Lending Industry Changes Will Affect Real Estate Investors

Lending Industry Changes Will Affect Real Estate Investors




Given the alarming events of the last two weeks encompassing the stock, bond and housing markets, it comes as no surprise that both investors and industry participants alike are trying to make sense of what has now become one of the most tumultuous periods over the last 20 years for the real estate and mortgage industries.



The past two weeks have fostered a clear contraction of the mortgage banking industry. Some very well known, and some not so well known, mortgage banks have closed their doors in the past 30 days, laying off thousands of employees while seeking protection from creditors within the bankruptcy courts. There is no doubt over the next 30 days we will witness more carnage and the number will swell as the investors who loan these mortgage facilities money to in turn lend to consumers, proceed to either temporarily cease all “warehouse lending” to those mortgage banks or severely reduce the “menu” of loan options they will allow a mortgage bank to underwrite. Negative amortization and other “pay option loans” (the ones which allow the borrower to choose the kind of monthly payment they would prefer and are popular amongst real estate investors) will either be eliminated or reserved for only the strongest of borrowers.






The credit crunch has not been restricted to home owners and small investors however. It is being felt all the way up the top of the borrower food chain with the likes of famed buyout firms such as Kohlberg Kravis Roberts (KKR) and buyout fund Cerberus Capital Management. Both firms were rebuffed by global debt markets in July along with forty-four other leveraged buyout deals in failed attempts to raise some $60 billion . “We are seeing a simple but extremely powerful de-leveraging of the global markets” observed Doug Cliggett, Chief Investment Officer of Dover Management.



Over the last few days, what started as a whisper thoughtout the industry has now become a clamoring for the Fed to step in, lower rates, and save us all. Unfortunately, this is probably not going to happen. The Fed’s responsibility is to provide one of the “one-two punch” that manages the U.S. economy, monetary and fiscal policy. Their use of monetary policy is a double-edged sword. If the overall economy is doing well today, which it is, lower rates will provide too much stimulus and drive long-term interest rates higher, thus killing the patient it sought to cure.



Current data, as of last week, provides us with a picture of a healthy, stable economy. According to Barrons August 6th, 2007 article by Gene Epstein, Jobs Data: Goldilocks Lives, job trends over the past 12 months show that both overall and private payroll employment is up 1.4% since July of last year with the unemployment rate at 4.6% consistent with the flat trend in the unemployment rate. The recently released advance estimate for second quarter real GDP growth ran at an annual rate of 3.4%. More importantly, performance of the various components indicated that growth could easily run in excess of 3% for the next 2 quarters. Historically, real growth in GDP of 3% or more has been considered healthy and it compares favorably with growth of only .6% in the first quarter of this year.



So what about the stock market? After the correction of the last 2 weeks, some 800 points from its closing high of 14001 on the Dow is up 5.8% year to date. and the S&P is up a paltry 1%. Second-quarter earnings for the S&P 500 seemed on track to rise by 9% according to Thomson Financial. It doesn’t appear to be grossly inflated.



So what will the Fed do? We will have to wait until when the policy-making committee meets. For as much pain as mortgage and real estate investors have either felt or seen in the past two weeks and for as much as we may see in the coming months, the Fed will almost certainly not act in haste. Based on the analysis of the facts presented here we believe the Fed will not change short-term rates. But hopefully we will see a change of bias that lets everyone know the cavalry is just over the horizon.



In closing, the mortgage and banking industry and Wall Street will bear the brunt of this credit crunch. It will feed on fear and uncertainty. Lenders can compensate for fear by raising rates or tightening underwriting standards. But, uncertainty can never be compensated for. If the loans you write in the future carry an indeterminable amount of loss, how can you hedge that risk? The bottom line… if you are going to borrow money to buy real estate, you better be ready for a much more inquisitive lender.