When the Foreclosure Era began in 2006, Sean O’Toole had spent five years buying and selling California foreclosures. He had a ton of foreclosure data so he shelved plans to start a general property listing site and launched one in 2007 devoted entirely to foreclosures, providing data from public sources exclusively, ForeclosureRadar, which became popular with investors in California.
I wanted to speak with Sean today and get his opinion, from his unique position, on the current state of the US Housing Market.
You had a driver’s seat in the whole Foreclosure Era, maybe more so than anyone in the whole country. Looking back on what foreclosure did to housing in America, what’s the takeaway? How did those six years of distress sales changing housing in America? What are the good things and the bad things?
I think the most surprising thing to me is that anyone would think foreclosures caused anything in housing. Foreclosures did no damage to our markets. What did damage was excess credit, excess lending. Foreclosures were just the result. People keep looking at foreclosures as the disease. They are just the symptoms.
We’re making the same mistakes now that caused the so-called foreclosure crisis. We’re putting people into loan modifications that are far worse that the worst of the worst pay option ARMs, yet we seem to think they are a solution.
The other thing that drove prices up to a point of being unsustainable was pay option credit, and look at what we are doing to interest rates. We are driving interest rates lower and lower and lower, creating artificially higher prices, but is a 3 ¾ percent on a thirty year mortgage really sustainable long term? Should government be subsidizing those loans?
In some ways, we are in a less healthy position now than we were in 2007. The bigger surprise to me is that nobody learned anything from that, and instead, we are taking away lessons that are worthless. For example, people point to the fact that we made “pulse” loans in 2007, meaning anyone with a pulse got a loan. That was absolutely the worse time to give anyone a loan, not just somebody who had a pulse. We were lending at unsustainable high prices. Yet, at the bottom of the market, when prices were so low you could have done 100 percent financing to somebody with bad credit and never lost a dime, it was very, very hard to get a loan. The problem with making pulse loans in 2007 wasn’t that people couldn’t qualify, it was that the price was too high.
But that’s not the lesson we took away. The lesson we took away is that we had to drop prices because we made loans to people who couldn’t qualify. We had to drop prices because they were too high to be sustained by the incomes of the buyers.
When you talk to people about their expectations, they end up saying they need to get back to where they were in 2005.
Where they were in 2005 was really, really unhealthy for our economy. When you put that much on a house, our incomes nationally need to double to be back to those price points with a healthy economy. That said, we’re trying to get back at those price points with unsubsidized lending, unrealistic loan modifications and other band-aids that fail to see the real problem, which is that those prices just aren’t affordable by the income we have.
Small investors have mushroomed and they are still growing in numbers today. Do you see them surviving? Will investor small or large continue to account for 20 percent of home sales?
Why investors came into their own in California and other markets when they did is because real estate was actually a good investment. What I think the National Association of Realtors and others have missed is that lower prices actually make real estate a better investment, not the other way around. If they don’t understand real estate investors, they are making a fundamental error because we are never going to have more than two thirds of the country as homeowners, not on a long term sustainable basis. It just doesn’t make sense. It doesn’t make sense to own a home for two or three years. It’s a poor investment decision. You may get lucky through artificial appreciation in a two to three year period, but anyone who is planning to move or has a short-term job, they should be renting.
So do you think that the numbers of small investors will return to the level of 2007 or 2008?
What we’re seeing right now is a rise in price. In California, we are certainly pushing the bounds of what is possible, and maybe a little beyond that. Buyers do what buyers have always done, which is buy as much house as their banker tells them. They did that in 2007 and they do that today, and that’s what prices reflect.
The other thing that prices reflect when the bankers aren’t out of control as they are now and they were in 2007 is they reflect the return on investment. Hedge funds came into all these markets across the US in a big way because they realized return on investment was too high. Sacramento, Riverside you could buy houses with 10 percent return on investment all day long. So they came in and pushed prices up dramatically very quickly because they realized they should back up the truck until return on investment was below seven, in which case they should stop.
So coming back to your question about investors as a share of the market, as prices go up, return on investment goes down. This year I expect to see prices go up and return go down. Return on investment and affordability are closely linked. It really comes down to income, affordability and what a person can pay for rent.
People got confused that investment is appreciation. That that’s where you get your return on investment. The real source of return on investment is return on rents.