Draw a Line in the Sand for Residential

Mario Savoia - Fotolia

WE’RE HEARING a lot about underwriting loosening a bit in the residential mortgage world, and while it still sounds pretty tight, we think it is a good time for investors to think about where to stop when it comes to what they will buy so we don’t go too far, as some fear has already occurred in commercial.

It’s a lot easier said than done. Investment implies you want to make some money off your investment, of course, and the way things work you simply don’t make much money unless you take some risk.

But regardless of your appetite for risk there are some risks that, if you think about them, are just unpalatable. (Unless, perhaps someone pays you enough to eat them, but make sure they will if that’s the case.)

The main thing I would look for, having observed mortgage trends since the mid-1990s, are well-known but can sound complex. Suffice to say, its boils down to the extent to which risks are layered or concentrated, and what incentives the parties to the transaction have to uphold their responsibilities.

Economists are certainly not right about everything, but their stress on supply-demand pressures—which I’ll put in the “incentives to uphold responsibilities” category—are worth remembering and are why I think it is important for investors to start thinking about their residential risk tolerances now.

Clearly, as market participants like Lennar Corp. CEO Stuart Miller have been telling us, supply-demand pressures (as well as the economy) have a lot to do with why home prices have been rising. And as we remember from the last downturn, home prices have a lot to do with a mortgage investment’s value.

So watch this trend closely and consider using models that apply some discounts to account for supply-demand pressures. Also, watch closely supply-demand pressures that lie closer to home in the securitized market in terms of investments available versus investors’ demand for them.

When supply-demand becomes too imbalanced, pricing can become irrational. Investors who keep a cool head and use some common sense may find some opportunity there, but if it goes so far it becomes a house of cards there is nothing in it for anyone.

By no means is the housing finance market at that point yet. From what we hear, underwriting is still too tight and “normalizing.” But with rates rising, things could change.

Bonnie Sinnock is managing editor of National Mortgage News and editor of Origination News. She has been covering the mortgage industry since 1995.