Spotting Signs of a US Residential Real Estate Bottom:

30 Yr. Fixed Mortgage Rates at 4 - 4.5%...Here's How!
by Paul Mraz

If saving 7-9 million people from foreclosure via the Obama Housing Plan isn’t enough to bottom the US residential housing market, what will it take to bottom this real estate market and turn the tide toward growth?

Spotting Signs That a Real Estate Bottom Is Coming

In addition to taking action to help stem the growing tide of foreclosures, the Fed’s focus needs to turn toward increasing the bank’s ability to lend. With initial TARP liquidity injections, the Fed was able to reduce the LIBOR and two year swap spreads significantly, and created enough liquidity in credit markets that banks are lending again, albeit at prohibitive quantities and at higher than necessary costs.

Banks still cannot lend as much or as inexpensively as desired due in great part to the “toxic” assets still residing on their balance sheets. The “toxic” assets are mostly composed of over-leveraged investment instruments (i.e. CDO’s, SIV’s) that were acquired by many global banks, pension funds and corporations. At their core, most of these structured products are groups of mortgages (based on residential real estate) that were packaged, securitized, and then sold as debt investments.

The toxic assets were supposed to be addressed at the forefront of the $700B TARP. However, due to the urgency of liquidity needed on the equity side of the bank’s balance sheets, addressing this issue was delayed. The toxic real estate assets are causing a major clog in the financial system and are one of the key issues preventing banks from being able to issue more and less expensive loans.

The Fed needs to act soon on their promise to purge the liability side of the bank’s balance sheets so qualified and responsible lending can resume. There continues to be much speculation and opinion around whom and how the toxic real estate assets should be acquired, held, and sold. Solid options with historical merit and success such as a “bad bank”, a public-private partnership, and/or liquidation company much like the RTC of the 1980’s has been discussed. However, even though time is of the essence, no clear structure, direction, or details have been put in place at this time.

How to appropriately price the toxic real estate assets has become a major sticking point delaying the plan’s release. Asset pricing is a paramount concern of any proposed plan and needs to be done properly if the plan is going to work. It is a struggle because it isn’t possible to price and sell the distressed real estate assets at a natural, market-determined price (for the Level II & III assets) because the market for these assets has all but dried up. To maximize their position, bank’s using internal value models are asking for more than private capital buyers using “market” based value models will pay. In both instances it is likely that the banks prices are too high and the “market” pricing models are too low. We now look to the Obama Administration to step in and provide a clearly structured plan and effective pricing direction that clears this major hurdle and re-ignites the critical lending our economy so desperately needs to function.

The good news here is two-fold. First, it finally seems that this critical area has the attention of our law makers, and that they are focused on putting an appropriate program in place to clear the credit and lending system clog. If they could just move a bit faster!

Second, it is important to recognize that there is private capital demand for the toxic real estate assets. Despite what everyone hears everyday via almost every media outlet, maybe real estate is not as hated and useless as it is portrayed. Private capital wants to buy these assets in bulk because they believe, and are willing to put large sums of money behind, the notion that real estate will be a highly desired asset again, and that they will profit greatly from this venture.

Expected Results: 30 Year Fixed Mortgage Rates Hit 4 % - 4.5 %

If the plan is structured appropriately and is put into action quickly a meaningful amount of toxic real estate assets will be wiped from the bank’s balance sheets. Cleaner balance sheets combined with near 0% overnight fed fund rates, and lower spreads on 10yr treasury bonds could create an environment in which the US may enjoy 30yr fixed mortgage interest rates between 4% - 4.5%. This would be the lowest recorded mortgage interest rates in at least the last 50 years of lending. Low rates should act as a catalyst to help further stem foreclosures and create massive re-financing for real estate owners.

Record low mortgage rates combined with residential real estate prices down 30% - 40% in many markets could become a significant demand catalyst and the opportunity of a lifetime for many to thoughtfully consider buying real estate again.

Help More! Waive the Appraisal Requirement for a Mortgage Refinance

To ignite massive amounts of debt re-financing and more stopped foreclosures the Fed should institute a waiver of the appraisal requirement on existing home re-finances. Many argue vehemently against this suggestion as it seems to directly oppose the theories of “mark to market” and present asset value accounting. However, this waiver would allow real estate owners suffering from the deadly combination of increasing adjustable rate loans, and home prices that have deteriorated past acceptable loan to value ratios to take advantage of what could be the lowest fixed rates of their lifetime.

The appraisal waiver would allow real estate owners to modify their loan based on the home value at the time of their last appraisal or when the note was issued in a purposeful oversight of the market’s recent decline, allowing a much greater portion of home owners to carry more affordable mortgages. This move would also satisfy banks because more foreclosures would be avoided and loan principles would not be decreased or forgiven.

Finally: A Real Estate Market Bottom and Brighter Days Ahead

With these actions, the real estate market will bottom, and is close in some areas without it. Many well-known economic experts predict the bottom of the real estate market to occur in June 2009.

However, the longer it takes to deliver and implement a clear, effective government action plan, the worse the residential real estate market could get because buyer demand will wait to act due to confusion and uncertain forward market conditions.

Keep an active eye out for the plan, how it is constructed, and position yourself to take advantage of the right opportunities before the demand surge that will lead to the real estate market bottom, and brighter days ahead.

Best wishes,

Paul