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HAVE CHANGES IN FINANCING CONTRIBUTED TO THE LOSS OF LOW-COST RENTAL UNITS AND RENT INCREASES?
- Monday, 10 June 2019
by Michael Reher, 2018 Meyer Fellow, Joint Center for Housing Studies of Harvard University.
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Michael Reher, 2018 Meyer Fellow, Joint Center for Housing Studies of Harvard University.[/caption]
While these changes have spurred significant academic and popular discussions about affordability, gentrification, and urban change, most of these conversations have overlooked the fact that changes in financing practices may have contributed to the rent increases and loss of low-cost units. I examine this question in a new working paper and find that much of the growth in apartment improvements, the rise in rents, and the loss of low-income units were the result of a change in bank regulations and the interplay between low-interest rates and the rules that govern underfunded public pension funds.
I start by documenting the surge in renovation activity since the Great Recession. Specifically, data from Trepp LLC (a provider of data and analytics to the global securities and investment management industries) indicates that the share of multifamily housing units that are renovated each year, which had dropped precipitously with the onset of the Great Recession, vigorously recovered from its 2008 low, surpassed its pre-Recession high by 2014, and now is higher than ever (Figure 1). I also estimate that the increase in improvements was responsible for 65 percent of the post-Recession growth in rents.
FIGURE 1
Source: Author’s calculations from data provided by Trepp LLC
Next, I turn to two changes that may have contributed to the growth in improvements by channeling financing to improvements and away from other types of residential investment. The first is High Volatility Commercial Real Estate (HVCRE) bank capital requirements introduced in 2015 in accordance with the requirements of the 2010 Dodd-Frank Wall Street Improvement and Consumer Protection Act. These regulations, which were supposed to make the financial system more stable by requiring banks to have greater reserves for riskier loans, categorized loans secured by improvements on rental properties as significantly less risky than loans for the construction of new rental units. Because this meant that banks had to keep larger capital reserves on hand for the latter loan type, this distinction introduced a wedge in the effective cost of funds for different types of loans. This, in turn, might have incentivized banks to prefer improvement projects over new construction.
To see if this was the case, I used loan-level data from Trepp LLC to compare multifamily mortgage loans made by banks (which were subject to the new rules) to those made by specialty nonbank lenders (which were not). I found that the HVCRE capital requirements increased banks’ supply of credit for improvements.
Consequently, there was a pronounced increase in improvement activity at properties located in counties where regulated banks historically had made a greater share of the real-estate related loans. In total, I found that the regulatory change accounted for 44 percent of real improvement activity over 2015-16, when such activity increased sharply. It also led to an aggregate reallocation from construction to improvement projects (Figure 2). However, the long-term effects of this particular policy shock are uncertain, since HVCRE regulations changed substantially in 2018 with the passage of the Economic Growth, Regulatory Relief, and Consumer Protection Act.
FIGURE 2
Source: Author’s calculation from data provided by Trepp LLC
My second analysis focused on a shift in the supply of financing for private equity real estate funds. These funds, which comprise half of aggregate investment in rental markets, typically take an equity stake in residential investment projects. They raise money in discrete rounds and rely on large institutional limited partners, including public pension funds, which account for about 40 percent of the investors in private equity real estate funds.
Many of these pension funds are underfunded and, as others have shown, as their underfunding gap grows, so does public pension fund managers’ propensity to make riskier investments, which will produce higher returns if they are successful. Moreover, this behavior has been especially pronounced when safe yields are low, as they have been since the onset of the Great Recession. In addition, Governmental Accounting Standards Board (GASB) rules provide an incentive for such risk-shifting, since they allow public pensions to use their expected rate of return to set required contributions and discount actuarial liabilities (instead of using a lower risk-free return, which many have argued is the appropriate benchmark for these calculations).
Applying these observations to real estate, I used data from Preqin (a provider of financial data and information on the alternative assets market) to show that more-underfunded pensions responded to declining safe yields by reallocating money away from safer private equity funds (which pursue buy-and-hold strategies that produce steadier but lower returns) to riskier funds (which make improvements and generate higher, but more volatile returns). To trace reallocation at the pension level down to real investments, I used the fact that investing relationships are sticky. Specifically, I found that, relative to other managers, real estate fund managers who were historically reliant on more-underfunded pension managers for fundraising increased their real investment in improvements over 2010-2016. In fact, I estimate that, had all public pensions been fully funded in 2008, aggregate investment in real improvements would have been 15 percent less than it actually was between 2010 and 2016.
Collectively, my findings indicate that the regulatory changes and the changes made by public pension fund managers together accounted for around one-third of real improvement activity over 2010-2016. During this period, quality improvements accounted for 65 percent of rent growth (though this number includes improvements not necessarily created by the previous two shifts). More broadly, these findings imply that finance – and seemingly unrelated changes in financial regulations and practices – can have significant impacts not only on rents and housing quality but on urban neighborhoods as well.
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Affordability Improves for the First Time Since 2016, According to First American Real House Price Index
- Tuesday, 28 May 2019
First American Financial Corp released the March 2019 First American Real House Price Index (RHPI). The RHPI measures the price changes of single-family properties throughout the U.S. adjusted for the impact of income and interest rate changes on consumer house-buying power over time at national, state and metropolitan area levels. Because the RHPI adjusts for house-buying power, it also serves as a measure of housing affordability.
“Nationally, affordability improved on a year-over-year basis for the first time since 2016.”
March 2019 Real House Price Index
- Real house prices decreased 0.9 percent between February 2019 and March 2019
- Real house prices declined 0.04 percent between March 2018 and March 2019
- Consumer house-buying power, how much one can buy based on changes in income and interest rates, increased 1.5 percent between February 2019 and March 2019 and increased 5.2 percent year over year.
- Average household income has increased 3.0 percent since March 2018 and 56 percent since January 2000.
- Real house prices are 15 percent less expensive than in January 2000.
- While unadjusted house prices are now 2.6 percent above the housing boom peak in 2006, real house-buying power-adjusted house prices remain 40 percent below their 2006 housing boom peak.
Chief Economist Analysis: Market Forces Swing Toward Improving Affordability
“What began as a modest shift toward a buyers’ market in six cities last month has expanded into a national shift in affordability,” said Mark Fleming, chief economist at First American. “The shift is a departure from the long-term trend in the Real House Price Index (RHPI), which had been steadily increasing throughout the rising mortgage rate environment that began in 2017 and continued until late 2018. Rising mortgage rates caused consumer house-buying power to decline at the same time as tight supply pushed house prices up rapidly.
“In March, two main components of the RHPI swung in favor of increased affordability – continued strong household income growth and declining mortgage rates,” said Fleming. “Nationally, affordability improved on a year-over-year basis for the first time since 2016.”
House-Buying Power Soars to 2017 Levels
“In March, nominal house price appreciation increased to 5.2 percent compared with March 2018, after an 11-month slowdown. Yet, despite nominal house price acceleration, real house prices fell,” said Fleming. “The reason? Declining mortgage rates and rising household income worked together to boost consumer house-buying power sufficiently to overcome the drag on affordability from rising nominal house prices.
“Consumer house-buying power climbed to $383,700 in March, 1.5 percent higher than last month and 5.2 percent higher than one year ago, reaching the highest level since December 2017,” said Fleming. “Mortgage rates in March fell to 4.27 percent, or 0.17 percentage points lower than one year ago. The decline in mortgage rates increased house-buying power by $7,800 since March 2018. Over the same period, household income grew by 3.0 percent, which boosted consumer house-buying power by nearly $11,000. The net effect? Overall, consumer house-buying power increased by nearly $19,000 in March compared with one year ago.”
Falling Real House Prices in More Markets
“Given the trend nationally, it’s no surprise that more markets experienced falling real house prices,” said Fleming. “In last month’s report, we identified the six cities that saw year-over-year declines in the RHPI, but this month 15 of the 44 markets we track experienced a year-over-year decline in the RHPI, and 43 out of 44 markets experienced quarterly declines. The clear trend is affordability levels are improving in more parts of the country.
“Surging consumer house-buying power is increasing demand, as can be seen in the continued increase in purchase applications. But, unless supply can keep pace with demand, we should expect nominal house price appreciation to pick up,” said Fleming. “The housing market, while different in many respects, still reacts to tight supply and rising demand the old-fashioned way – with faster price appreciation.”
March Real House Price State Highlights
- The five states with the greatest year-over-year increase in the RHPI are : Wisconsin (4.6%), New Hampshire (3.9%), Ohio(3.7%), Missouri (3%) and Alaska (3%)
- The five states with the greatest year-over-year decrease in the RHPI are: Wyoming (-6.9%), West Virginia (-4.1%), Louisiana(-4.1%), Alabama (-4%) and Oklahoma (-3.7%).
March 2019 Real House Price Local Market Highlights
- Among the Core Based Statistical Areas(CBSA's) tracked by First American, the five markets with the greatest year-over-year increase in the RHPI are: Columbus,Ohio (+5.9%), Providence R.I. (+5.5%), Salt Lake City (+5.1%), Atlanta (+3.7%) and Cincinnati (+3.6%)
- The five markets with the greatest year-over-year decrease in RHPI are: San Jose, Calif (-7.6%), Seattle (-6.4%), San Francisco (-4.4%), Portland, Ore (-3.9%) and Los Angeles (-3.1%).
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Consolidated Analytics Launches Consolidated Collateral Analysis
- Friday, 24 May 2019
Consolidated Analytics, the premier provider of mortgage services, today announced the launch of its Consolidated Collateral Analysis (CCA), a collateral risk reporting tool that assesses the integrity and accuracy of an underlying appraisal by combining a licensed review appraiser's analysis and commentary with an intelligent, rules-driven risk score, and an Automated Valuation Model (AVM).
The Consolidated Collateral Analysis tool provides whole loan investors and capital markets participants with the collateral risk insights required to better stratify portfolio risk and make improved transaction, investment, or portfolio disposition decisions. It also highlights regulatory compliance issues that may influence portfolio and loan decisions.
"Overreliance on outdated appraisal data could leave a loan buyer or seller in an unenviable position downstream, without the ability to recover losses," said Consolidated Analytics' President, Brian Gehl. "Our Consolidated Collateral Analysis solution adds another layer of scrutiny to the underlying collateral valuation so that clients can approach transaction decisions strategically, with the end-result in mind."
An alternative to ordering a full second appraisal, the tool provides mortgage buyers and sellers with an accurate, comprehensive, and yet easy-to-read analysis of a completed appraisal to determine its reliability and validity.
The key features of the CCA tool include:
Appraisal Risk Analysis - A comprehensive collateral risk analysis completed by a licensed appraiser who reviews the original appraisal report and the appraiser's methodology for accuracy, consistency and integrity.
Collateral Risk Score - A system-driven comparison with MLS and public record data validates the accuracy of the original appraisal report and identifies costly data entry errors. A final score indicates the risk level associated with the underlying appraisal.
Embedded Automated Valuation Model (AVM)- An AVM value is displayed within the report to serve as a reference point for the property value as of the effective date of the appraisal report under review.
Review Appraiser's Value- The Review Appraiser's final recommended value and supporting commentary is provided when the original appraisal value is deemed to be unsupported.
"The accuracy and credibility of an appraisal is critical in transaction decisions," said Devin Demers, VP, Operations at Consolidated Analytics. "Our aim is to instill confidence in the valuation by verifying the accuracy of the underlying appraisal, or conversely, uncovering risks and abnormalities associated with property value, property condition and surrounding market trends."
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