Last year Wells Fargo, the fifth largest bank, announced that it was avoiding another type of mortgage designed for borrowers who could not qualify for traditional home loan products, further restricting money flow into the already struggling real estate market. The bank no longer offers Alt-A mortgages, a “no doc” loan requiring that borrowers only state their income, without providing any verification. Wells Fargo, the largest Alt-A lender, made this announcement following their withdrawal from the riskier business of subprime lending. Alt-A mortgages offered exotic features such as monthly payments that only cover interest expense or the ability for borrowers to forgo the full interest payment in exchange for relinquishing a piece of equity in the home, i.e., a negative amortization loan. For these mortgages, lenders waived the income verification process and offered a temporary introductory low interest rate in the early years of the loan. After 1 - 3 years buyers could not afford these payments and, consequently, mortgage lenders have been saddled with hefty losses. It was this supply of easy money which played a pivotal role in propelling real estate prices during the boom years. Alt-A loans targeted middle borrowers with blemishes on their credit. These borrowers did not have the “straight A” credit needed to apply for a “full doc” loan (where income was verified), but were a step above the subprime market where borrowers had bad credit. As a result, investors are no longer buying bundles of Alt-A mortgages and Moody’s Investor Service was forced to increase its loss assumptions for this category. Homeowners who had grossly exaggerated their incomes in the past to qualify for these “liar loans” are now unsuccessfully trying to refi after the 1 - 3 year introductory interest rate period elapses. Homeowners hoping to refi are finding themselves locked out, as lenders such as Wells Fargo have curtailed their exposure to Alt-A home loans after already pulling out of the subprime market.
Conclusion
We are now in a rental real estate market where home prices have dramatically dropped. The aforementioned homeowners are going to continue to default on their mortgages as they initially lied or exaggerated about their incomes and received an artificially low interest rate. Mortgage companies will continue to tighten up their lending, further exacerbating money flow which has already devastated some builders in the process. People who are losing their homes or people who do not want to buy a home in a declining market will rent. For the last couple of years occupancies have been decreasing marginally, but rental income has been increasing. In this climate, however, occupancy and rents are both increasing.
Interest rates are still relatively low, and market prices remain under value due to the credit crunch. Thousands of people continue to be foreclosed on, losing their homes. These people, however, are not living on the street. They have been and, will be, forced to rent. The law of supply and demand dictates that average rents have been driven up while vacancy has decreased.
The only people who can take advantage of this perfect storm are those who are not locked out of the credit market. In other words, as has always happened throughout history, the rich will get richer and the poor will get poorer. Our clients are winning now with high rents and high occupancy as landlords have the leverage to raise rents in this perfect storm. Consistent with the law of supply and demand, our clients will also win once the credit markets loosen and people begin buying homes again. As buying pressure increases, the values of their investment homes will increase.
AFFILIATED WITH GREAT REAL ESTATE, INC.
Market Outlook
