The inside scoop on commercial US real estate, plus the robo-signing scandal...
FOLLOWING the real estate debacle of the 1980s, Andy Miller co-founded SevoMiller, Inc. in 1990, writes David Galland of Casey Research.
The company provided workout services for major financial institutions throughout the United States, and also began buying and developing apartments, retail and office properties. From its founding to the present, the company's acquisitions totaled over 30,000 apartment units, several million square feet of retail space, and numerous office projects throughout the country, including the states of Colorado, Arizona, California, Nevada, Illinois, Texas, Louisiana, Indiana, Oklahoma, Georgia, and Florida.
Employing over 500 people, SevoMiller also built, managed, marketed, leased, and sold commercial real estate for many institutions and third-party owners across the country. Clients included General Electric Credit, SunAmerica, and Huntington Bank, as well as many defunct banks, savings and loans, and private equity groups.
In 1994, Andy and Dave Frishman co-founded Realty Funding Group, a mortgage and finance company that has acted as a mortgage broker and mortgage banker for numerous commercial real estate projects across the US RFG has provided financing for over $1 billion of commercial real estate. In 1998, Andy founded Rapid Funding, a commercial and residential hard-money lender that has loaned in excess of $200 million for land developments, shopping centers, office buildings, and construction loans on condominium buildings. In addition to sourcing and servicing real estate loans, Rapid Funding also handled its own workouts and sales.
Each of these companies founded or co-founded by Andy now operates as part of the Miller Frishman Group. Here, I speak to Andy Miller on behalf of The Casey Report, where readers seek big profits from big trends...
David Galland: Given the importance of real estate to the economy, it's not surprising that we get a lot of questions about the sector. What's the buzz in the industry?
Andy Miller: Talking about single family, as opposed to commercial real estate, the most visible news story is what happens with the "robo signing" scandal and the foreclosure moratorium.
The short answer is that we don't know the full implications yet. A lot will depend on how inclusive this becomes in terms of which lenders will also adopt this moratorium, in how many states, and for how long? All those questions have yet to be answered, but as a generic comment, I'll say this; if what happens results in a concerted effort to impede or stop or delay foreclosures throughout the country, it's going to have a very, very big impact. It's going to have an impact in some ways that are obvious, and some ways that aren't so obvious.
We believe there are roughly 8 million loans now in some stage of default or foreclosure. If those 8 million loans are impeded, if the time that it takes to foreclose is extended, or if state attorney generals won't let lenders start foreclosures, that will have serious repercussions.
Paradoxically, because it will reduce the number of foreclosures and short-sales coming to market, one of the things you may see is the home market improve slightly over the next three to five months. That may seem like a blessing to the politicians as it will certainly staunch some of the negative news headlines out there around foreclosures, but it doesn't do you any good because ultimately the price paid for the short-term abatement in the news cycle could be high.
DG: Okay, so that's a plus for the political optics of the situation, but what about the flipside?
Andy Miller: Well, for starters you have to ask what impact this will have in the mid to long term on the ability to sell mortgage-backed securities into the marketplace? If you're an investor or institution that's already loaded up on a bunch of mortgage-backed securities and your master servicers or your special servicers are saying, "We're really stuck in this mire right now where we can't foreclose or address our defaults," how much more of this paper are you going to want to buy? I don't think very much.
Now, the truth is that the Fed is buying a lot of these things, but at some point in time, it is going to need to divest itself of the trillions of Dollars of mortgage-backed securities, and who's going to want to buy those, and at what yields? I mean, if you know that with the swipe of a pen, an attorney general can impose a moratorium or somehow prohibit you from doing foreclosures, that has to have dire implications for the future of mortgage-backed securities.
DG: Then there's the moral hazard.
Andy Miller: Absolutely. If you're a hard-working person who has stayed current on your mortgage even at some hardship to yourself, and your neighbor who's been living in his home for 12 or 15 months without making payments comes over to the barbecue on Saturday afternoon and tells you, "Oh by the way, my foreclosure has been blocked. It looks like I get to live here another 12 or 18 months scot-free," does that encourage anybody else to do the same? It's very hard to know, David, but it doesn't do the market any good.
As you know, it's my contention that the only thing that's going to fix this situation is to let the free market deal with the issues so that prices can settle at their own level. All these machinations to manipulate foreclosures and/or prices and/or interest rates are only exacerbating the already bad consequences for the home market.
DG: What should concern investors in all of this?
Andy Miller: Frankly, we can't know yet. There are too many variables still unsettled. What I would advise is that everybody should be acutely aware of what's happening right now, and once we really know how much time this is going to take and what lenders are most involved, only then will we be able to interpret how bad this is going to be and what the risks are. But right now it's unknown. It just doesn't look very good.
DG: What about commercial real estate?
Andy Miller: In contrast with the residential housing market, on the commercial side everybody has the giggles. I've never seen anything like it. It's a real paradox, because there's a very active commercial market right now with all kinds of money entering the market and paying ridiculously high prices for assets, and it is almost as if the crisis never happened. In some cases, meaning some states and some product types, we are actually seeing commercial real estate prices at about what they were in '07.
DG: These are people looking to deploy their cash into tangible, productive assets?
Andy Miller: Yes. There's a lot of institutional money on the sidelines earning no yield that is increasingly being deployed. A lot of this hot money has found its way into commercial real estate. There are very few individual buyers out there that are actually laying out their own money to buy product – this is mostly institutional money, which means the buyers are using other people's money to chase product, and we see that acutely.
DG: So these institutional money managers are often given time limits during which they have to deploy the money they are entrusted with, or return it to the investors. And so the buying can become fairly indiscriminate. Do these chickens come home to roost at some point?
Andy Miller: Yes, absolutely. David, the commercial business is a mess. The fundamentals are not improving. We've talked about this before, but just to reiterate, you have to start by asking, what constitutes a recovery in commercial real estate?
Everybody is very convinced right now that we're seeing a recovery. In commercial real estate, we can be specific in defining what that actually means. Recovery means one or more of three things are happening: either your rents are going up, your expenses are going down, or your vacancies are going down. That's it.
In order for commercial real estate to be in recovery, one or more of those factors have to be present. That is a recovery. If you measure each section of the United States, if you look at all the various product types within those states, those fundamental factors are not improving, meaning there is no recovery happening. In fact, I would argue that they're eroding.
DG: What about the banks? Recently money manager Chris Whalen made the case that despite being given essentially free money by the Fed, and lots of it, the big banks are still in deep trouble over their mortgage portfolios.
Andy Miller: The banks have been very fortunate because they've managed to squirrel away a lot of money into their reserves, at least those institutions that focus on the commercial side. This is not true on residential. On the commercial side, I think they are very heavily reserved for a lot of what they see as their problems. Most of the banks that I come into contact with feel very comfortable that they have adequate reserves, so that no matter what happens to commercial real estate, they believe they're covered.
DG: I guess we'll find out in time if they are.
Andy Miller: Yes, we will. Even so, I don't think commercial is the big Achilles heel for these institutions right now because of the manipulations the federal government has undertaken. I think the real Achilles heel for all these banks, and for bond markets, is going to be the residential markets. Not to be overly dramatic, but this is a huge ticking time bomb. Things are getting worse, not better.
In fact, what we see now is that the distress is moving up the scale. The single-family home markets under $350,000 in a lot of the country are fairly sound. There is a pick-up in sales activity and lending. But when you get to the mid and the upper ends of the marketplace, there's no upward mobility. In other words, people aren't selling less expensive houses in order to trade up, which was very much going on in the housing bubble. In fact, people are having a very difficult time in the mid and upper ranges selling their homes.
For one reason: it is now very difficult to finance these homes without a large down payment. We've watched that situation closely and think that's going to really exacerbate the problems in the market.
DG: How serious do you think the problems in loan origination documents are?
Andy Miller: It's certainly problematic, and there was a lot of sloppiness when these loans were securitized and sold off. Who knows where the original documents are or what shape they are in? I can tell you, however, that if you lose an original note and you have to file a foreclosure, it's not the end of the world. You can have that addressed by a title company, but it's expensive and it's time consuming. But at this point we don't know the extent to which documents are lost, poorly executed, or don't exist.
For the time being, Bank of America has put a national moratorium on foreclosures. In order to understand how big a problem this really is, I think we have to wait and see who else follows suit, and how long this will last. If you take this to its nth degree and you assume that the worst case unfolds, it's bad. It's going to look good in the short run, but it's really bad for the market, and it's really bad for homeowners going forward.
DG: Obama's refusal to sign the bill regarding electronic notarizations strikes me as being based as much on politics as anything. After all, ahead of an election, it wouldn't do to be seen signing something considered supportive of foreclosures. So the administration has just kicked the can down the road, past the election.
Andy Miller: At this point I would judge every event and every news story that you see by just one criterion, and that is that the government is doing everything it can to slow down or impede the foreclosure process.
So whether the president signs something or doesn't sign something, or says something or doesn't say something, the intent is to do whatever it takes to impede or slow down this crisis. If there are losses to mortgage holders and investors, the politicians will try to turn this to their advantage by framing it as being that the banks and mortgage lenders deserve the losses because they're the cause of this problem. That's what you're going to see, that's what you're going to hear, and it's all intended to be a feel-good solution that makes everybody believe that our government is really looking out for us. Meanwhile, the SOBs that originated all these mortgages are going to get what they deserve.
DG: But ultimately this has to be resolved – that is unless the government is willing to give a bunch of people free houses...
Andy Miller: Years ago I said to you that what was happening in real estate was going to culminate in a big crisis, but that if it were to happen in a measured way that let the free market do what it does best, then the crisis would be less intense. But the latest developments are going to create a lot of intensity and only make things worse.
DG: What about Fannie and Freddie? At this point, they are de facto government institutions, so not letting them foreclose would seem to set up another huge loss to taxpayers.
Andy Miller: The nice thing about being the federal government is that you can throw Fannie and Freddie under the bus and suffer no real consequences, at least not in the short term. For most people, that will look good.
The important thing for your readers to remember is that these aren't solutions that do anything. These are solutions that have optics, that's all. There's an election coming up. The government wants people to feel good. They want everybody to feel like our government is really addressing these problems. They want it to seem to the public like the government cares. And that's what this is, that's what this is all about, in my opinion, and I think you're going to see some really very, very undesirable, unintended consequences.
DG: And on that note, thank you very much for your time. Very interesting, as always.
Andy Miller: Happy to help out. Let's talk again soon.
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