America's Housing Problem

This is not a political post. This is a housing post.

In about 60 days, Americans will peacefully (we hope) decide upon one of two new inhabitants for the office with no right angles. You’ve seen this before. But this time around, a growing centerpiece of policy changes includes housing, which is simultaneously refreshing and disconcerting.

As the rest of the country waits, debates and predicts an economic recession, the United States housing market has been languishing in a historic one for more than 2 years. Both candidates have plans to resurrect this market which, by the way, is the largest asset class in the entire world.

Both plans reference help for home builders, with one candidate calling for 3 million new homes to be built while another seeks to release federal land for development while cutting the cost (regulation) to build a home. There are few specifics, particularly around how we’re going to force builders to build. Even if we could do that, it’s akin to swallowing an aspirin next year for a headache you have now. Analogy for the win.

But both plans also offer aid/assistance for first-time homebuyers. These come in the form of grants (free money) or tax incentives but would surely need to be realized at the closing table to have any desired impact.

Wherever you land politically, the problem with housing is there’s no easily digestible solution. There’s no soundbite that can compete with free money for first-time homebuyers. It just rolls off the tongue. But free money is a pandora’s box we’ve cracked open before. It creates as many, if not more, problems as it solves. Just ask Jerome Powell.

Demand is not our issue, folks. As an owner of a mortgage company and a 20-year housing veteran, I can tell you there’s no shortage of people who want to buy just as there is no shortage of builders who want to build. But transactions are still hovering at industry lows and building permits/starts are anemic. Why?

Super simple: Affordability.

Offering free money to first-time homebuyers doesn’t slay the affordability dragon and it could anger it. Free money, at its most optimistic conclusion, defeats down payment. Grab your HP-12c and play along. For every $1,000 down payment on a $350,000 home, you’ll reduce monthly payment by about $6. That free $25K the Dems are offering up will only drop a similar mortgage payment by $150. If you’re into calculating break-evens, it's 167 months. In short, that won’t do it. The exact same result could be achieved for all homebuyers (not just first-timers) with a mortgage rate reduction of 0.625%. While positively impacting everyone, mortgage rate reductions also don’t drive up deficits. It’s estimated that the gratis $25K will pump the deficit north by over $1 trillion. There’s nothing free about free money.

Before you walk away thinking that I’m bashing the Democrats, consider the Republican plan calls for “tax incentives and support for first-time homebuyers.” That’s it. Milk jugs aren’t this opaque. The first 3 hits from Googling “Republican plan for housing” are references to the Democrat plan. It seems like not having a plan is the Republican plan.

So, if not free money, what then? Glad you asked.

The National Institute of Mark Milam, headquartered in midtown Atlanta with a satellite office at Kevin Rathbun’s Steak, has proposed the following three items, none of which can be reduced to a soundbite and none of which are intuitive and none of which are sexy.

But hat in hand, bourbon in the other, and smile on face, let’s press on and resurrect housing in America.

1. Temporary Reduction of Capital Gains Tax for sale of investment properties under $750,000.

a.      Some stats:

As recently as 2023, it is estimated that investors accounted for 27% of all single-family home purchases.

Contrary to popular opinion, the majority of rental properties are not owned by hedge funds, but rather small and medium-sized landlords or “mom-and-pop” investors. According to Chase, 41% of the 50+ million residential rental units belong to this type of investor. That’s somewhere near 20 million properties. That’s a lot of front doors.

Overall, the market share of investors has ballooned to 30%.

b.      What if, for a window of time, the United States reduced the capital gains tax on the sale of investment properties by half? If you would normally pay 20% based upon your tax bracket, you’ll pay 10% instead. If you would normally pay 15%, you’ll pay 7.5%. This could be a huge win-win-win (country, seller, buyer). The country will realize tax revenue they might not otherwise receive at a time of desperate need. Currently, our tax revenue only covers 75% of our spending. The seller saves a huge chunk on this highly appreciated asset. And, increased inventory at lower price points promotes a balanced market with price stability for the buyer.

c.     We could even go so far as to allow for a further reduction of up to two-thirds of the capital gains tax liability if the condition of the sold investment property is C3 or better, as determined by an appraiser. Well-conditioned inventory hitting the market will serve a greater immediate need.

d.      This would be a temporary solution, perhaps from Q4 2024 to Q4 2025. 

2. The Implementation of Yield Management.

a.      Don’t fall asleep on me.

b.     Currently, there is very little “yield” on mortgage rates. Yield allows lenders to absorb pricing penalties, offer lower closing costs and generally provide more favorable terms to a client.

c.      The reason yield has left the building faster than Matt Lauer left The Today Show is because investors are worried about pre-payment speeds. Everyone who is buying a home now is just waiting to refi. The United States prime mortgage offerings have no prepayment penalty to the consumer. You can pay the loan off the day after closing with no impact – to you. But the impact for the issuer of that mortgage is huge. Lenders make money over the long haul via interest. Duh. A loan that pays off early doesn’t provide any interest and everyone on the lending side loses. Guess what? Lenders aren’t in business to lose.

d.     When lenders perceive an increased risk of early payoffs, they take yield off the table, pushing a borrower to have more “skin in the game” and mitigate prepayment speeds. This punishes all borrowers, not just the ones who plan to pay their mortgage in full within the first year.  

e.      For this reason, we should institute what I’ll call “Yield Management” and inform the consumer that, should their mortgage pay off within the first 12 months after closing, their payoff will be increased by the amount of yield needed to make the original investor whole.

f.        From there, investors could relax, assured of avoiding such losses. Yield purse strings will loosen, allowing lenders to offer more competitive terms. Lenders don’t get kicked in the teeth with early payoffs and every single borrower realizes improvements to terms. This, again, improves affordability. There’s that word again.

3. Simplify Loan Level Price Adjustments

a.     See, I told you these will never work as soundbites.

b.     What the hell is a loan level price adjustment? The regulator of Fannie Mae/Freddie Mac is an entity called the Federal Housing Finance Agency. It’s this entity that establishes, among other things, a chart of loan level price adjustments based upon the “risk” of a given loan. Some call it risk-based pricing, as if all pricing isn’t risk based.

c.      In the 20 years I’ve been lending, these price adjustments have expanded, worsened, expanded more, and worsened more. They are cash cows for Fannie Mae and Freddie Mac. Don’t believe me?

d.     In Q2 of 2024, Fannie Mae reported net income of $4.5 billion. Don’t miss that. Net income, not gross. And it’s billion, with a “b.” And it’s for the quarter. For an industry in recession.

e.      Compare that number to prior quarters and years and it looks pretty much in line.

Q2 YTD 2024: $8.8 billion (on pace for more than $17B)

2023: $17.4 billion

2022: $12.9 billion

f.        What’s the big deal? The big deal is the volume. Here are the volume figures that underpin those profitability figures. This is funded mortgage volume for single and multi-family homes:

2024 YTD: $168 billion

2023: $369 billion

2022: $684 billion

g.      More money, less volume. I want that job.

h.      And this is just Fannie Mae. Freddie Mac has its own numbers reflective of the same mathematical wizardry. I’ll ask this question: How do you make more money on less volume? It’s called margin and it’s not a substitute for butter.

i.        We need a radical overhaul and simplification of the loan level pricing adjustments (LLPA) imposed upon borrowers. Here’s an example:       

A borrower putting down 20% with a credit score of 740 would currently have an LLPA of 0.875. Is a 740 credit score with 20% equity risky? Nope, but it’s priced as such.  

If that LLPA were removed, our borrower’s interest rate today shifts from 6.875% to 5.990%, lowering the monthly payment on a $400,000 loan by $232 per month or $2,785 per year.

j.        Instant help for affordability. Lower rates. More transactions. More velocity of money. Which creates more tax revenue. Which helps our government and reduces our deficit. Which, in turn, lowers our interest rates further. Is Rathbun's open yet?

k.      A few less rubles for Fannie Mae, maybe. No doubt, they’ll make it up on volume.

Welp, there you go, folks. My three items to resurrect housing in America. Soundbite free, low in saturated fat and good for your heart. Cheers.