Surfacing issues

As the real estate universe settles into the new normal reality of higher interest rates and a softening economy, and some of the longer range societal changes brought about from the pandemic take hold — remote work, migration from cities to more open spaces — there are interesting issues arising out of all this turbulence.

Rising interest rates are not only affecting the buyer side of the market. Some homeowners are finding themselves underwater as they seek loan modifications to deal with delinquent mortgages. In the Federal Reserve mission to bring down the inflation rate by keeping interest rates high, one of the target metrics the Fed monitors is the employment rate.

Higher unemployment signals a weakening economy, which theoretically reduces upward pressure on prices. Classical macroeconomic gurus like John Maynard Keynes, Milton Friedman, and Paul Samuelson had these various theories of fine-tuning employment, but if you ask me, any government policies that actually cost people their job are wrong-headed. Besides, those guys are all dead now, and today’s economy is more complex than they ever dreamed of. Meanwhile, following the Old School Theories, as the Fed commits to reducing the inflation rate with its higher interest rate program, and the economy begins to slow down, the net effect is putting many homeowners in financial difficulty.

For homeowners who have lost their jobs, and are behind on their mortgage payment, there are a wide variety of federal loan modification programs. The problem is that these programs essentially require the homeowner to surrender a lower existing mortgage rate. The net effect of the modification would actually increase the current monthly payment, given that rates are fully double what they were a year ago. The Federal Housing Administration has recognized this dilemma, and recently proposed a new structure for borrowers who are behind on their payments. The FHA would pay part of the monthly payment and tack the amount on to the back of the mortgage as a second mortgage. For a period up to five years the monthly principal and interest payment could be reduced by 25%, with the homeowner paying off the balance at the end of the loan term. If housing prices continue to climb, the additional equity could meet this second loan payout. As I write this article in early June, the FHA proposal is not yet approved, but I expect it to be in effect in 30 days. For further information contact either myself or your mortgage lender.

One other phenomenon the current market environment has created is so-called “zombie mortgages” which are dormant second mortgages (payments for which have not been kept current) that are now attractive investments due to rising home prices. These loans were made as long as 10 or 15 years ago, and many lenders wrote them off as unpayable and sold them to investors for pennies on the dollar. The lender stopped sending monthly statements and the homeowner wasn’t aware these were still legal charges against the property. As increasing home prices generated more equity in the property, these second charges suddenly rose from the grave and now have real value.

The only way for these investors to cash in on the increased value/accumulated equity is by way of foreclosure, and yes, that’s just as bad as it sounds. The property is sold off, the first mortgage is retired, and then the second mortgage is paid out. If there are any proceeds left, the homeowner gets that. So just when you thought you had built up a little cushion, a nest egg of equity in your home, along come these vulture-investors. Yes, the second mortgage was a contractual obligation and yes we live under the rule of law, but still. Some of the aggressive tactics of these debt collectors have drawn attention from the Consumer Financial Protection Bureau, and the agency is currently drafting guidelines to protect homeowners.

The residential real estate market is not the only sector undergoing pressurized change. Over the next three years, about $1.5 trillion in commercial mortgages is coming due. One trillion is one thousand billions: $1,000,000,000,000. This issue has both the borrowers and lenders of these vast sums really nervous. It used to be that one of the preferred asset classes for institutional investors and pension funds was office complexes located in the downtown core area of major US cities. The pandemic and work-from-home movement has altered the dynamic however, and while it is too early in the cycle of change to tell if the change is permanent, many of these towers are sitting empty right now.

Rents pay the mortgage: as net rent revenue has declined precipitously and interest rates doubled, the value of these office towers has plummeted. Many regional banks have a significant exposure to these empty towers, putting further stress on their already precarious balance sheets. Given the interconnectedness of everything in the financial system, there will be ripple effects as these loans come up for renewal.

The above three issues are some of the thornier challenges that have surfaced recently, but there are also positive effects from the churn the market is going through. I think of a river in the spring flood stage. It is an annual and necessary event that changes the river channel sometimes, and wipes out gravel bars and favorite fishing pools, but it invigorates the entire ecosystem. Right now we are going through the initial raging flood stage, but I see smoother water ahead, and my next column will highlight three positive market effects.

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Raphael Barta is an associate broker with a practice in residential, vacant land and commercial/investment properties. raphaelb@sandpoint.com