The 2008 economic crash was the worst in American history — but market fallout from the COVID-19 lockdown may be much, much worse. We’re joined today by Dr. Michael Krein, the President of the National REO Brokers Association to learn how the coronavirus lockdown may critically destabilize the housing market in the coming months…
Michael, Welcome! Let’s start with your background: tell me about yourself and National REO Brokers Association (NRBA). This is the only national organization focused solely on foreclosures & bank-owned properties, giving you foresight & expertise on market trends.
Sure. I’ve been doing real estate for over 30 years now, so I’ve been around quite a while and done a number of different things. I’ve owned independent offices, as well as franchises like Century 21, Better Homes & Gardens, and Sell State. I’ve been a trainer, owned real estate schools, owned title companies, and owned mortgage companies.
I retired back in 2012 when I sold my real estate company and all its operations, but I’ve stayed with the NRBA as a passion project. We created the organization back in 1999, and many of us were working together informally for years before that. These are my friends for over 30 years, some of them, and we all work together as a group.
We do the training and vetting of brokers on behalf of REO clients so they know if they use one of our members, they’ll get a qualified professional who’s competent to represent them. So the NRBA is really a great group, and I do it more because I enjoy it than anything else.
Your experience in REO & real estate is exactly why I wanted to interview you. There’s a very real concern out there that the COVID-19 lockdown is going to damage the economy, and you’re one of the few foreclosure experts with the both the knowledge & media experience to speak on it.
Yeah. It’s kind of funny you said that. I’m all over the media. It wasn’t intentional, but I have become a bit of a media whore. I’m the first one to admit it. I write for Forbes, I’ve been on Fox, CNN and the BBC, and the Wall Street Journal and Bloomberg use me as their source for default and REO. So, yeah, I’ve been all over.
This week is particularly crazy — all I’m doing is answering the phone and emails. Everybody is calling, because I track the default real estate market and I’ve called the last six downturns. So, you know, people forget we had a downturn in the 80s. We had another one to late-nineties. We had another minor recession between 2000 & 2002, and then we had the crash of 2008. In most market areas, if you you go back and look historically, you’ll see that the markets really topped in December of 2006 and transitioned in ’07, and then the media really started driving the crash message in 2008.
So REO & foreclosure is really my niche, and I’ve always made more money in a down market as well — I think a lot of people do. I mean, take a look at Bill Ackman. Anybody who can turn 27 million into 2.7 billion in 30 days has my vote. Yes, there will be hard times, but there are a lot of opportunities as well.
I’ve heard that the money is flowing in any market, it just flows to different people.
Correct. That’s especially true in real estate. I don’t care if the market is going up or going down — it’s when it’s going nowhere that you struggle.
Unfortunately, I’d say that 90% of the people in the real estate industry only know how to make money in a bull-market — and when it turns on them, they blame the market instead of themselves. The reality is that you can’t change the market, but you can change yourself. You’ve got to learn to adapt.
So let’s break down today’s situation: as I understand things, the market has been getting ready for a downturn for a couple of years. Add in massive unemployment from the coronavirus lockdown, and you believe that we’re headed for a crash that may be bigger than 2008?
Yes to all of that, unfortunately. I’m speaking about the the real estate market, not the general economy. Do I think the stock market was a little overheated to begin with? Yes, but that’s not my area of expertise. I focus solely on the real estate market and primarily the short sale / REO portion of it.
With that being said, the real estate market was due for a correction, and that’s one reason that I’ve been liquidating most of my real estate portfolio over the last 18 months. Most of that was in medical buildings, which has been where I’d been spending the last few years — the single family market has been overdue for a correction for a while, for several reasons.
You hear all of politicians screaming about a housing shortage. Let’s get something straight: there was never a housing shortage — it was a shortage of affordable housing. If you go into any market and have $1 million to spend, there’s plenty of inventory to buy.
So what’s going on is that the market is trifurcated. Homes in the lower price ranges for first time buyers are very limited in supply for the simple reason that people are staying in their homes much, much longer. The average person previously stayed in their home for about seven years, but they’re now actually staying for 14 years and rising — people are staying put.
It’s important to remember that the average American owns three houses in their lifetime. You buy a starter house when you first get married, then upgrade to a bigger house to raise your kids. Then when you retire, you downgrade to something smaller.
The problem is that people aren’t trading up to mid-level homes. They’re staying put, so there’s very little inventory in the lower price ranges. There’s plenty in the mid levels, very difficult to sell mid-level. Now when we get into the higher end of the jumbo market, that’s where the biggest problems have already started — that market was actually the fastest rising area for mortgage defaults last year.
OK, what you’ve said about people staying low-end homes hurting mid-level sales makes sense — but what’s going on with high-end sales?
One of the reasons for the high-end defaults comes from something known as volatile income — and right now, about one-third of Americans have volatile income. I know this is true for me, and it’s also true for REALTORS®, car salesmen, and even doctors, lawyers, restaurant owners, and other professionals.
Basically, volatile income means that your income will vary by more than 25% year to year. Now if you’re one of those people with a volatile income, are you going to go out and buy a much more expensive house, not knowing what your income might be next year? That’s been one of the other reasons why people are tending to stay where they are. Then when you add in the SALT tax issue where property taxes aren’t deductible over $10,000 anymore, in high tax states like California, New York, Massachusetts & Illinois, people are leaving because the tax advantages aren’t there — which was already making the high-end market soft.
Now about six months ago, defaults started creeping up on new purchase money mortgages — which are people getting mortgage to buy homes, not refinancing or investors. Those started increasing quite rapidly about six months ago, and the majority of those loans were defaulting right around the six month mark. But why?
What this basically means is that the affordability index is completely out of whack. This is where you compare the average person making the average salary against the average price of a home in the market where they live, and you can use this to determine what percentage of the average people can afford the average priced home.
When the affordability index starts dropping below 17% it’s an indicator of a major problem — and in some markets it dipped down to 11%. That means that only 1 in 10 people living and working in that area could afford the average priced home there, and when you add that to the fact that people are getting shoehorned into mortgages they barely qualify for, it means you’re going to see defaults.
You have to understand 40% of Americans can’t even write a check for $1,000. They don’t have any savings. They have no cushion. They are one paycheck away from disaster. It could be job layoff, it could be illness, it could be a car accident, it could be a divorce, it could be another family member. They have to bail out of trouble, and they have been — so we were seeing a lot of these loans default.
I’m a huge fan of Mark Twain, especially his quote, “Lies, Damned Lies and Statistics”. This is especially true when it comes to housing numbers — while they may be technically correct, it doesn’t mean they’re true. For example, there’s the claim that Americans have more homeowner equity than ever before.
There’s some truth to that, but the people with all the equity today bought their homes between 2009 and 2014. Anybody who bought in the last three years usually does not because of all the costs associated with the sale — typically between eight to 12% of the sale price. If the economy goes south and you have no equity, there’s no motivation to keep paying the mortgage, which is what we’re going to get into with what’s happening today.
On top of that, too much credit has been extended, there’s more debt than ever before. One of the indicators that’s never been wrong is car loans — the last number I saw indicated that 43% of all new car loans are subprime, which are people who don’t really qualify because of their credit or income history. This is telling us that car manufacturers have run out of qualified people to sell new cars to — so they’re selling to unqualified people that really shouldn’t be taking on this debt. The same is happening again in the mortgage industry, too.
You can look at all of these indicators as being like dominoes — all lined up and waiting for one to fall, taking the rest with it. That’s what should have happened — but it didn’t. Instead, the coronavirus came long, and knocked all our dominoes over at once.
So the market was ready for downturn, and the coronavirus is the tipping point. Now the 2008 real estate crash was bad — development tracts with hundreds of home were sitting vacant because nobody could afford them, and vandals were stripping materials out of them to sell for pennies on the dollar. How will this downturn compare to that?
Yeah, 2008 was bad —they were stripping houses on me, and I was losing five or six pool heaters a week sometimes because they’re quick, easy money for thieves. Back then I was carrying around a thousand to 1,500 homes of inventory for my clients. I was the largest REO broker in the country for years, with over 3,000 REO transactions in a single year, and that’s not including my retail operations.
So how does today’s situation compare to 2008? Well, there are parallels, but also a lot of things that are really different, and its the differences that really concern me.
If you look back historically, the stock market was the lowest and unemployment was the highest around spring of 2009. This was the very bottom of the market — but even then, unemployment only hit 10.1%. In contrast, today you’ve got half of Americans staying at home, not working. How long until those jobs come back, and how many won’t come back?
Nationally, one out of 10 people’s jobs are connected to tourism and leisure in some manner. Down in Florida, they just lost the entire tourism season for the year. I live outside of Las Vegas, and the strip is closed. Nobody’s ever seen that before. Forty percent of our locals work in tourism in one form or another — how long before their jobs come back?
Remember, housing is directly tied to employment. People who don’t have jobs can’t buy houses or pay rent to the landlords who have mortgages, which creates a cascade effect. The worst it got during the crash of 2008 was 10.1% unemployment. We’re going to have twice that for quite a while — which means the housing market is going to get pounded quite hard.
What do you think the timeline is going to be on this? I’ve heard that we’ll probably see the market flooded with short sales first, followed by a massive wave of foreclosures after that. Does that sound right?
That sounds right because our financial institutions aren’t known for their speed — but let’s break this down so people understand what we’re talking about.
Let’s say you get yourself in trouble and can’t pay your mortgage, and when the bank reaches out to you, you decide to ignore them. They have no choice but to take the house, kick you out and sell the house to get their money back. That’s a foreclosure, also known as an REO, or “real estate owned” property.
In contrast, if you get yourself in trouble but you’re willing to work with the bank, you may end up doing a short sale — selling the house for less than you owe on it, because you have no equity. Most lenders prefer doing a short sale to foreclosure — it’s less expensive for them, and it doesn’t impact your credit as much either.
Typically the short sales will hit the market first. You’re going to have a lot of people that really don’t have any equity in their homes yet due to cost of sale, and when the value of the home drops, it just puts them further underwater. Why would they keep paying on it?
People used to be ashamed of a foreclosure or they think they could never get a house again. Since the 2008 crash, they’ve learned that it’s okay if you lose your house to foreclosure, you can go get an FHA loan again in two years — and sometimes sooner for a short sale. So why keep paying for a house where you owe more than it’s worth if you’ve lost or reduced your income?
On top of that, the government forbearance program has just told all the lenders to let you go 12 months without payments — so you’ve got a year of living there free, plus another year or two for the foreclosure. With a deal like that, I’d say that a lot of people are going to be walking away.
You mentioned forbearance — this puts the 12-month “pause” button on payments, but it doesn’t pause interest, right? Will interest still be accruing on these loans?
Of course it’s accruing. It’s compounding actually, because now the principal amount is increasing every month and there’s interest on top of that — and it’s going to put a lot more people upside down in their homes, which gives them less motivation to stay and pay.
This will be an issue because I think a lot of people don’t understand what forbearance actually means. It doesn’t mean the bank is forgetting about the payment — it just means we’re forgetting about the payment today. You’re still going to have to pay that money back.
So in a 12 month forbearance agreement, maybe they’ll just rewrite the loan so you pay a little bit more each month, or they’ll tack it on to the principal at the end of the loan or extend the term of the loan. They can restructure it a number of ways, but you’re going to end up paying a lot more, and a lot of people aren’t going to be motivated to stick with it, especially if they can start over with another home in a couple of years.
It’s been 12 years since the crash: is part of the underlying problem that we have a new generation of millennial homebuyers entering the housing market? What are takeaways that you might have for people who weren’t in the market the last time around?
Well, part of the problem is that our economy is based on consumerism, and the urge to buy is compounded by a social pressure start building equity, and put down roots. So you’ll hear, “why are you wasting money on rent when you could be building equity with it,” but you’re not taking into account the market trends or income risk.
In terms of millennials, there are a few issues. They are highly mobile. They transfer jobs and move around the country quite a bit — and when it comes to buying a house, unless you know you’re going to be there for five years, you probably should not be buying a house.
Another thing to keep in mind is that a lot of the millennials watched their parents and family members lose their homes in the crash. They’ve seen it firsthand. They’re afraid of it, and they should be. You know, its only just in the last year or two that we saw them starting to come out and buy — and that’s because they’re aging. They’re starting to get married, starting to have kids, and looking for a good school district and a nice park on a safe street.
It sounds like one of the takeaways for millennials is that they should probably really think twice before getting into a house. Is there any other advice to help people avoid getting into a bad financial situation?
I think the main thing, like right now I can tell you personally, I don’t like giving other people advice.
For me personally, I’m sitting on the sidelines. I didn’t like where the real estate market was going, so I’ve liquidated quite a bit in the last 18 months or so — and that was before coronavirus. I’m sitting this one out.
As for advice? You know, you don’t have to have a house tomorrow as long as you’ve got a roof over your head. I don’t know what the market is going to look like in the next few months, but I think it’s going to be worse than it is now and we’re going to see quite a bit of problems. There’s no reason to buy a house when you’re unsure of the market. You can sit on the sidelines too.
About Our Guest
Dr. Michael Krein is the President of the National REO Brokers Association. Since 1999, the NRBA has served a membership specializing in the disposition and sale of Bank-owned properties and dedicated to maintaining the highest standards of professional excellence in the industry.
Dr. Krein is also the CEO of RIO Software Solutions, the parent company and provider of the RIO Genesis software platform, which leverages Dr. Krein’s 30+ years of experience in the real estate and default servicing industry into a seamless real estate management platform. Learn more at https://www.nrba.com/ and https://riogenesis.com/