Mortgage Dynamics And Demography (w/ Logan Mohtashami)
ASH BENNINGTON: Let's talk about something you touched about a little bit earlier, which was the transmission mechanism between the 10-year rate and mortgage rates. What is the function of that transmission mechanism? How does it actually work, and what's happened here that's been different from in past cycles? LOGAN MOHTASHAMI: What I tell people right now is-- I did a Twitter live talking about a mortgage market meltdown, margin called really early, and people didn't understand, and I think for me to tell viewers that mortgage rates should be below 3% right now, if the 10-year yield is below 1%, mortgage backed securities actually get some purchasing, mortgage rates to be under 3%. If you look at the historical average of the 10-year yield from 1981 where mortgage rates were at 16%, 17%, 18% that chart has gone all the way down. Personally, for myself, recessionary yields are about 62 basis points, and negative 21 on the 10-year yield, so mortgage rates should be a lower but because of the mortgage market meltdown, whatever you want to call it, mortgage rates are still much higher than what they should be. Rule of thumb is that if the 10-year yield is below 1%, mortgage rates should be under 3%. ASH BENNINGTON: Yeah, I think a lot of people were perplexed about those two moving in the opposite direction. LOGAN MOHTASHAMI: Yeah. That's just the stress. Just because I work in the industry, I could see that within hours, that week of March 9th, there were things that were done that were similar to what I saw in 2008. I remember in 2008 in August, Wells Fargo basically printed 8% mortgage rates, their rate sheet and that's just basically saying we're out of business. We're not doing anything right now. That's some of the actions that I saw-- now, it's a much different situation this time than it was in 2008. We don't have a massive wave of defaults about to happen, home prices coming down and overleveraged credit cycle, but you can see the stress happen within hours, and that by the end of the week, by March 14th , the chaos actually started in the mortgage market. We're still dealing with it right now. One thing I always try to emphasize with everyone is that we should be very grateful that Freddie and Fannie were not taken out a conservatorship and they're publicly traded companies on their own. Because if that was the case, and we ran into this, first of all, those stocks would be pennies right now and we would have to require the government to take them back in. The one benefit of all this is that that process of taking them out of conservative did not happen. If that was the case, we'd be talking about much bigger problems and the government coming back and taking Freddie and Fannie into conservatorship. ASH BENNINGTON: I know it's an imperfect metaphor, but one of the things we often default to with new crises is comparing this to the 2008, 2009 cycle. You talked a little bit about that, in a little bit more detail in terms of the durability of the risk and downside that we saw then versus what we see now and the outlook. LOGAN MOHTASHAMI: Here's the biggest difference. From 2000-- well, I would say from 1996 to 2005, the loan quality was not great. The cash out boom really accelerated from 2003 to 2006. This cycle has the best home loan profile I've ever seen in my career in 24 years and our family's been in banking since the late 1950s. We have very high FICO scores as homeowners, there's no exotic debt structures. That's the main thing. That's the biggest difference between this cycle and the previous cycle. Your previous cycle was rotted with exotic long debt structures. That means if you had two people working, and those were loans re-casted, nobody could afford those homes. Here, we have a lot of nested equity. Nested equity means that people that bought homes from 2010 to 2017 have a lot of equity built in so they have selling equity. The stress right now goes back to traditional FHA homebuyers in 2018 to 2019 because these are 3.5% downs with upfront mortgages added to the balance. They don't have any selling equity, and especially those that got loans with FICO scores below 620, that's the stress market. That is where we could see a job loss recession actually become a legitimate foreclosure down the line. I know the government is going to do whatever it can to keep foreclosures from happening anytime soon, but that's the marketplace that you should see the stress. Outside of that, it's been a very clean housing profile in terms of the loan quality, and we are going to benefit from that demand coming from legitimate homeowners that do not need what I call non-owning capacity debt to own the house and that's the big difference between 2006 to 2008 to 2018 to 2020. ASH BENNINGTON: To engage in a little bit of a counterfactual here, it sounds like if we hadn't had this terrible virus, you would be very bullish about the US housing market. LOGAN MOHTASHAMI: You know what, for myself, I am-- all my work was based on years 2020 to 2024 housing getting better. Even for myself, the first two months of 2020, outperforming. Housing starts, up almost 40% year-over-year, purchase application at cycle highs, existing home sales, 13-year highs. It is not an overheating market. Existing home sales were at 7.26 million during the peak of the housing bubble, but it's a little bit stronger than I thought. If there was no virus, I'd be writing about well, home prices are accelerating way too fast right now. Maybe we should look to curtailing credit to stop this from accelerating because the demographics of housing, the bread and butter of the housing market in these next few years has the best demographic patch ever seen in US history in mortgage rates are low but if mortgage rates ever increased, even 4.5% to 5%, you've always seen a hit on demand. There's a fine equilibrium to work with but yeah, the first two months of the year, even for myself, surprised me. ASH BENNINGTON: You mentioned something earlier about the impact of mortgage rates on coastal regions more so than the rest of the country. Why would that be the case in New York and California, when obviously, it's the same mortgage market? Why is it so much more sensitive here and where you are than everywhere else? LOGAN MOHTASHAMI: For example, my neighborhood that I live in is in Irvine, California, 92603. Median home price is 1.2 million. Whenever you get to these coastal areas, the median sales price is much higher, which means you need bear down payments, which means that mortgage balance is stretched to a degree so that marginal homebuyer is always going to be at risk. This is something that's very odd for people because back in 2013, in May, I remember writing about, hey, listen, mortgage rates are going to go up, it's going to impact housing, people started to say no, payments are only going to go up $120. It doesn't matter. The marginal homebuyer will always be at risk when mortgage rates go up, and it's these coastal areas. We saw that, I think 2014 is a really good example. 2014, purchase applications were down 20% yearover-year on trend during the heat months. We really haven't had any negative downtrend with duration, but now, we're going to see it mostly due because people aren't going out to buy but yes, the coastal areas, just because the median sales prices is much higher than the Midwest, and even in the south, there's marginal homebuyers that simply cannot afford the house. That's where we've always seen the demand hit when the mortgage rates are higher. It doesn't mean that the entire total home sale market is going to collapse, but those areas always see the demand hit. ASH BENNINGTON: Two questions sorted together and first is what's the role of internet cash inflows in those two markets and what's the impact of international cash inflows or rather, what's the impact of the virus to the international buying now? LOGAN MOHTASHAMI: Well, this is a great question. A lot of people always thought that international cash buyers were a much bigger portion of the market in general but definitely in coastal areas, I remember here in Irvine in 2013 and 2014, there's like 80% of the new homes were being bought by the Chinese here in the city. Cash buyers is roughly 250 to 300,000 homes bought per year out of a 6 million total home sales market. That gives you a rough idea. The Chinese homebuyer has fallen last year actually to the lowest levels of the cycle. That cash buyer, but in general, cash buyers themselves have been falling during this cycle. We've had a record breaking level of cash buyers, 20% to 30% of the market in general have been cash buyers, not so much all international but you see real estate investors buying homes to rent them out or buying homes to flip them. Even recently, the cash buyers are about 16%, 17% of all the homes bought for the existing home sales market. That is extremely high still on a historical basis. If that isn't the case for the new home sales market, and that's one of the reasons why new home sales market always gets hit with higher mortgage rates because that's roughly a 90% to 93% mortgage marketplace. It's not like the existing home sales market that's benefited from 20% to 30% cash buyers. In a low interest rate environment, real estate investors are always going to be there to try to grab deals just to rent out homes, because there's always going to be a portion of the marketplace in general, demographics that are always going to be lifetime renters. They're just simply never going to be homebuyers. It'll be interesting to see how the real estate investor acts in this in the next few months. They think they can get deals where they want to put some of that cash into the marketplace, but in general, you're looking at 250 to 300,000 homes that were bought every year in the cycle from international buyers. Russians, Brazilians, Canadians were all part of that process, and definitely, we saw the Chinese, when capital controls were put in, limit their buying cycles last year, we should see that again this year. ASH BENNINGTON: While it's relatively small on a unit by unit basis, it has to have an outsized impact on a dollar basis, as I wander around here on the Upper East Side, the nicest apartments in this neighborhood are empty 50 weeks out of the year because they're bought by international buyers who come into town or just use them purely as investment vehicles. What's the impact of that? LOGAN MOHTASHAMI: The very, very high end marketplace gets impacted by that. I remember when I was helping my parents sell their house in Nellie Gale Ranch and it was a $2 million house and I see Chinese buyers coming in-- this was back in 2016, and just majority of them were Chinese looking in and looking to see if they just wanted to put cash in, so the high end marketplace, that is where you see the biggest impact with international money not coming. In areas in New York where you have-- relatively to the total marketplace, it's small, but definitely for sure, when the cash buyer is drying up, you see those areas where homes are empty. We should expect that in the future, we're not going to have 20% to 30% of all home or existing homes being bought with cash. When the cash international buyer dries up, there are certain marketplaces that you will just see the impact like this. This is why you've probably seen that in New York. We've seen that here in California, especially you can see that in Seattle, that some of those markets, some of those high end money is not there anymore. ASH BENNINGTON: You mentioned the rental market. One of the things that got really out of whack during the Great Financial Crisis and something that I think laymen could follow was in certain areas, for example, Las Vegas, the Inland Empire, you saw these ratios of the price of rental to purchase get dramatically skewed. Are we seeing anything that looks like that happening right now? LOGAN MOHTASHAMI: We're seeing some of that skewed marketplace, but I think the thing about when you look at those data lines, we saw an explosion. The best way for me to explain it, real home prices really went too hot from 2002 to 2005. You see the rent equivalence from 2002 to 2005 really take off. If you look at now, the duration is longer, the trajectory is smaller, but we still have this where the rent price to homes still not to the level to where it was during the housing bubble, you still see that gap out there. The thing about rentals is that we literally do not build enough low rental construction in our country. The rental inflation story will always be there for that marketplace and that takes income capacity away from low wage renters always and until we actually massively overbuild, and that's like which we're still never doing, we're just trying to build this marketplace for rental units as possible. That type of inflation is hurtful because relatively to their incomes, they're going to get impacted always unless you have 3D printing just build really cheap homes, the rental aspect is just going to still have that inflationary factor. ASH BENNINGTON: Logan, what's the cause of that distortion and what's its impact more broadly on the society and on the market? LOGAN MOHTASHAMI: We're always told that we need to build more homes. For the last eight years, the housing market never agreed with anyone. It just simply builds off demand. The multifamily construction, while it has had its best cycle in many, many decades, still is always going to be underbuilt because it's simply too expensive to build rental properties in coastal cities. It's cheap, in the Midwest and the South, rent is cheap but in these areas where we have a higher wages relatively to home homeowners versus rental capacity people, it's just simply, we simply do not supply the marketplace so that it's very difficult to move up in society, when that much of your liability cost is going to your shelter costs. I think that's something, after this crisis, we need to really look at how do we produce cheap rentals that the private sector and the public sector can work together because it's very difficult when people say, well, let's just increase wages. Well, okay, that helps except that landlord is going to get some of that capacity and then raise rents as well. It's a very complicated problem, because even if you raise wages on the lower end, the rent inflation is simply going to eat it because there's not enough supply there. ASH BENNINGTON: Right, and we see this especially in the New York market. This is something that's a particularly acute problem here. LOGAN MOHTASHAMI: Yeah, in Los Angeles, 50% plus of the working population are dual renters in one household. You have a lot of roommates, in a sense, just because even renting for yourself is too expensive. You have a lot of people renting rooms in homes. ASH BENNINGTON: Yeah, New York City is one of the few places where you meet people in their 30s who are doctors, lawyers, and have roommates. It's not something that's-- LOGAN MOHTASHAMI: Yes, and it's the same in Los Angeles, even in Orange County too.