Non-Sequiturs

The spread between the 10 year constant maturity Treasury and average conventional mortgage rates has narrowed from about 2.6% at the end of January to about 1.95% last week. That compares with a spread in April, 2008 of about 2.2% and about 1.5% in April 2007. The Treasury's plan to buy mortgage backed securities has precipitated some narrowing of the spread – which helps lower consumer mortgage rates. But the spread has not yet returned to the levels that existed before the financial crisis began.

Today, 30 year fixed conventional mortgage financing is available at approximately 4.75% plus a 1% origination fee.

In the last sixty days, 30 year fixed financing for jumbo loans (greater than $417K) has begun to return. Some lenders are quoting 30 year fixed rate jumbo financing in the high 5's with a 1% origination fee. Jumbo adjustable rate financing with the rate fixed for the first five years is plentiful - with the first five year's rate in the high 4's and low 5's.

In the fall of 2008, Fannie Mae and Freddie Mac tightened their mortgage qualification guidelines for investment property purchases and refinances. Their guidelines were changed to limit the number of financed properties owned by the borrower to five. Effective May 1, they have raised that limit back to ten properties. The qualifying and down payment requirements have been tightened for those borrowers who own 5 to 10financed properties. Nonetheless, this affords investors the opportunity to refinance their existing properties and to acquire new properties. This should help absorb some of the foreclosure inventory.

The state and federal moratoriums on foreclosures have expired, or soon expire, in most states. The federal foreclosure assistance programs do not work for everyone. We will see a spike in foreclosures and inventory over the next 30 to 120 days.

On April 29th, the Treasury will announce it's 10 year and 30 year offerings for the May bond auctions. Bond investors are concerned about the possible needs of the Treasury, the size of the auctions and the market's ability to absorb huge supplies of new bonds. This auction could be a glimpse of things to come. The fiscal deficits are just beginning to put pressure on the bond markets. It is reasonable to believe that this could signal the bottom of this interest rate cycle. If the auctions go well, rates could drop. But it will probably be temporary. If the auctions go poorly, rates could spike.

Your Home - Shelter or Investment?

In recent postings, I have opined that it's a good time to buy a house – if you need a home and can afford to buy. My rational is that existing homes are selling below replacement cost and mortgage interest rates are at historical lows.

But is a house a good investment? Or should it matter? My Dad told me to buy a house with the primary motivation as shelter for me and my family. If it works out to be a good investment, that's even better. He also told me that a good investment is usually measured by what you buy it for, and not what you sell it for. OK, that works. If I need and can afford a house, I can now buy one cheap with a very low mortgage rate.

The things that assure the investment value of a house are exactly the same things that attract me to a house – good schools, good location, close to jobs, access to public transportation, access to good shopping, access to entertainment and cultural things, a stable local government with affordable property taxes, a price range that is affordable for the area in which I am buying (don't buy the most expensive house in the neighborhood – even if it looks like a great deal). If I stray from those values, I endanger the long term investment value of my home.

I believe the economic situation in which our country finds itself has changed the rules about real estate investing – at least for the next decade. The tremendous federal deficits will keep pressure on interest rates for the foreseeable future. The deficits and resulting financing needs will gradually erode our government's ability to impact interest rates with fiscal and monetary policy. That could create huge spikes and valleys in interest rates. It will cause banks and institutional investors to be volatile enterprises that behave with increased unpredictability. I believe that today's low, fixed rate mortgage financing offers generational opportunity to those who can afford a home.

For the next decade, I do not necessarily think that homes will be a great investment. Here's why.

If you think the federal government has problems, think about our state and local governments. I know very few that are healthy. Many state and local governments are facing large property tax increases, large income tax increases and cuts in services. If you purchase a home in one of those communities – and there are many – the value and “affordability” of your home will be impacted.

There is a large segment of our population that is unemployed, under-employed or nervous about their job stability. Do you see anything on the horizon that might cause that to get a lot better? I don't. If I'm right, that will inhibit home purchases and will probably keep home prices low, albeit stable, for the next five to ten years.

Interest rates will go up. When they do, that is likely to inhibit home sales. Hopefully, the rise in interest rates will be accompanied by economic improvement and consumer confidence. But it is more likely that it will be primarily due to huge federal financing needs.

Many think that the federal deficit will lead to inflation. In times of inflation, those who own tangible, scarce commodities usually win. Although it has lost its appeal, gold is the most common example of a scarce commodity. Real estate is also recognized as a good hedge against inflation. The current inventory of unsold homes seems to conflict with the notion of scarcity. That is probably a short term condition. But I believe it is only short term in those communities where there is or will be scarcity of housing. A fabulous home on 50 acres that is 75 miles from downtown is scarce. But the demand for such a property is limited and inconsistent. The supply of small homes on an 80X100 lot in a great school district that is 2 miles from downtown is limited and demand is fairly consistent. Many of us cannot afford the home close to downtown. But there are many communities that exhibit, or will exhibit in the future, the same characteristics.

I don't mean to sound negative. Actually, I see incredible opportunity.

If you are buying homes for investment, be disciplined and be prepared for a 10 year investment horizon. It's going to take awhile to straighten out this mess and the government is in the driver's seat. The government is unpredictable and has both social and economic agendas. The “bank problem” is not over. In fact, it is probably still in the early innings. For the foreseeable future, free market capitalism rules have been “trumped.” If you accept that and plan accordingly, you will be the smartest guy in the room. You will likely do very well on your investment.

If you need a home for shelter and can afford to buy one, this is a very good time to do so. But be careful, do your homework and be smart. Buy your home as shelter for you and your family. Keep some cushion in your cash reserves. Do your homework and don't stray from the basics of real estate investing. What the heck - plan on staying in the house for 20 years.

Blooms on The Rose

“I compare you to a kiss from a rose on the gray, the more I get of you, the stranger it feels, and now that your rose is in bloom, a light hits the gloom on the gray” – Seal

Mustard seeds, blooms on the rose, chutes of green, the end of the Depression, the bottom of the market, St. Patty’s Day bear rally, return of a bull market, historically low mortgage rates, record high foreclosure rates, foreclosure relief, $1.4 trillion dollar federal deficits, 8.5% unemployment rate, at least 650,000 jobs lost each of the last three months, a strong dollar, mark to market relaxed, bank bailouts, federal debt at 80% of GDP, $ 1 trillion of IMF support for under developed countries, Madonna denied adoption rights (just slipped that one in to see if you’re paying attention).

Omigosh – talk about information overload! I watch the financial news far too much. It reminds me of a herd of cows following a feed truck with a leak in the truck bed. The cows want the feed. The truck driver is wandering through the field looking for a dry spot to park. The cows and the truck wander aimlessly through field, and it’s pouring down rain.

The financial markets are behaving much the same way. They seem to wander. Everyone is tired of the “gloom on the gray” and wants to acclaim the bloom on the rose. We have two or three weeks when bad news produces good results, and two or three weeks when bad news produces bad results. We are all looking for some sign of recovery, or some positive results from all of the money that our government is throwing at this problem. And the bad news just keeps pouring down.

Are there any blooms, or any buds on the vine? There are a few.

Mortgage rates are at incredibly low levels – in the mid 4’s. Given the outrageous financing needs that our government faces, I just do not see how they sustain these low levels. If you have not yet refinanced, hurry. If you need and can afford to buy a house, now is the time.

There are some indications that houses are beginning to sell. Realtors and mortgage companies are reporting increased activity. Prices are still below replacement cost in most areas of the country. The housing affordability index is at an all time high. New construction has been at a slow pace for almost a year. Foreclosures are still pervasive, but are showing some sign of stabilizing. As supply and demand stabilizes, home prices will go up. I believe there is little doubt that mortgage rates will go up – within the next year. If you need or want to buy or refinance your house, the bloom is on the rose.

Say what you will about the plan. It’s not perfect. But we finally have a plan. Banks are actually starting to see some operating profits. The government’s toxic asset plan and relaxation of mark to market rules will diminish the huge loan losses. Banks will soon begin to report decent quarterly operating profits – perhaps even this quarter. Once the banks sustain that profitability for a few quarters, we will see private capital start to come back into the banks. That will further the process of improving credit availability. It’s not a bloom, but there’s a bud on the vine for the banks and the availability of credit.

The notion of a world economy is disconcerting. It’s also a reality. Our country’s deficit is too large for us to be arrogant and protectionist. Let’s face it. We’re in better shape than most of them. But we badly need the rest of the world’s money to finance our bad habits and expensive mistakes. We also need to sell them our goods and services. I read where Rosetta Stone Co. will soon complete a $100 mm IPO. It’s time to brush up on your Arabic and Chinese. The recent G20 meeting signaled a new era of international cooperation for the economic good of all countries. That is a change of recent world status for our country, and a bloom on the rose.

There remains a “gloom on the gray” that bothers us all – job loss and unemployment. I think everyone would like to believe that the monthly job loss numbers have stabilized at the lowest levels we will see. But no one seems ready to say they will return to normal numbers. That’s the most positive way that one can think of such gloomy numbers. Unemployment stands at 8.5%. It is hard to imagine that it will not reach 10%.

The last issue is “the gray” itself. That is inflation and federal deficits. We are entering a gray zone in which we have never before been. Everyone likes to compare this to the great depression of the 1930’s. I don’t see it. Government and its institutions, the demographics and education of world population, the nature of industry and the point from which we are coming are all too different. Only time will tell. Our vigilance against run away inflation is the easy part. What to do is the problem. The speed and immensity of the fiscal stimulus could produce equally fast and immense inflation. If the Fed raises short term rates to fight inflation (and the yield curve flattens), they will harm the already weakened bank and financial sector. If we have to increase intermediate and long term rates to attract money to finance our federal debt, this could slow economic growth. This is the gray zone. A lot of smart and well educated guys are trying to figure this out. My guess is that we will just have to watch and be fast and graceful on our feet – something at which our government has never been good. Is it just me, or is the new group in Washington better dancers?