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Market Challenges/Users/adamp/Desktop/Stuff for FAR/Magazine Assets/SEPT08/images/Coverstory

Smoothing Out the Bumps for a Stronger Industry

Changes are afoot that will make our market stronger than ever.

There’s an old saying, “It takes money to make money,” that has particular relevance for Florida’s real estate professionals. When buyers have a difficult time obtaining financing, it becomes harder to complete transactions. That’s why the subprime loan problems, national credit crunch and other financial issues have had such an impact on Florida’s real estate market.

Fortunately, there are some strong signs that Florida is finally coming out of the financial storm. While conditions may persist into 2009, many real estate and mortgage experts expect a major improvement by year end. Most important, they say that changes in state and federal regulation, higher lending standards and the natural evolution of the financial markets will lay a solid foundation for long-term growth.

“Lenders are more acutely aware of the necessity to put people into loans they can afford and to remove fraud from the originating process,” says Nigel Fullick, head of Southview Mortgage, a joint venture of John R. Wood Realtors® and Element Funding in Bonita Springs. “This will have a positive effect on both the real estate industry and the long-term health of our economy.” 

Tim Allen, president of the Mortgage Bankers Association of Florida, points out that the entire state will benefit as lenders go back to the basics when underwriting mortgages. “For several years, loose credit standards allowed investors to buy properties at prices that could not be justified by market rents,” he says. Now, more buyers will be actual residents, who support Florida supermarkets, restaurants and other local businesses.

“Real estate professionals will benefit because they can help educate these real buyers about local markets, the benefits of ownership and how to pursue sources of funding,” Allen says.

Because 2008 is an election year, analysts say, it’s more likely that state and federal lawmakers and regulators will approve reform proposals. Early in the year, for example, the Federal Housing Administration (FHA) raised its loan limits, making this increasingly attractive source of financing more available to buyers in Florida markets.

 “Since housing is roughly 20 percent of our nation’s economy, our elected officials are working diligently to put programs in place that will support the housing market,” says Clark W. Toole III, president and chief operating officer of Coldwell Banker Residential Real Estate in Sarasota.

Here’s a closer look at the key financial issues affecting the Florida market and what’s likely to occur in coming months.

Subprime Loans
In the early 2000s, it was easy for mortgage applicants to get loans without showing proof of income, assets or debts. Even borrowers with low credit scores could qualify for a zero-down mortgage because rapidly rising home values appeared to limit the lender’s risk. Jumping on the opportunity to invest in real estate assets, Wall Street investment banks packaged those subprime loans as mortgage-backed securities (MBS) and resold them on the secondary markets. 

But when changing conditions in the housing market caused a significant number of subprime loans to go bad, the value of those MBS plummeted. As a result, major investment banks have had to write off billions of dollars in nonperforming subprime loans.

But many analysts believe that the subprime loan situation will begin to stabilize this summer and fall. “A lot of the write-downs have already been exposed,” Toole says, “and that’s a sign that the financial markets will start to improve.”

The U.S. Treasury Department recently released a blueprint for reforming financial institutions. “This is the most sweeping proposal for restructuring the financial regulatory environment since the Great Depression,” says Gibran Nicholas, chairman of the CMPS Institute, an organization that certifies mortgage bankers and brokers.

In general, the Federal Reserve would play a more active role in the mortgage market. For instance, the Fed has proposed that lenders be required to verify income and assets when underwriting subprime mortgages.

Regardless of the details of regulatory reform, Allen says, the result will be a higher level of professionalism throughout the lending industry. “Everyone will have a better understanding of the basics of lending,” he says, “as they go through the training courses and become more proficient in their field.”

While subprime lending has grabbed the headlines, analyst Jack McCabe, principal with McCabe Research & Consulting in Deerfield Beach, says the real home finance issue is much broader. Nationally, an estimated 1.5 million adjustable-rate mortgages (ARM) will reset to higher interest rates this year, including interest-only and other exotic loans issued during the boom years. That puts many Florida home-owners at risk of falling behind on their payments.

“When that monthly payment jumps 40 to 50 percent, your credit rating doesn’t matter,” says McCabe. “It’s not the fact the lenders gave mortgages to borrowers with poor credit—it’s the severe adjustment terms that put borrowers into foreclosure regardless of credit.”

Unfortunately for the state’s real estate market, McCabe says, the wave of ARM adjustments will continue into next year. However, new legislation recently passed aims to ease the ARM adjustments by allowing borrowers to refinance into more affordable mortgages. For more information on this landmark legislation, see “New Housing Law Expected to Boost Sales” on page 19. “I expect to see pricing pressure on almost all Florida markets through the end of 2009. Of course some of the state’s markets are in better shape than others, based on the fundamentals of supply and demand.”

Tight Credit
With U.S. banks and mortgage lenders licking their wounds, it’s hardly surprising that credit policies are relatively tight at every level. That trend toward reducing the risk of nonpayment means higher qualifying standards for borrowers applying for conventional mortgages and tougher underwriting on home values.

Based on his conversations with institutional lenders, real estate professional Craig Studnicky, president of International Sales Group in Aventura, says, “Liquidity is a big issue facing banks as they clean up their loan portfolios. We expect to see most balance sheets come back into balance in the fourth quarter [2008]. At that point, you’ll see liquidity come back big time, as the banks will no longer have to use their reserves to offset those loan write-offs.”

The federal Economic Stimulus Package recently passed by Congress and signed by President Bush may help to ease the credit crunch as well. For instance, the package increases the limit on conventional mortgages to $417,000 based on local median sale prices—a step that would make it easier for lenders to resell those mortgages on the secondary market.

But, longer term, the higher credit standards are expected to strengthen the financial and residential real estate markets. “The quality of loans in 2007 is the highest in years,” Allen says. “These mortgages are fully documented and will perform well as a group. That will help begin the process of making loan money more available.”

FHA Loans
Recognizing the need to help homebuyers, the FHA has stepped in to fill the gap left by tight credit policies and subprime lending concerns. [For more information, see “New FHA Loan Limits Open Doors,” on page 24 of the July/August issue of Florida Realtor.]

Mike Pappas, president/CEO of The Keyes Co./Realtors in Miami, believes that FHA loans may command as much as 30 to 40 percent of the South Florida market in origination of new loans this year.

“Our industry is working through the subprime financing debacle, thanks in large part to FHA loans,” Pappas says. “In addition, the Federal Reserve has done a good job by lowering interest rates, which improves the financial situation for buyers.”

In addition to FHA-backed mortgages, Fullick points out, there are other sources of loans for buyers with less than top credit scores. “Our mortgage professionals are still able to find programs at competitive rates for buyers with less than perfect credit,” he says. “However, buyers with weak credit and a small down payment should consider using FHA loans. We expect the FHA to continue revitalizing its programs and make them even more accessible.”

Mortgage Fraud
Not all the financial issues affecting the Florida market result from miscalculations by borrowers or lenders. Some involve falsified loan applications, false appraisals, illegal payoffs and other types of mortgage fraud.
According to the Mortgage Asset Research Institute, Florida led the nation in mortgage fraud rates in 2006 and 2007, increasing the state’s foreclosure rates and impacting local communities.

In Miami-Dade County alone, more than 1,500 cases of suspected fraud were reported to police from September 2007 to March 2008 after formation of the Miami-Dade County Mayor’s Mortgage Fraud Task Force.

Last year, the Florida Legislature set stiffer criminal penalties for mortgage fraud, and even stronger measures are under consideration this year, such as making mortgage fraud a second-degree felony punishable by up to 15 years in prison.

“The Legislature has really helped us,” says Nancy Hogan, managing broker of Coldwell Banker Coral Gables and a member of the Miami-Dade task force, “by making it easier for law enforcement to investigate and prosecute these crimes.”

But because of the complexity of these cases, it may be three to five years before all the fraudulent loans made in 2007 are uncovered. And Hogan expects mortgage fraud to remain an ongoing problem. “Fraud is certainly a factor in today’s slow mortgage market,” she adds.

Inflated Appraisals
Pressure on appraisers to inflate home values contributed to the national rise in foreclosures and mortgage fraud, according to industry experts. A recent study by October Research Corp. found that 90 percent of appraisers were pressured to raise property valuations to enable deals to go through, doubling similar findings from three years ago.

“They are told to doctor their appraisals or else never see work from those parties again,” says Alan Hummel, chief appraiser for Forsythe Appraisals in St. Paul, Minn., and former chairman of the Appraisal Institute’s Government Relations Committee.

Testifying on Capitol Hill last year, Hummel said, “It’s time to elevate the practices of mortgage brokers, mortgage lenders and bankers, and create a single standard for ordering appraisals. We need to aggressively enforce laws to punish bad actors.”

Restoring the independence of professional appraisers is the goal of a proposed agreement of New York State Attorney General Andrew Cuomo with Fannie Mae and Freddie Mac, the two largest sources of U.S. mortgage financing.

Under the agreement—which followed a New York State investigation of lending industry practices—Fannie Mae and Freddie Mac will buy home loans only from lenders that endorse an appraiser code of conduct with provisions for “arms-length” lender relationships.

“This is one of the greatest, most dramatic reforms of the housing industry in the last 20 years,” Cuomo said at a recent press conference. “We believe, as a group, that this will be a significant and dramatically positive reform.”

A Positive Impact
Collectively, these sweeping changes in the nation’s financial markets are expected to help Florida’s real estate industry regain its footing and return to a more normal growth path.

“One of the long-term benefits of subprime going away is that we’re far less likely to see the collapse of so many financial institutions, the loss of jobs and the foreclosures that resulted from lax credit standards and fraud,” says Fullick.

Slower market conditions and declining prices are also helping to ease the state’s affordability issue. “People who are buying now are getting some really good bargains,” Toole says. “If you’ve ever thought about owning real estate, now’s the time to do it.”

In tomorrow’s real estate market, the successful real estate professionals will understand the basics of home mortgage lending as part of a sound business practice. “[Real estate professionals] will have to know about financing, but not every detail,” says Toole. “The most important thing is to have a good business plan and practice your real estate skills. It’s an ever-changing market, and you have to keep learning in order to achieve your goals.”

Richard Westlund is a Miami-based freelance writer.