There comes a point at which reasonable folk take a step back, survey the latest nonsensical trend in lending, and conclude their own rational thought has been the problem all along. We don’t need a rehash of why we’re sittin’ in the economic rubble of a woefully failed economy. Allow me to sum it up in a few concise sentences.
Wall Street figured how to get in on the real estate bubble.
Lenders were very hospitable to Wall Street.
Regulators took nearly a decade long holiday.
The crazies ran the asylum with predictable consequences.
We’re now payin’ the price.
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Fast forward to the present
Real estate investors have been hit from all sides with ever tightening underwriting policies — increased down payment requirements, and the like. As far as increased credit worthiness is concerned, most of us would probably lead that charge. When it comes to lending to an investor, it’s important they are not only relatively bullet proof credit wise, but that they have sufficient skin in the game.
Having been originally licensed during Nixon’s first year in office, I’ve surely not seen everything, but I have seen what has happened — almost always live and in person. Fannie and Freddie have increased the down payments to a minimum of 20% — fine with me. Add in closing costs and an investor has $50-60,000 in a purchase of a $250,000 duplex. That’s plenty of skin — risk capital if you prefer. This ignores the likelihood that the loan wouldn’t have been made but for a decent cash on cash return as perceived by the lender.
Better credit, more skin required, enlarged cash reserves, and must cash flow. Again, works for me.
Then they began to drink their own Kool-Aid. They’ve been consistent though, as the new rules are just as clueless and, unfortunately, destructive as the old stealth underwriting used to be.
Under what system of rational thought do you limit the number of properties a well healed investor can buy? Four? Really? Ya said that out loud? Gimme a break. That’s when it became clear to many of us that the same Einsteins who brought us the great real estate bubble/crash, are now makin’ it far worse. At least they’re consistent.
Let us count the Dumb & Dumber, um, I mean Fannie/Freddie policy changes of late.
- Four property limit.
- Increased down payment, FICO score, and reserves for properties 5-10.
Those two alone plugged up the pipeline leading to recovery pretty effectively — but apparently not enough. They then turned up the heat, and right at the point when cooler heads were sorely needed. This of course conveniently ignores how those buyers of loans have, for the most part, studiously avoided buying ‘5th-10th’ loans. This has begun to change, but most lenders simply won’t or don’t wish to be in that market. Again, it defies logic.
- If an investor’s portfolio includes income properties owned less than two years, underwriters ambush them with the following newly invoked policy.
They take the year’s loan payments of each of those ‘bad’ properties and count them against the investor’s qualification. Now, reasonable people might opine that was harsh enough. Not for these guys. They then disallow the sinful property’s income. Imagine what this does to the buyer’s ‘back end ratios’. It destroys them. What’s worse? It’s completely artificial, a mirage if you will.
Still, they weren’t done.
- Freddie has now decreed that first time investors, regardless of all the aforementioned underwriting improvements, must prove they have two years of management experience. What? Huh? Freddie already defines them as ‘first time’ investors. Are we missin’ something?
Dumb and Dumber helped get us into this mess. Now they’re seemingly on a mission to ensure the road to real estate recovery is strewn with potholes, nails, and the odd couch.
Imagine all the experienced investors with more than adequate investment capital, great credit, and more than sufficient cash reserves. Add the wannabe newbies who are just as well qualified financially. Now imagine all the properties those two groups would be buying today if not for some combination of the four mindless changes above.
NOTE: #2 seems reasonable, but increasing the down payment is, IMHO, overkill. 20% plus closing costs add up to sufficient risk capital to maintain the attention of the investor. Yeah, I know, Captain Obvious lives.
Literally thousands of properties are going unsold as a direct result of these fantasy underwriting policies. Properties sporting 4-10% cash on cash, 60-80% LTV’s, massive cash reserves, and maintained by folks with enough risk capital in the game to care big time. Does that sound like a bad thing to you? To anyone with a three digit IQ?
Allow me a real life example.
An experienced investor. Makes close to $100,000 a year. FICO over 770. Real estate portfolio generates another $30-40,000/yr cash flow — all of which is tax sheltered. He was turned down for the loan. He was gonna put down 25% plus closing costs. The property would cash flow, according to the lender, not me, at a 1.25 Debt Coverage Ratio. (DCR) For Heaven’s sake, even lenders makin’ loans to self-directed IRA’s only require 1.2 DCR’s most of the time — and they’re non-recourse. But I digress.
Since a minority of his portfolio was acquired less than two years ago, their combined annual debt service was counted against him, while the income was ignored. This resulted in a back end ratio of 70%! With that number he couldn’t finance a Snickers Bar. What really galls? It’s completely artificial — made up outa whole cloth. In real life, this guy lives far below his means, has completely sheltered cash flow of roughly $3,000 monthly, not to mention almost $200,000 in cash reserves.
What’s wrong with this picture?