In Part 1, we looked at the opportunities that might arise for iBuyers because the housing market is about to go cray-cray. The basic idea is that as hyperinflation hits housing, sellers will come to prioritize timing and certainty over getting the most money possible, because most of them will be buyers on the other side.
I drew on what we saw in Canada, especially in Vancouver and to a lesser extent in Toronto, to see what could happen when an asset class is simply flooded with money. In Canada’s case, it was partially an increase in the money supply, but it was also partially (largely?) because of foreign investment flooding in to the Canadian residential real estate market.
In this part, I want to explore another angle drawn from the experiences of our brothers and sisters up North: mortgages.
New Doors Open
A crazy 40% a year asset bubble market could open doors to iBuyers that are somewhat closed today. Hell, those doors could open at thresholds below 40% a year. I just got off the phone with a client in Arizona, and he mentioned that home prices were up 14% YOY where he was, which is about 1% per month. Imagine that $300,000 house you liked becoming $303,000 in 30 days… with no changes to the house or anything… then it becomes $306,000. Jesus on a pogo stick!
Now, I’m already on record as saying that iBuyers are actually mortgage plays, not housing plays. That has not yet come to pass, for a variety of reasons. And frankly, it may never come to pass for a variety of reasons, most of them named “complex regulations.”
However, Canada provides a possible look into what new opportunities might arise. This article from Western Investor is extremely interesting:
The value of Canada’s non-bank residential mortgages skyrocketed by more than 10 times in the period 2007-2018, according to Statistics Canada data released last week – a much more rapid increase than residential property values.
Statistics Canada found that the value of all non-bank mortgage loans ballooned by 924.2 per cent in the 11-year period of the study. In that same period, the composite benchmark home price in Canada increased 81.8 per cent from $337,900 in January 2007 to $614,400 in December 2018, according to the Canadian Real Estate Association.
Hmm. What could have led to a tenfold increase over 11-years?
Taylor Little, CEO of private lender Neighbourhood Holdings, told Glacier Media that a steady string of tightening in the mortgage regulatory system was largely the cause of the increase in non-bank lending, especially in the private lending space.
He said, “Coming out of the financial crisis, we start to see mortgage rules change and tightening. Starting around 2010, we really see more aggressive changes, ending in the [2018] stress test, which is the big one. For example, in 2010, they increased the minimum down payment for an uninsured mortgage to 10 per cent. And then in 2011 the maximum amortization period was shortened from 35 years to 30, and then again later to 25 years. So you can start to see the gradual tightening in mortgage policy.”
Little said that these tighter rules caused many borrowers to turn to private lenders for short-term loans to enable them to buy their homes while they got their affairs in order, prior to taking out a long-term regulated mortgage. He added that the increase in the gig economy, with borrowers’ fluctuating incomes coming from different and variable sources, has also boosted the private lending space.
Huh. More and tighter regulation on banks… gig economy… fluctuating incomes… huh. Starting to sound familiar….
The “How Canada’s real estate market went completely insane” article from Canadian Business linked to in Part 1 puts more color on the rise of private lenders:
Private lenders can help those who are turned away from traditional financial institutions, too. Since October, Farber, at Corwin Mortgage Capital, has been fielding more calls from first-time buyers. He’s not cheap—the interest rate for a first mortgage starts at 6.99 per cent—but he’s flexible. “The bank wants to see what your income is in black and white, whereas a private lender like myself will take everything into account,” he says. Farber is most concerned with the amount of equity in the property and how quickly he can move it again if a borrower is unable to make payments.
Some of his clients are millennials, whose parents are not only supplying a down payment but will be helping with payments, too. A bank would steer clear of that situation, but Farber will meet with the parents to hear them out first-hand. “That’s a story I want to hear,” he says. “For a bank manager, that story doesn’t fly. But to me, I have more sympathy and compassion for these younger first-time homebuyers.” [Emphasis added]
I know it’s complete speculation, but… that sounds exactly like what either Opendoor or Zillow could do with mortgages.
The iMortgage
Let’s start with the premise from Part 1. Hyper-inflationary housing markets lead to consumers going to iBuyers to coordinate closings. They get an offer from Opendoor, then go browse Opendoor’s inventory for a house they’d like. They find one for $350K, which is perfect since Opendoor offered them $350K for their house.
Now, here’s the process of the Trade-In program, according to Opendoor:
See anything missing?
I do. In fact, I see about 2,314 steps missing between Step 3: Make an offer and Step 4: Save thousands. Those 2,314 steps involve getting a loan to actually buy the house.
That’s where the pain is. That’s where the delay is. That’s where the uncertainty is in many cases, for the buyer certainly, but also for the seller. “What if he doesn’t qualify?” and “What if the appraisal comes in too low?” and so on and so forth.
On the assumptions that we have made about this asset bubblicious market, money will be plentiful and cheap. But that doesn’t mean normal banks and mortgage companies can simply ignore all kinds of underwriting standards and regulations and so on.
However… as VIP readers know already, I believe there is a major opportunity for market makers to step in and start providing institutionalized seller financing and revolutionize mortgages. Let me quote from that post at length:
We know that Dodd-Frank and the subsequent rules by CFPB imposed some serious restrictions and regulations on mortgage lending practices. The ones we are concerned with have to do with the Loan Originator rule and the exclusions from various regulations for seller financing, in which the owner of the property provides the mortgage to the buyer.
Without getting too buried in the details, we know that the seller financing exclusions mostly have to do with what someone has to do not to be classified as a Loan Originator, who is subject to all of the Dodd-Frank and CFPB regulations, including prohibitions on certain kinds of loans (balloon payments, interest only, etc.). Plainly put, a company cannot offer seller financing on more than three (3) properties a year.
Seller financing also requires a “good faith effort” to determine the borrower’s Ability to Repay.
…
Does the government really care all that much if a giant multi-billion corporation risks its own capital to help a buyer finance the purchase of a property that it owns outright? I don’t know, but I’m leaning towards no.
Banks have to worry about their depositors and FDIC and various banking regulations. Zillow and Opendoor do not. The Federal Reserve has to worry about major money-center banks and their stability; I don’t think the Fed worries about large corporations that have no depositors and are not actual banks.
But from where I sit, it isn’t clear that for large iBuyers like Zillow and Opendoor, whether even that matters. If Zillow or Opendoor, as the owner of thousands of properties, used their own Loan Originators (all of whom are registered with NMLS ) to offer seller financing on their own properties, they appear to be able to offer all kinds of fully amortized mortgages using their own underwriting standards with fairly minimal ATR requirements. There are only 8 required ATR underwriting factors after all and the regulations are pretty reasonable.
When I read about the rise of private lenders in Canada due to the housing bubble (?) there, I can’t help but think that this is precisely what iMortgage might look like.
Imagine a Step 4 in the Opendoor Trade-In process that goes like this:
Finance your purchase easily within 72 hours with the push of a button. Good credit, bad credit, no credit — we’ll look at your individual circumstance, not go by a checklist like a banker.
Opendoor could even make the acceptance of their purchase offer (of the seller-buyer’s own home) contingent on the seller-buyer getting financed through Opendoor Mortgage, so the consumer is never left in the lurch. I mean, who else can do such a thing?
Opendoor and Zillow can do this for the same reason that Canadian private lenders can make loans that traditional banks won’t touch. From the highlighted above, “Farber is most concerned with the amount of equity in the property and how quickly he can move it again if a borrower is unable to make payments.”
Who can move a property quickly better than an iBuyer can? Even private lenders have to foreclose, then go find someone to clean the house, make it ready for market, then list it and sell it. iBuyers already do that every single day as part of their business. They can foreclose on a house, then put it right back into inventory.
So they can “take everything into account” for a borrower, take some risks (at a premium, of course), and if things go bad… well, back into inventory the house goes… to be sold 90 days later for 10% more just on market appreciation.
Now does it make more sense why Zillow might have brought Zillow Offers in-house?
In a hyperinflationary housing environment, where waiting six weeks to find out whether you got the loan or not could be disastrous, something like this iMortgage would be incredibly valuable to consumers. It would be even more valuable to consumers who would not qualify under standard bank underwriting standards; as we saw in Canada, maybe gig economy workers, or parents helping out, or whatever. Even at higher rates, consumers would flock to easy, fast iMortgages if the alternative is a months-long financial proctology exam.
Virtuous Cycle
Between a rapidly rising market and high capture rates on seller-financing iMortgages, market makers like Opendoor and Zillow should be able to capture significant economics from the transaction, while paying market value and selling for market value.
Take the example of the Trade-In seller-buyer above. He’s selling his house for $350K and buying a house for $350K.
His $350K house would be worth $380K by the time Opendoor is done cleaning, renovating, etc. simply because the market is appreciating at 40% a year (Vancouver actually did this), but he got what he asked for and on time to be able to buy his next house. He doesn’t care that Opendoor will sell his house for $380K (or more), just like he’s not going to care that Carmax is going to sell his car at a profit. That’s their business; he got what he wanted.
His $350K purchase makes him happy, and he’s thrilled that he was able to jump on it before prices rose again. Sure, he got the mortgage through Opendoor Mortgage at 6.99%, but that’s a fully amortizing, 30-year fixed loan… and he knows his home will be worth 10% more in three months. Plus, like Canadians did and do, he can refi once his finances are sorted again at lower conventional rates. I’m 1,000% sure that Opendoor Mortgage would happily refi the loan at such a time since that’s more revenues to them. Win-win!
For the market makers, the revenue opportunity looks dramatically different from what it looked like in 2019. Forget 200bps of margin; we’re looking at 1,000bps of margin just on price appreciation alone. Then add in the revenues from an above-market rate mortgage, and suddenly… this is a very profitable business.
The virtuous cycle completes when Opendoor and Zillow, with the elevated margins from market conditions, cut fees to the seller to sell their homes to them in the first place. If the average fee is 7%, with so much margin available, maybe the market makers drop the fee to 4%. Now, selling to the market maker is cheaper than listing with an agent, and it’s faster, and more convenient, with trade-in possibilities, easy fast mortgages, timing the closings, and so on. So more people sell to them, buy from them, and finance through them… which lets them drop the seller fees even further, and the wheel turns again.
That seems like a huge win to me.
Would It Happen?
The obvious answer is, I don’t know. Frankly, I can’t imagine that anybody would know. The existing regulations are complex enough, and even if you are a savant about current Dodd-Frank and CFPB regulations, along with banking regulations and seller financing regulations, you don’t know how things might change if home price appreciation hits 30% or 40% a year.
The banks are not likely to sit around twiddling their thumbs, of course, and their lobbyists are among the most connected in Washington DC.
Plus, REALTORS are not likely to sit around either twiddling their thumbs… actually, the executives at NAR, the very capable lobbying team there, and the smart people at the nation’s largest brokerages are not likely to sit around. The average REALTOR on the street likely has no idea what’s happening, or they’re just too busy trying to find a house for their clients to buy.
The important thing is, this could happen. We know this because it did happen up north in Canada, in a different form than iMortgage, as private mortgage rushed in to fill the holes left by traditional banks.
But all of that speculation is based on what we might call “known unknowns” of politics. What we can reasonably expect based on what we have seen before. In 2021 and beyond, that might be out the window, as the flood of money works its way down the housing market in a volatile political environment.
We tackle that in Part 3.
For now, I hope this was at least mildly entertaining in a way that any discussion about mortgages is not likely to be. And as VIP members, I hope you find it moderately useful to inform your thinking about what things could look like say in the second half of 2021.
-rsh
