"Why A Real Estate Appraiser Prefers The Stock Market To Real Estate," by Fred Carach

The twin crashes of the stock market and real estate that began in 2007 have devastated the American people as nothing has since the Great Depression. The American people today are far,far poorer than they were prior to these twin crashes. But something very strange has occurred. The stock market bottomed out in March of 2009 and since then has blasted upward in a powerful bull market rally while real estate the favorite investment of the American people and where most of their wealth resides has twisted ever so slowly in the wind.

It is time to ask a most important question. What accounts for this strange divergence? Before we go any further I need to state that in this article I use the narrow, popular definition of real estate. I refer only to condos,townhouses and single family homes. This article ignores apartment buildings and commercial real estate. Those interested in my considerably different views on commercial real estate are invited to read my article on commercial real estate and REITs titled, "How The Small Investor Can Afford To Buy Commercial Real Estate," on my blog.

It is important to point out that until the recent crash real estate had enjoyed one of the greatest sustained booms of all time. You have to go back  to the S&L crisis of the late 80s to find the last time that real estate was not in boom conditions. That crisis ended in 1991 and from 1991 until 2007 real estate did nothing but go up. Everyone was riding a wave that they couldn't lose on. You had to be truly stupid or unlucky to lose money in real estate during this fantastic 16 year period.
For reasons that I have never been able to understand people have enormous difficulty in understanding that in residential real estate it is impossible for real estate to rise faster than people's income for any sustained period of time because people will not be able to qualify for the mortgage.

And this is exactly what happened as the boom progressed. All sorts of strange mortgages were being created to fudge the issue that people could not possibly qualify for the homes that they wanted to buy. Mortgages with weird names such as ARMs, Alt A, negative amortizing mortgages and of course the famous liar loans dotted the landscape.

In 2007 the yawning gap between what people could honestly afford to pay and ever rising real estate prices could no longer be papered over and the whole rotten edifice collapsed. In that year the median priced home sold for $230,000 and the median income household could afford to buy a home in the $150,000-$175,000 price range using honest standards. Incidentally, that is exactly what the median priced home is selling for today. For the first time in many years the median income American family can afford to buy the median priced home.

Why then do I an insider with 30 years in the appraisal industry and a licensed realtor prefer the stock  market to real estate? It is indeed fortunate that real estate is selling for the first time in many years at a price range that is affordable to the American people but the $64,000 question is what will make real estate values rise. The answer I am afraid is that in the next five years there is almost nothing that I can see that will cause a sustained increase in real estate values on the national level.

It is amazing to me that people can not figure out why real estate values are dead in the water and refuse to rise. Contrary to popular belief real estate doesn't increase in value because they are not making any more of it or some other idiotic popular delusion. Real estate increases in value for only one reason and that reason is because buyers engage in bidding contests to purchase properties. In the absence of bidding contests real estate prices cannot and will not rise.

By now it should be obvious to the reader what the problem is. The problem is that the American people have been financially devastated by the twin crashes of the stock market and the real estate market. They are no longer players. They are too broke to engage in bidding contests.

Until the crash there were millions of active real estate players throughout the country who had a net worth of say at least $1 or $2 million on paper if not in reality that they could borrow against. Huge numbers of these players no longer exist. They are done, through, finished, foreclosed upon and have
declared bankruptcy. These now vanished players were the heart of the real estate market and they will not be coming back anytime soon. Indeed many of them will never come back. Their credit ratings have been destroyed and no bank will lend them money. This is a fatal combination in the world of real estate.

The stock market sails serenely on for the best of reasons. You don't need a credit rating of 620 or better to buy stocks and you don't need a bank loan to buy stocks. Stocks are a cash market. In this sea of darkness there is one light. The remarkable rise in real estate of the "cash buyer." For the cash buyer with a 7-10 year time horizon real estate is a market that has real potential.           

Forty Years a Speculator

Fred Carach

Oakland Park, FL 33309

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"WHY THE BANK WILL NOT MODIFY YOUR MORTGAGE" BY FRED CARACH

We cannot understand the present unless we understand the past. To understand today's banking and real estate crisis you have to go back to the last banking crisis. The savings and loan crisis of the late 1980s resulted in a new banking paradigm. Under the old paradigm almost all banks were "full service banks." In other words all real estate lending functions were handled in-house. By the time the crisis was over with the typical bank had been transformed beyond recognition. Banks went from being full service institutions to limited service institutions that had farmed out to others many banking functions that had hitherto been regarded as being important core functions.

However,none of these dramatic changes were visible to the typical bank customer. It looked like the same old bank to them.

This transformation was part of a much broader transformation that was taking America by storm. This new business philosophy held that every business had a core competency and that the way to maximize your profits was to concentrate on your core, high profit skills and to farm out to other institutions your low profit, non-competency functions. It was taken for granted that the activities that were earning you the greatest profits were your core competencies and that anything that was low profit was a low competency skill that was bested farmed out to others. The flaw in this system was that in times of crisis you no longer had the in-house skills to cope with the crisis because the skills had been farmed out to others.

It has to be admitted that in normal times the new paradigm delivered on its promise of lowering costs and increasing profits. This is why today when you make a call to complain about a product or service you end up talking to a speaker who lives in Calcutta, India.

The Old Bank Model

In-house staff real estate appraisers

In-house mortgage originators

In-house servicing of mortgage payments

In-house warehousing of mortgages

The New Bank Model

No in-house staff appraisers

Very limited amount of in-house mortgage originating

No in-house mortgage servicing

Almost no warehousing of mortgages

(mortgages were sold off rather than kept)

Under the old banking model when a mortgage got into trouble the bank had all the expertise needed to solve the problem in-house. Under the new banking model not only was the bank clueless but it was enshrouded in total darkness as well.

Under the old system when a mortgage problem arose the bank knew exactly what to do. Under the new system it sits around and sucks its thumb. Under the old system the first thing the bank would do was send out one of its in-house staff appraisers to do a complete inspection of the home and a complete professional appraisal. Under the new system they call up a real estate broker and ask for a BPO, a broker's price opinion. No doubt you are wondering why they don't hire an appraiser? The answer the bank will give you is that they are way too smart to pay the $275-$350 a complete appraisal would cost. This standard appraisal also includes a complete interior and exterior inspection of the property.

A BPO they craftily inform you will only cost them about $75. That's because the broker never leaves the office. He spends fifteen minutes scanning comparable sale listings on the MLS system. Eyeballs what seems to him to be an appropriate number and another fifteen minutes writing up the one or two page BPO. As the bankers will proudly tell you they are way too smart to get the job done right. Guessing is so much cheaper.

I speak with an insiders knowledge on this point. You see I was one of the in-house appraisers that were thrown out on the streets like a dog.

Let's step back in time and continue our analysis. In the old days when a client asked for a mortgage The in-house appraiser and loan officer would carefully scrutinize the deal. Due diligence was taken seriously because the mortgage was going to be warehoused by the bank until maturity and not sold off. If the mortgage blew up the bank took the loss. In this case the appraiser and the loan officer give the deal a thumbs down. The appraised value is below the sale price and there are problems with the buyer's earnings and credit. The bank turns the deal down.

A month later, an independent mortgage broker shows up at the bank with the same deal. Only this time as if by magic the appraised value hits the purchase price and the earnings and credit problems have disappeared from the mortgage application. Now you know why the banks fired all their staff appraisers and most of their in-house loan officers. Prior to this time the banks originated about 90% of all mortgages. By the bull market peak independent mortgage brokers originated over 70% of all mortgages.

Of course, if the banker has a brain in his poor,stupid head he has suspicions. However his hot, little hands are now holding an appraisal done by a licensed appraiser and a mortgage application that has been done by a licensed mortgage broker. The bank accepts the deal but there is no way he is going to warehouse this mortgage or the ever growing number of dubious mortgages that the bank is accepting from outside mortgage brokers. These mortgages are going to be pooled and securitized into various types of mortgage-backed securities ( MBS and CDO) as quickly as possible.

Let's now return to the present. The bank now realizes that the outside appraisal was dubious and the mortgage application was even more dubious. It has probably sold off the mortgage servicing rights and kept the mortgage or it may have sold the mortgage and kept the mortgage servicing rights. Do not underestimate the importance of mortgage servicing rights. This is what gives you control of the mortgage. Others may own the mortgage but the mortgage servicers control the mortgage. There are about 8,500 banks in this country. The vast majority of which do not service their own loans. The 27 largest mortgage servicers dominate the service industry.

You now know why the banks are responding so poorly to urgent requests to modify mortgages even when it is in their overwhelming interest to do so. It is the common assumption that the reason why banks will not help out their clients is because they are just being mean or greedy. The reality is that in today's brutal real estate market it is almost never in the bank's interest to foreclose. Yet, the foreclosures continue because they are on automatic pilot. It is often the case today that the mortgage servicers start and often finish foreclosure proceedings without prior approval from the bank.

You see mortgage servicers are paid for foreclosing on the mortgages that they are servicing but until a recent change in federal regulations, they were never paid to modify a mortgage.

You now know why the banks and troubled mortgage payers are in such trouble. The reason why banks appear to be wandering around in a stupor, is because they are in a stupor. To a shocking extent they have lost control of the ability to manage this crisis. They are in trouble because they are as blind and dumb as a fence post. The expertize that they once had is gone with the wind.

Fred Carach is the author of "Forty Years A Speculator. His blog is fortyyearsaspeculator.blogspot.com