JF2220: Why Tightened Lending Standards Benefit Apartment Investors | Syndication School with Theo Hicks
In today’s Syndication School episode, Theo Hicks, shares some of the reasons why the tightening of lending standards will benefit apartment investors in the near future.
To listen to other Syndication School series about the “How To’s” of apartment syndications and to download your FREE document, visit SyndicationSchool.com. Thank you for listening and I will talk to you tomorrow.
Joe Fairless: There needed to be a resource on apartment syndication that not only talked about each aspect of the syndication process, but how to actually do each of the things, and go into it in detail… And we thought “Hey, why not make it free, too?” That’s why we launched Syndication School.
Theo Hicks will go through a particular aspect of apartment syndication on today’s episode, and get into the details of how to do that particular thing. Enjoy this episode, and for more on apartment syndication and how to do things, go to apartmentsyndication.com, or to learn more about the Apartment Syndication School, go to syndicationschool.com, so you can listen to all the previous episodes.
Theo Hicks: Hello, Best Ever listeners and welcome to another episode of The Syndication School series, a free resource focused on the how-to’s of apartment syndication. As always, I am your host, Theo Hicks.
Each week, we air a podcast episode that focuses on a specific aspect of the apartment syndication investment strategy. For a lot of these past episodes, we’ve given away some free resources; these are free PDF ‘how-to’ guides, free PowerPoint presentation templates, and free Excel calculator templates. All of these resources as well as the Syndication School episodes will help you along your apartment syndication journey.
Today, we’re going to talk about some more current events, more market updates. As you can see by the title, we’re going to talk about the tightened standards that residential lenders have. This is a very recent development, really within the past six or so months, right before the onset of the Coronavirus, and then the largest decrease in the months of April and May. But before we get into that, some context.
This time last year, real estate was really showing no signs of stopping; rents were going up, prices were going up, the stock market was going up… However, like most economic expansions going back multiple years, the economic experts either predicting an impending recession or at the very least, preparing their audience for a potential recession.
Over a year and a half ago, back in January of 2019, we wrote a blog post entitled, Why I’m Confident Multifamily will Thrive During and After the Next Economic Recession. This wasn’t something that we kind of just made up or wrote because we focus on multifamily—obviously, this is a Syndication School podcast, but it was based on some interesting metrics.
If you read that blog post, one of the main things that we focus on is the portion of renters. Every year, the percentage of renters and the percentage of owners are tracked. Historically, what happens is, once a recession happens, then the numbers start to sway more towards more renters. The renters population will start going up. Then once the recession is over, it’ll keep going up for a little bit into the next economic expansion, but then eventually, it starts going back down, and more and more people start to buy homes again, because the economy’s turned around, and the cycle kind of repeats itself.
That’s held true from my understanding, every single recession to economic expansion cycle, except for the most recent economic recession. The one that started in 2006 and it ended in 2008, that recession obviously started off with more and more people renting, but then people continue to rent more and more, even into the economic expansion.
In that article, we talked about how the decade after the recession resulted in the overall increase in the renter population of 25%. And then in 2016, a decade after the start of the recession, more US households were renting than at any point in the last 50 years. It was between a 3% to 1% increase during the 2010/2015. So kind of the back end, where the economy was booming. During this time, the Dow Jones actually tripled, unemployment was cut in half, the GDP rose by nearly $5 trillion, yet more people were renting.
So we said because of this, and then because at the time—the data isn’t super relevant anymore, but essentially looking at some surveys of renters saying what they expected to do; did they expect to move, did they expect to keep renting, did they expect to buy…? If their rent increased, would they move? Things like that.
Because of all this, we said, well, even if there was a recession, because of the increase in renter population during the most recent economic expansion and the increase in renter population during all historical recessions, and due to the fact that the reason why people decided to rent while the economy was booming aren’t going away, therefore we expect multifamily to still be strong, during and after the next recession.
The next blog post I want to point you to is another one that we wrote, and this one we wrote in June and it is called Demand for Multifamily Rentals to Increase by nearly 50% in the Next Five Years. We talked about in the Why I’m confident multifamily will thrive blog post, some of the reasons why more people were renting while the economy was booming, and it had to do with student debt, poor credit, tighter lending standards, which we’ll talk about today. People were starting families later, and their inability to afford home payments, and how these weren’t going away. Then sure enough, a year and a half later, a study comes out in June 17th that says that we project the homeownership rate to decline before partial recovering by 2025, but during this five year period from 2020 to 2025, the demand for rental housing will increase somewhere between 33% and 49%. Why? This article says because of a lot of people are starting families later, student debt, an inability to make down payments, tightened lending standards. These are the reasons why people aren’t going to be buying homes and the rental demand is going to go up. That was in June.
Then one of the things that they talked about in that article, one of the things that we talked about in Why I am confident multifamily will thrive during and after the next recession is this concept of tightened lending standards. The study talked about tightened lending standards. It has been talked about since the previous recession.
The main topic of today is going to be talking about what that means for multifamily investors… Kind of obvious what that means, right? It’s hard to get a loan for a residential home, and then by default, people are going to rent… But I want to get kind of into more specifics as to how that is measured.
There’s a very interesting monthly report that is released each month by an organization called Mortgage Bankers Association, MBA; not to be confused with getting your MBA in business. They have an index called the Mortgage Credit Availability Index, or the MCAI. That’s just one of those indexes where they take a date and say it’s 100 at this date, and then everything else is kind of compared to that date. So is it getting better or is it getting worse?
According to MBA, it’s the only standardized quantitative index that focuses solely on mortgage credit. The way the index is supposed to work is that it’s a comparison tool. So if the index of 100 was set in March 2012, and you look at it month over month, and you say, “Okay, if this index is declining, that means that the lending standards are tightening. If this index is increasing, then that means that the lending standards are loosening.” Essentially, what this means is that, the higher this number is and the more it is increasing, the more people qualify for financing. The lower it is, then the less people qualify for financing.
They started tracking this data monthly; I believe it was March of 2011. Since March 2011, all the way up until November of 2019, there’s been some months where it’s gone down, there’s been some dips, but overall, the trendline is—it is actually strictly diagonal up, at a 45-degree angle. It’s kind of gradually increasing at the same rate every year, every month during that time. It started back in December 2012 in the high 80s, so a little bit less than that benchmark. And then it’s steadily increased up into the high 180s. So lending standards got a lot looser in November of 2019 than they were in 2012 because of the recession.
Then what happened, because the news broke of the Coronavirus, it wasn’t very concentrated until March, but there were reports on it in Decembe, and so it began to slowly decline. And then most things started closing down and as everyone became aware of the Coronavirus, that is when this index started declining a lot.
There were two really large drops. I included it in this blog post, which is on our website right now, called Residential Lenders Tightening their Lending Standards; Why this is Good News for Multifamily Investors. You can take a look at these actual graphs, and you can see a massive cliff, a massive fall off starting in March 2020. It dropped by 16.1% in one month, down to 152. The next month, it declined by another 12.2%, down to 133.5, and then it had some minor drops. Then it dropped again by about 5% last month in August down to 120.9, which is the lowest it’s been since March of 2014.
Within a six month period, there was a very large, almost 50% reduction in this. It went from about about high 180s down to the 120s, so a drop of about 60 points. So close to a 50% drop; more than 33% drop, I guess.
But anyways, so the associate VP of Economic & Industry Forecasting for MBA, [unintelligible [00:14:26].24] monthly reports, they’ll have a quote from him where he’ll kind of talk about why it went up, why it went down, what this means.
The quote that I have here is very interesting. He says that, “Credit continues to tighten because of uncertainty still looming around the health of the job market, even as other data on loan applications and home sales show a sharp rebound.” And the sharp rebound – there’s an article that came out I believe today about a big jump in home sales. You can find that in Bloomberg.
Anyways, so continuing the quote, he says, “A further reduction in loan programs with low credit scores, high LTVs, and reduced documentation requirements also continue to drive the overall decline in credit availability.”
This gives you an idea of how this MCAI index works. Essentially, I’m trying to think of a good analogy, but basically, you’ve got this pyramid of loans. At the bottom, you’ve got the loans that the most people qualify for, and at the very top of the pyramid you’ve got the loans that need to have astounding credit or have a high net worth, high liquidity to qualify for these types of loans. Whereas at the bottom, you can have a low credit score, very low downpayment, you don’t really need much documentation. I think back before the crash we didn’t need any documentation whatsoever, you can just write down your income and get a loan. [unintelligible [00:15:50].17] Well, that bottom of the pyramid, those are the first types of loans to go away. Once those are eliminated, that’s when this MCAI index will start to decrease, and as those come back, it will start to increase again. So the higher it is, the more people at the bottom of the pyramid can get loans.
What he’s saying in this quote is that because of the Coronavirus, lenders are tightening their standards. What this means is that you need a higher credit score. I believe we did an article, or a Syndication School episode about, maybe it was Morgan Stanley, or one of the big banks was eliminating any residential loans to candidates that had a credit score below 650, I believe. I think it was JP Morgan, or maybe it was Morgan Stanley. It was one of those two.
Again, since we talked about in that Why I’m Confident in Multifamily article, the demand for multifamily – why is it going up? Well, because of the inability to make a down payment. Why is the MCAI index going down? Because of the high LTV loans being eliminated.
Another reason why people are renting is because of the credit scores, they can’t qualify. Well, even more people aren’t going to qualify for loans now, because they’re eliminating low credit score loans up to 650; and then reduced documentation I guess wasn’t technically addressed in any of the previous blog posts.
Overall, as I mentioned in the beginning, people are always going to need a place to live. That’s like the last thing that they’ll give up; they’ll give up a car, they’ll give up entertainment, they’ll give up everything before they give up a place to actually live. When it comes to having a place to live, you really only have two major options, at least, you can either rent a home or you can buy a home.
As indicated by these massive MCAI declines, since the end of 2019, less and less people are going to be able to qualify for residential mortgages. The programs available to people with low credit, who can’t afford a high downpayment for a lower LTV loan, those aren’t available anymore. If those people who would have qualified for those loans don’t qualify for them anymore, their only other option, since they can’t buy a house, is to rent. So by default, more people are going to be renting. That’s kind of the main crux of this post of this podcast, is to take a look at these different metrics and see is this good for buyers or is this good for renters? If it is good for buyers, and obviously, people who fix and flip homes, they’re going to benefit from those types of economies. It is better for renters, and people who do buy and hold are going to benefit, and people do apartments are going to benefit.
Now the last thing I did want to mention before I sign off, I just thought this was kind of an interesting tidbit that was added on to these reports. I was trying to think — I see that there’s a big drop, but this data only goes back until 2011. Like, what happened with this MCAI index? What happened with lending standards after the 2007 through 2009 recession?
At the very end of these MCAI reports, they have a graph where they say, “We expanded the data back by about a decade. We had it go back all the way to 2004 up to 2011” – it’s this kind of this old approach, where they were able to pull this MCAI data that was generated annually. And then they kind of like interpolated it back to be monthly. It was not super accurate. Whereas after March of 2011, they were able to pull these reports monthly and the data is going to be a lot more accurate.
When you look at this graph, you see that, well, before the crash, this MCAI index was almost in the 900s. And so I’m going to go back to June of 2004 – it is about 400; and then it shoots up to about 900 in mid-2006. And then from the end of 2006 to mid-2008 is when it drops down back to 100. When you compare the more recent drop in the MSCAI index, over the past 10 years, it’s a pretty big drop. But if you open it up to 20 years, then it’s not that big of a drop.
When I read that, it makes me think that, “Okay, well, the decline in the MCAI index, the reaction was not as severe because apparently, the [unintelligible [00:20:16].26] were a lot more loose before the 2008 recession compared to now. Hopefully, that indicates that this recession or this setback, or this slowdown, depending who you talk to, is not going to be or is not as severe as 2008.
Again, it’d be good to check out the blog post that we have, Residential Lenders Tightening their Lending Standards; Why this is Good News for Multifamily Investors, just to see those graphs, or you can also go to the website that has the monthly reports. It is called https://www.mba.org/ and then it’s the Mortgage Credit Availability Index, underneath their news, research, and resources page and kind of click-through a few things and you’ll be able to find it.
That concludes this episode of Mortgage News for Multifamily Investors. Make sure you check out some of the other Syndication School episodes we have about the how-to’s of apartment syndication, check out those free documents as well.
Thank you for tuning in. Have a best ever day and we’ll talk to you tomorrow.
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