it pertains to all the things we just talked about and relevant to our clients? And then we'll get into some, I'll share some data that we have and then we can go into a discussion from our perspective.

Darren Blomquist:

Sure. Yeah, I think that I'll preface this connecting back to something I said earlier that 55% of our buyers when we surveyed them in March said their market is overvalued with the correction possible. Those are the fix and flippers, those are the prime fix and flippers. And so at first blush, you'd be a little concerned that they're getting bearish on the market. However, about 80% of our buyers said they're planning to either buy the same or more properties than in 2022 as they did in 21, and only 17% are expecting home prices to go down in 2022. So it's kind of this interesting thing. I would say they're being a little bit more cautious because they do think there's more risk for this correction, but they still want more inventory, they still want to buy. And so from a fix and flip perspective, I think there's going to be a lot of demand for that continuing in 2022 just based on that. And then also based on this data, which is actually from ATTOM, again, on the right hand side, you see the short term flips, and this is by quarter spiking through 2021 properties that are flipped within six months of the first purchase. It's actually a little bit of a concerning trend as well, but it does show that there's a lot of demand because of this low supply environment that we're in.

Kevin Kim:

Well, that raises an interesting question though, Darren, because this goes to 2021, right?

Darren Blomquist:

Take out It's actually got the first quarter of 22 in there, although it's not in

Kevin Kim:

There. Okay,

Darren Blomquist:

The

Kevin Kim:

Question I get all the time is, okay, rates just climb through the roof mortgage rates now it's 6% roughly. That happened recently. And this is, we know it's going to cause a massive issue on DSCR and we'll talk about that in a second. But when it comes to flips, the question mark becomes how does that actually impact the frequency of fix and flip and construction? Because those rates are not necessarily correlated directly to mortgage rates. And so the lender will decide based off of effectively what their capital partners and the cost of capital is, and also market demand, but it's not directly correlated to actual mortgage rates. And have you seen any change in that when it comes to, I guess on the borrower side is the best way to look at it, right?

Darren Blomquist:

I mean, yeah, we look at demand metrics on our platform, which are the two big ones are sales rate, the percentage of properties that come to auction that are selling, and then the price execution. And there was a little bit of a dip at the end of last year, and I'm not sure what that was, but those demand metrics have actually bounced back in the first quarter of this year despite the rising mortgage rates. And so to the extent that we're continuing to see strong demand from our buyers who about 60% of our buyers fix and flip about 30% hold for rent, and then the rest are a different strategy, but we're still seeing strong demand in the face of those mortgage rates. So I'll stop there unless I'm not sure if that answers your

Kevin Kim:

Question. No, it does.

Rick Sharga:

Just to add to what Darren is saying, our data on the fix and flip market did show a little bit of a decline in the percentage of fix and flip executions that were financed at the end of 2021. So since 2018, it's been roughly 60% cash purchase and 40% finance purchase, give or take a percentage point. It probably dropped one or 2% as we got toward the end of the year, and that happened while we were actually seeing more flips. So it doesn't look like the percentage is going down simply because we have the same number of flips and fewer people are financing. But that's a trend to watch as rates go up. I know you said they're not directly connected, but certainly conventional rates have some impact on Oh, it

Kevin Kim:

Does.

Rick Sharga:

Private, they can share. Yeah.

Kevin Kim:

Yeah, I mean, they're all dependent on it for sure, because it's takeoff financing for the sale. And I'd like to share on some of the data that we pulled from our platform. So give a little background on this slide here. gii for those listeners who don't know, is we prepare loan documents and closing documents and close loans for private lenders across the United States. My partner, Nima pulled this data from our platform and what this compares two big different products, bridge versus construction, bridge versus rental, I'm sorry. And so you see that sharp decline, and this is a national aggregation of data for our origination from January to May, basically yesterday. And so you saw a sharp decline effectively in the rental product, but you don't see as much in the bridge product. And when we say bridge, we're contemplating fix and flip bridge and construction loans on residential real estate.

And so what found really interesting was that also if you look at the rates in the middle bar graph there is that the rates were going up, and I mean logically rental rates because they're correlated to the mortgage rates, they're climbing in association with mortgage rates, but the fix and flip in the construction rates are going up, and it started out beginning of the year and average at 8.9%. Now in May on average at 9.45%. And so I think we're starting to see a little bit, not dramatically compared to 200 basis point increase on the rental product, but what's interesting is that fixed and flip and just, we call it bridge, has remained quite healthy absent a slight, our clients actually echo the same sentiment. Rick was like, January was weird for everybody, and the beginning of January was weird for everybody and no one could explain why. But then it all picked back up again midyear mid month, and then toward February it got better. And then Q2 for at least for our bridge lender clients, seemed to be quite healthy. What's fascinating is because all of this is now funded through various institutional investors who have their cost of capital directly tied to the Fed funds rate. So with that being said, I'm not quite sure if you guys watched this stuff, but I'll get your thoughts on this.

I talk a lot about this with clients is during 2020, during covid, the institutions had a liquidity scare and they pulled out from the market from a secondary market, they're buying loans perspective. Do you feel that with all the institutional intention that has come to both private lending and also to residential real estate as a whole, do you feel like there may be a little bit of a pullback from the institutional investors as we start getting into this higher rate environment when mortgage rate is six? Jerome Powell is basically saying that he's going to keep hiking rates until we get inflation under control. We're only at 75 bibs so far, but who knows where it's going to go, and we have this joke in the office, like our mortgage rate's going to be at 12% again. Right? So that's kind of the question mark for you guys, and I want to get your thoughts on it. How do you guys feel about the institutional investors' perspective on this and where are they going to head?

Darren Blomquist:

One quick question, Kevin, on this is my assumption is the main numbers are not, of course, fully baked, right? So that huge drop is you probably want to stick with the April numbers to look at

Kevin Kim:

Your, well, I mean, so fully baked

Darren Blomquist:

Trend or is

Kevin Kim:

That Yeah, overall, this is clearly when the rate, so give you some anecdotal evidences. In March, there was a big change in rates on the DSCR product and the volume of DSCR origination because our platform is purely loan document production and closing. So rates were going up, institutional investors were having trouble figuring out what the pricing was going to be on the purchase of the loan. And so there was a lot of uncertainty come April and May. That volume definitely tanked because of our client's inability to originate because dependent on the secondary from an acquisition or funding standpoint, because purely an institutional product. So I mean anecdotal, I can tell you there have been many clients telling me who originate this stuff been telling me a lot of the programs out there have either gone by the wayside, no longer exist or have gotten significantly more expensive. And so volume on the DSCR rental product has definitely taken a dive.

Rick Sharga:

It'd be a surprise if capital costs don't go up, which private lenders will then have to reflect in their interest rates.

To me personally would also be a surprise if capital suddenly dried up. There's just an unbelievable amount of capital still parked on the sidelines right now. What you haven't talked about that could also be an interesting factor into this mix and could scuttle all of our projections is how fast the Fed unwinds its positions in mortgage backed securities. Are they going to have to sell off a lot of those assets? If they do, does that compete in the capital markets with the funds that would otherwise be available to your private lending clients? So that, that's a real X factor in my mind, but just in general terms, everything in the secondary market right now seems to be, everybody seems to be looking for things to invest in. So MSR numbers are through the roof. Any non-performing loan pools get gobbled up. Reperforming loan pools are getting gobbled up. I don't see lack of capital becoming a problem immediately, but I also didn't see covid two years ago, so don't take my word for it.

Kevin Kim:

Right. A shock to the system on whether they could, I felt like the explanations given to me, at least during covid was they weren't sure whether they should be deploying the money. So they were because of valuation concerns and that created liquidity crunch. But in this situation, we're not having as much of valuation concern in the asset class. So you're suggesting that there's a redirection of capital flow because of the release of RMBS from the Fed, which is a valid thing

Rick Sharga:

Potentially that could be an issue. And again, capital costs are absolutely going to go up and that's going to ultimately get passed along to the borrower. I did speak to the CEO of one of the larger private lenders about their stance in covid when they shut down. And his indication to me wasn't that they couldn't get capital at that point, but they weren't willing to take on the risk of the unknown because nobody knew what the impact on the housing market was going to be, how long it would be, how deep it would be, and they didn't want to put that capital at risk. So it wasn't lack of capital, it was basically lack of knowledge about what was going to be happening next.

Kevin Kim:

Do you guys expect any kind of negative impact with our clientele originating these loans? A lot of our clients are really uncertain everything that they're seeing. And I get this a lot. They always say, this happened during covid too. Everything, they're seems to be fine, right? Volume is fine, borrowers are fine with the rates. There's not much of a concern. Borrowers are okay with an increasing rate environment, at least on the flips of the construction. They understand seems from their perspective, not so much to be concerned about. Now, DSCR is a totally different topic, but let's just concentrate on bridge for now. But what I'm hearing from you guys is that there might be a challenge that may be facing and based off the earlier part of the discussion on the inventory, whatever it is, please expand and give me your thoughts on of the overarching impact on the bridge space and where you think they're going to be landing in the next year or two.

Darren Blomquist:

Yeah, there was a lot of questions in there, I think. But yeah, I think it boils down to, yeah, I mean, how confident are we? And I think the big thing that changes the dynamic for me is if we see signs of that home buyer correction materializing, that changes a lot. All of a sudden

The formulas change for the fix and flippers and the confidence in what the future market will do changes as well. And so I think if we see that potential correction materializing, that could put a lot more uncertainty into the bridge market and create some negative issues for private lenders potentially. And so that to me, that's the biggest wild card is this trend that we're on going to lead eventually to some type of, I think it's certainly going to lead to a slowdown in home price appreciation, which will take away some of your, I guess, the looky-loo investors who are relying very heavily on home price appreciation, but you'll still have your core customers who are still operating in that environment in a slow down environment. I think in a negative price appreciation environment, then you see a lot, at least a lot of the investors I talked to all of a sudden, instead of flipping that property, they keep it as a rental and so it switches to that rental bucket rather than the maybe fix and flip bucket. And so that's the biggest wild card for me.

Rick Sharga:

There's likely to be margin compression both for the lenders and for the fix and flip investors themselves? I think less so to Darren's point on the rental owners because they can amortize that over time. Once they have a tenant in place, they can get more conventional financing if they need to. But capital cost going up means that the cost of borrowing is going to go up if we do have a price correction in the market, or even if price appreciation just plateaus and levels off at a much lower number, that's always an inflection point where flippers who came into the market at precisely that time, unfortunately, you're going to take a hit. And so you could have more problem loans for private investors or private lenders during that period until the market adjusts. The best case I can offer you of being a little bit off on a big number is Zillow offers who wound up selling a lot of properties for less than they bought them for, which is a recipe that at scale leads you to lose $300 million in a quarter. So a little bit of a change in appreciation, a little bit of a change in interest can have real meaningful numbers, a real meaningful impact on the margins.

Kevin Kim:

I like the comment is the idea of a driving toward rental, but our feel of things seems to be on our industry side of things is that the term rental product for the private lending industry, which was just a massively popular product for a lot of our lenders, is falling apart for them. And a lot of folks have been saying now we're now kind of figured things out because now the securitizations have figured out where prices are going to go. But the concern on our end is it seems to be at least that DSCR may not be as prevalent, but it sounds like you guys are saying that as things head more toward a rental strategy from an investor perspective, that as long as there's some type of certainty from a rate perspective, that they'd still be willing to do it and then they can always refi out to a perm loan with government agency or something like that. Is that what, okay, that's a good, okay.

Darren Blomquist:

Yeah, I think that's fair. I mean, I am looking at it more from the perspective of the behavior of the investors in terms of acquisitions and strategy now, how they will react to rates. I am less confident there. Yeah.

Kevin Kim:

Yeah. I mean it's a pretty big shock to the system, right? I mean, at least for the DSER clients, two, 300 basis point increase is a pretty big shock. I've been told that it's a product of the uncertainty on the bond side, but they're going to have to swallow that bitter pill eventually, 6%, 7% rates, and that seems to be the case on conventional as well. Okay. Well, I mean, I guess the last question I'd like to ask you guys is I kind of want to circle back to the type of recession that you guys think we're going to be facing. It's not like we're in agreement. There's going to be some type of recession coming. We should prepare for that, I think so we can close with that. Where do you guys think it'll end up? Give me your outlook on that. Will it be the soft landing we're all hoping for, or is it going to be a little more sharp?

Rick Sharga:

Briefly for me, I think we do enter a recession probably about the middle of next year, middle of next year. I don't think it's a particularly deep recession. I don't think this is one where we're going to see jobless rates or unemployment rates skyrocket, but probably fairly short. I would say probably no more than two to three quarters. And to quote Lawrence Young, it might not feel like it's all that bad a recession once we get through it.

Darren Blomquist:

Yeah, I think I'm generally on the same page. I want to disagree with Rick, but I just can't. So yeah, I think that's actually kind of in our forecast when we plug in a recession, we're plugging it in. And I guess I've been around economists too much, but I look at it as scenarios. There's an increased likelihood of a recession scenario. It's again, not a hundred percent, but increasing likelihood of that. And we're plugging that in around the second half of 2023. And yeah, I guess to Rick's point about what Lawrence Yon said is that the recession is actually the lesser of two evils than continued rising inflation. So you don't want to minimize a recession. But in that sense, it's almost a needed correction to this overheated kind of economy that we've been in. In terms of specifically our world. It will make a difference. I mean, we do see elevated when we plug in a recession scenario, we do definitely see elevated levels of foreclosure activity without the recession. We see basically foreclosure activity returning to 2019 levels, somewhere around there and leveling off with the recession. We would see those foreclosure of volumes return more like to 2016, 2017 levels, but not 2009, 2010 levels.

Kevin Kim:

So we're all in agreement. We're not facing that. But I mean, one of the jokes that was made is, I guess we hear on the news too, is started the podcast with shades of the eighties. And I don't think that's the right analogy. It sounds like, I think probably more a unique situation. A lot of this has kind of artificially been generated. It sounds like. I get nervous just because of cost of capital, and I think that's the biggest concern I have. Frankly, from my perspective, the clients that I serve, mostly balance sheet lenders, mostly not so reliant on Wall Street and capital markets, would love an opportunity to have an increasing opportunity to do more foreclosures, which means more opportunity for their borrowers. And an increasing cost of capital means less competition from the institutional markets. So I think there's some pros and cons that come with that type of down cycle. So I think there's going to be some benefits from that and hopefully some NPL opportunities come up for our private lenders and our real estate investors to go get after some new opportunities that way. So I'm hoping that that's kind the silver lining for our industry.

Alright, I think that's all the time we have for today. I want to really thank you guys. It's hard to make doom and gloom fun, but I think we did and really appreciate you guys coming on the show. And this will be out as a recording as well later down the line. And so once again, thank you guys for joining us on the show and we'll make sure to get you guys on social media so you can share that to your audience as well. All right. For everyone listening in, this was Kevin Kim for Lender Lounge. We will see you on the next one. Thank you.