Whither interest rates?

Literally every day, I ponder the following questions:

  1. When will the Fed stop buying bonds and allow interest rates to rise?, and
  2. When rates rise, how much will they rise by?

If you believe that the Fed is going to keep stimulating the economy for several years and/or that, when it stops, rates won’t rise by much, then you’re bullish on 5+ unit deals.

If you believe the Fed will stop imminently and / or that rates will jump sharply when it does, then you’re not touching 5+ unit deals with a ten-foot pole unless you have a strong value-add strategy.

Where do you come down?

FHA deals are still possible (I think)

A very good agent who works with me, Marcus, got a client of ours into an FHA deal on a fourplex last week.

Does the property need work? Yes.

Is it in the best location in the world? No.

Is the buyer going to make a lot of money on the deal? Almost certainly, yes.

It isn’t rocket science. If you can figure out how to do an FHA deal on a fourplex, you’re going to put down 3.5-5% to buy. In this case, we’re talking roughly $25-30k to buy a more than 4,000 sq ft apartment building with parking.

Sure, the deal won’t cashflow to begin. But, because the buyer is retiring such a large loan, his all-in return is going to be pretty amazing.

Now, I don’t want to get everyone all excited. It’s not like there are a million of these deals just sitting out there to be done. Marcus hustled a bit and the buyer, understanding how amazing it is to be able to make an FHA deal work on a big fourplex, has been very open to looking at areas that he might have ignored if he were more of a snob or less well informed.

We’re certainly not over the finish line yet. I will update you as we move through inspections and the loan contingency. But, for now, I’m feeling like FHA isn’t quite dead yet.

Where’s the single family home market going?

Hadn’t really considered this question in a while, until a client asked me yesterday.

Let me start out by saying that anyone who is 100% certain of the direction of any market ought to be at a hedge fund betting on their ideas. In the case of the residential housing market, I think you could probably buy some kind of future contract on the Case Schiller Index. Or, you could just go buy a house or two!

The reason my client asked the question is that he is wondering what will happen to housisng prices when interest rates inevitably start to climb. The theory is that, as rates climb, monthly payments climb. So, someone who can handle, say, a $400k mortgage now ($1850 / month payment 3.75%), would only be able to handle a $355k mortgage if rates were 4.75%. Valid concern, right?

Yes.

But there is potentially a counter-vailing force, which is a gradual loosening of underwriting standards. As a result of the mortgage mayhem of 2005-7, bank got burned. They mostly stopped lending in 2008-10 and have opened up only slightly since. Sure, you can get a mortgage if you have very good credit, a stable job, and plenty of cash in the bank. But more marginal borrowers still find it extremely difficult.

If, as many people expect, banks continue to loosen underwriting standards, you might see a bunch of marginal borrowers coming into the single family market, even if interest rates go up. This might have the effect of continuing to push prices up, even with higher rates.

All things being equal, I think it’s a reasonable time to buy a single family home (assuming you don’t do a stupid deal).

Standard Kagan’s Blog warning abouts single family homes: Don’t view buying one as an investment decision!! Single family homes are not assets, because they don’t cashflow. They are liabilities that you take on because you want to consume a certain type of housing. Either buy them all-cash or wait until you have enough passive income that, if you lose your job, you can still make the mortgage payments.

Banks and rents in LA

Right now, one of the biggest problems I see across multiple deals is the total lack of understanding of LA rent control among bank underwriters.

Underwriters are the guys (and gals) who review the property and the borrower to help the bank decide whether- and how much- to loan on a given deal.

Because they see a lot of rent rolls, they tend to think they know the rents in different areas. But, without understanding how rent control works, seeing a rent roll can actually lead you far astray.

For example: Say you, the underwriter, look at five rent control deals in Silver Lake in a row. All contain one bedroom apartments with legacy tenants paying between $600-1250. You think you’re now an expert on Silver Lake rents. You probably think that the right range for market rents for 1/1s in Silver Lake is $1000-1250.

You’re totally wrong. Market rent for a decently renovated unit in Silver Lake is easily $1500 and probably more like $1600. But you, the underwriter, don’t know that, because you’ve seen a bunch of rent rolls with rent-controlled tenants paying less.

So, then, when I bring you a building with a few vacancies and I tell you the rent for those units will be $1500-1600, you think I’m bullshitting you. But I’m not. You just don’t know what you don’t know.

More on demands

We briefly discussed demands (the documentation provided by the lender of what the borrower still owes on a loan that’s about to be paid off) a few days ago, because I was dealing with a particularly irritating lender who was taking forever to issue a demand.

You’re not going to believe this, but the lender is still playing at silly-buggers (this is an expression I learned from Lucy and it totally fits).

First, the lender delayed getting us the demand until the 29th or so for closing on the 31st. That didn’t give anyone enough time, so we agreed to move closing to the 6th.

Then, the lender announced today that they only allow payoffs of their loan at the end of the month, so we have to wait to close until the end of November or pay a penalty to close sooner.

I’ve never heard of a lender inserting a clause like this into loan docs, so I looked into it a bit. Turns out it’s not allowed on 1-4 unit loans. 5+ unit loans are a different story, because its assumed by the regulators that everyone involved is a big boy (or girl!). In this particular case, the borrower signed this ridiculous loan, presumably without considering the implications for a sale. So, we’re stuck.

Now, should we, the listing and selling brokers, have known about this? I’ve never had this be an issue on the 30+ deals I’ve done in the past few years. And the listing agent hasn’t seen it either in his 30+ year career. So neither of us thought to ask the seller if there was anything in the loan docs that would prevent closing on the 6th. And escrow, whose responsibility this is, didn’t think to check either.

You better believe I’m checking from now on before I agree to any closing dates. And, I recommend that anyone considering signing loan docs look carefully to see whether this ridiculous clause is included.