Monday, May 29, 2006
Equity Of Redemption
Understanding the reasons why banks view real estate foreclosures as recourses of last resort.
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A mortgage is an interest in land created by a contract, not a loan. More specifically, a mortgage is a type of security for a debt. Although almost all mortgage agreements contain a promise to repay a debt, a mortgage is not a debt by and in itself. More importantly, a mortgage is a transfer of a legal or equitable interest in land, on the condition sine qua non that the interest will be returned when the terms of the mortgage contract are performed. This right of the borrower to repay the lender once the terms of the mortgage contract are fully satisfied is known, at law, as equity of redemption.
Mortgage Law originated in the English feudal system in approximately the 12th century A.D. In the early part of the English feudal period, the legal effect of a mortgage was to convey to the lender both the title of an interest in land and the actual possession of the land. This conveyance was absolute, subject only to the lender’s promise to re-convey the property to the borrower, if the specified sum of the underlying debt was repaid by the date set out in the mortgage contract. If the borrower failed to comply with the terms, the interest in land became the lender’s, and the borrower had no further claim or recourse to the property.
Because the law at that time did not recognize an agreement as security for a debt, the land and possession of it had to be transferred to the lender, so as to provide him with security. There were two types of mortgages: a vivum vadium (Latin for ‘live pledge’), in which the income from the land was used by the lender to repay the debt, and a mortuum vadium (Latin for ‘dead pledge’), where the lender kept the income and the debtor had to raise funds elsewhere. The ‘live pledge’ was acceptable at law, but the ‘dead pledge’ offended the prevailing laws against usury, as well as Canonic laws.
So much, therefore, for the more or less partisan misinformation of consumer advocates, who believe that governments created mortgages to enrich themselves at the expenses of the poor.
Mortgages were treated differently at common law than by the courts of equity. Common law took the view that mortgages, like any other contract, had to be performed exactly according to their terms. This meant, that if the borrower was even one day late in making a payment, the interest in land was forfeited to the lender and yet the borrower was still liable for the debt.
The courts of equity, on the other hand, altered both the relationship of the parties to the mortgage contract as well as the remedies available in case of default. These courts recognized that the mortgage was only security for a loan and, therefore, they limited the lender’s right only to the interest on the loan, and further required him to make a full accounting of all income from the land while he was in possession.
Because of this equitable interpretation of the courts, the lender no longer received an actual advantage from possession of the land. Possession, in other words, was of value only if the borrower did not honor the contract. With this legal development, furthermore, the borrower was vested with the right, in essence, to possession of the land and to full use of its income to pay interest and to raise principal for debt repayment.
Finally, the courts of equity also changed the rights of a borrower who did not repay on time, through the development of what nowadays is referred to as The Doctrine Of The Equity Of Redemption. This doctrine allows the borrower the right to repay the debt and regain the property even after the contractual date for repayment has lapsed.
Because of this, furthermore, the Courts want to be fully satisfied that the lender, in fact, has offered all possible remedies and venues of redemption to the borrower prior to granting an Order Absolute Of Foreclosure. As this involves considerable legal expenses on the part of the lender, cost of man/hour, interest accrued that may not be recoverable in its entirety as well as cost of opportunity, lenders view foreclosure as the recourse of very last resort available to them.
Luigi Frascati
Real Estate Chronicle
Friday, May 26, 2006
And Ben Bernanke Says [...]
The Chairman is not particularly worried about real estate bubbles.
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On May 19, 2006 Ben Bernanke, Chairman of the Federal Reserve System, has touched on the housing situation in the United States in his Report on Monetary Policy. In essence, the forecast of Prof. Bernanke is that there is not going to be the dreaded bubble burst predicted by so many ‘bubbleologists’ out there (who have been predicting Apocalypse Now consistently since early 2002), but that real estate appreciation is poised to slow down considerably from recent years. The second point made by the Chairman is that the slow down in real property appreciation comes as a respite for the whole economy, as the surge in housing prices has been one of the major inflationary forces in recent times.
According to the Chairman, the U.S. economy will continue to perform well for the remainder of 2006 and in 2007. To be sure, higher energy prices will probably put some restraint on economic activity for a while longer. But so long as cost of energy increases slowly, as it is suggested by futures prices, this restraint should diminish as 2006 progresses. In addition, economic activity has continued to receive some impetus from post-hurricane recovery efforts, and the reopening of facilities shut down by the hurricanes is already being reflected in the rebound in industrial production. Federal assistance will continue to buttress rebuilding activity in coming quarters.
More broadly, the major factors that contributed to the favorable performance of the U.S. economy in 2005 will remain in place. Long-term interest rates are expected to remain at acceptable (low) levels, and conditions in corporate credit markets are generally positive. The household sector is also in good financial shape overall and should stay so even if - as expected - housing markets cool down. In addition, the improved outlook for economic growth abroad bodes well for U.S. exports. However, the effects of the cumulative tightening in monetary policy should keep the growth in aggregate output close to that of its longer-run potential.
Core inflation is likely to remain under some upward pressure in the near term from rising costs, as the pass-through of higher energy prices runs its course. But those cost pressures should wane as the year progresses, offset by the slow-down presently occurring in real estate. Moreover, strength in labor productivity should continue to dampen business costs more generally. With little evidence to date that resource utilization has put appreciable upward pressure on prices, and with longer-run inflation expectations continuing to be well anchored, core inflation will remain contained in 2006 and should stay the same in 2007.
Prof. Bernanke, furthermore, commented that nonetheless, some risks attend his economic outlook, with some of the uncertainty centered on the prospects for the housing sector. He cited some observers who believe that home values have moved above levels that can be supported by fundamentals, and that some realignment is warranted. Such realignment - if abrupt - could materially sap household wealth and confidence and, in turn, depress consumer spending. But that does not seem to be the case. Citing, in fact, an upward trend in consumer spending, the Chairman commented that it was aided by a corresponding upward trend in disposable income.
Focusing specifically on real estate, The Chairman observed that if home values were to continue to register outsized increases, the accompanying increment to household wealth would stimulate aggregate demand and raise resource utilization further. With the economy already operating in the neighborhood of its productive potential, this higher resource utilization would risk adding to inflation pressures. Because of this, therefore, the Chairman welcomed the respite in real estate for the benefit of the economy as a whole, taking care to stress the fact that far from being a bubble burst, slow-down in real property appreciation is more of a ‘soft-landing’. Finally, the Chairman has predicted that real estate will continue ‘to do fairly well’ for the remainder of the year.
Another major source of uncertainty, in Prof. Bernanke’s view, is the price of energy, which continues to be buffeted by concerns about future supply disruptions, especially in light of the forthcoming hurricane season Additional steep increases in the price of energy have the potential to intensify cost pressures and weigh on economic activity.
Anyone out there who cares to enlighten us some more with his bubble-bursting theories?
Luigi Frascati
Real Estate Chronicle
Monday, May 22, 2006
Selling In A Cooling Market
Wednesday, May 17, 2006
Title Indefeasibility
Friday, May 12, 2006
Fractional Ownership And The Partition of Title
The pro’s and con’s of deeded title partitioning in real estate.
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Second homes are possibly the ultimate ‘status goods’ – something that many people would like to have but no one really needs. Purchasing a second home, whether a place at the beach, the lake or in the mountains is a fascinating trend in real estate, but often times those who finally own one are quick to express frustration at not being able to spend more time there. It hardly makes sense to have the expense of a mortgage, upkeep, insurance and taxes for a place you don't use more than a couple of weeks a year.
Fractional ownership, therefore, was developed to obviate to the superfluous costs associated with ownership of vacation properties. Modeled upon time-shares, fractional ownership takes the practice one step further by fractionalizing the deeded titles of real property assets. As in time-shares, certain privileges are granted to the individual owners, such as a number of days or weeks allotted for using the asset, and may also offer a proportionate share of income as well.
The main difference between fractional ownership and time-shares is the manner in which title is held. Whereas time-shares give the right to use of the real capital asset in accordance with the contract, but at some point the contract ends and all rights revert to the property owner, fractional ownership offers deeded titles and is, therefore, real property. The other big differences between time-shares and fractional ownership holdings are prices, financing and fees. While time-shares can be purchased for a few thousand dollars, fractional ownerships can run $100,000 or more - much more.
Lenders are general restive when it comes to lending on fractional ownerships. This is due not only to the partition of a single title into many deeded ‘mini-titles’, but also because of the difficulty in assessing a market value on the individual fractions. Market value in fractional ownership, in fact, is in direct function of all the strings that attach to them, such as usage time.
For instance, four investors may each own one equal fractional title in a chalet in Whistler, British Columbia, a typical Winter resort. The total aggregate market value of the chalet is $1 million, so that each investor should theoretically own a real property asset valued at $250,000. Unfortunately, because of the seasonal nature of the resort, the value of the fractional ownerships of the two investors that can use the chalet over the Winter months will likely be higher than those of the other two investors. This is so, because demand for chalets in Whistler is higher during Winter, so that values escalate accordingly.
As a direct and proximate result of a limited pool of financing, the market for fractional ownerships is limited as well, since the pool of prospective purchasers dwindles in tandem. And because of this, if the borrower defaults it could be difficult for the lender to sell the property. Additionally, maintenance fees running in the thousands of dollars per year tend to complicate matters further.
Under the circumstances, then, who buys into fractional ownership? Typically, they are people who could afford a vacation home, but don't have the time to use it fully. Furthermore, the more expensive the property, the more fractional ownership makes sense. It is not a type of investment one would get himself into to make a killing in real estate. The fractions usually are sold at a premium, so unless the property values in a market just go through the roof, gains will be modest. But the vast majority of fractional ownership buyers are not real estate investors - they are, more often than not, typical status good seekers looking for a getaway.
Luigi Frascati
Real Estate Chronicle
Friday, May 05, 2006
Buying In A Cooling Market
A few professional observations that market participants may want to consider when operating in a slower real estate market.
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Depending on where you are, the real estate market may not have cooled off at all. The general trend in North America, however, is for markets to slow down from the frantic pace of these past few years to more normal levels – which fact one would hardly define as a problem. Quite away from being caused by the bursting of the mythological ‘real estate bubble’ that doomsayers have been so fond of prospecting to the general public, slower demand for real estate products, particularly residential, has to do with the monetary policies of the Central Banks. By reducing the money stock, the cost to the banks for using the available capital is raised and passed on to consumers with a mark-up factor. This, in turn, discourages consumer spending on goods and services and, conversely, stimulates consumer saving. As interest rates slowly ooze upwards, demand lowers and markets cool off.
The effects are widespread and reverberate throughout the economic basket of goods and services including, of course, real estate. But unlike a real estate bubble, which occurs when speculation causes prices to increase so much and so fast, that the bubble ultimately bursts when prices of goods are so absurdly high that consumers either refuse or cannot afford to purchase, thus sending demand tumbling down, a cooling-off trend through higher interest rates has the beneficial effect of consolidating market wealth achieved thus far. This is so, specifically because a slowdown in capital appreciation allows real wages to catch up and it does, therefore, regenerate the pool of buyers. Higher interest rates, moreover, promote domestic saving and attract foreign capitals thus reinforcing both the intrinsic and nominal value of the currency, another beneficial factor in finance albeit not in trade.
Because of this, the National Association of Realtors (NAR) estimates that in 2006, overall new and existing home sales will decline by an average six percent, meaning that about 400,000 fewer people will purchase homes compared with 2005. And yet, home prices will continue to increase, albeit at a milder pace than in previous years, with a real capital appreciation ranging from 5 percent to 10 percent, depending on the location.
A slower market has unquestionably beneficial effects for savvy homebuyers, since missing is the sense of urgency so characteristic of these past few years. This means that Buyers can now take a longer time to look and select the product they want – both the real estate product and the financing that goes with it. In fact, it is important for consumers to realize that profitability in real estate comes not only from a lower purchase price, but also from the overall savings received with lower interests paid to institutional lenders. In the highly competitive lending industry, as interest rates increase lenders typically begin to offer over-the-counter products to lure borrowers and mortgagors. This combination of lower price and lesser cost is what maximizes the return on investment in real estate.
Buyers should also come to terms with the realization that in a cooler market, just like in any other market, the so called low-ball offers will get them nowhere, more often than not. This is so, because the vast majority of Sellers invariably have the alternative of not selling at all for overly discounted prices. Real Estate Boards across Canada and the United States report that inventory levels are ‘seasonally normal’ – an indication that the anticipated glut of housing due to the inability of homeowners to meet mortgage payments has failed to materialize, thus far. And, furthermore, the vast majority of mortgagors with adjustable-rate mortgages have locked already into fixed-rate products, which are not at all influenced by the present upward trend in interest rates. Which means, therefore, that it is not true that Sellers who choose to sell now must do so because the only alternative they have is to face foreclosure.
Of course, this is not to say that ‘super deals’ cannot be found: they certainly can be, now as in any other time. But it is not going to be this slower market that will make super deals more common or more accessible. The best strategy for Buyers is to ask their agents to run a check on homes in the area they have selected, that have recently sold and on those that are still up for sale, so as to price offers accordingly. Likewise, in sizzling real estate markets, desperate buyers occasionally have gone to such extremes as to forego home inspections in order to snatch a home as fast as possible. This is no longer the case, though, and wise home purchasers should do their homework entirely, so as to avoid unpleasant surprises later on.
Finally, Buyers need not to procrastinate a purchase for fears that home values will abate further. Market stabilization and softening prices do not equate to capital depreciation. Not only economic forecasts anticipate capital appreciation ranging from five percent to ten percent in 2006 as aforesaid but, moreover, there is a very sound economic reason to invest and to continue to invest in real estate: consumers confidence, which remains high in all sectors of the economy. Historically, a strong income-employment factor generates consumption, since when people acquire income they tend to invest it, and it is the correlation between employment and spending which, ultimately, generates economic growth – also in real estate.
Luigi Frascati
Real Estate Chronicle
Tuesday, May 02, 2006
Real Estate Bubble – The End
In light of the recent stream of statistical and economic data coming from the Feds, it can be safely asserted that, rather than popping up with a loud burst, the real estate bubble has now sunken. Just like I forecasted in December, 2005.
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All those illustrious ‘bubbleologists’ out there are not going to like this one bit: not all real estate bubbles burst. Some of them actually sink – just like The Titanic.
Only a few weeks ago the real estate bubble captured the attention of a great many bloggers, authors, even news commentators all of which had in common a very dire prediction, which can be encapsulated into what has become known as the ninth note of the musical diatonic scale, right after Do-Re-Mi-Fa-Sol-La-Ti-Do: ‘Pop’, with all the consequences that such novel high-octave implied, including a cataclysmic price crash, Armageddon and, possibly, the end of life on Earth (save and except, perhaps, for a handful of protozoa).
At the root of the Theory of The Bubble, it will be recalled, were the notions that U.S. consumers have too much already and want more, that they do not save enough, that the trade deficit is too large and bound to become even larger and that the American economy is far too dependent on housing. Absent from the minds of the bubbleologists, however, was the fact that much of this debt is anchored on the built-in equity of real property assets, which thus far has been growing steadily. So therefore, to make the monthly debt burden onerous enough to cause a bubble to burst - that is a cascade of mortgage defaults with a flood of foreclosures on the market, which in turn would bring prices down - one would have to look not to higher interest rates but, rather, for a big drop in family income. As monthly debt payments remain the same, a drop in income would quickly dry up the cash reserves of many consumers, so that the predicted avalanche of mortgage defaults would start rolling down.
Unfortunately for the doomsayers, however, not only nothing of the kind has happened but, furthermore, data released by the Federal Reserve System and the U.S Department of Commerce indicate that consumers are far, far away from suffering a catastrophic drop in family income for a very long time to come. As a matter of fact, the US economy has created 211,000 new jobs in March, according to the Labor Department, which have contributed to an overall drop in the unemployment rate to 4.7 percent, annualized. This level of activity, furthermore, has caused consumer spending to rise by 0.6 percent, up from the 0.2 percent growth seen in February. Which rise in spending, the bubbleologists should be made aware, was aided by an increase in family income, up 0.8 percent in March compared to the 0.3 percent jump in February.
This past week, in fact, Ben Shalom Bernanke, the new Feds’ boss has announced that the economy grew at an annualized rate of 4.2 percent in the January-to-March quarter, the highest level in these past two and a half years. This marks a vast improvement from the anemic 1.7 percent growth rate in the final quarter of 2005. And on April 19, 2006 the US Department of Commerce has released data showing that the benchmark median housing price has increased at an annualized rate of 3.2 percent for the First Quarter of 2006 ending on March 31.
The Bureau of Labor Statistics, moreover, is pegging the Consumer Confidence Index at 109.6 in April, up from 107.5 in March and higher than the 103.8 of December, 2005, when I published the Article entitled “Breaking The Real Estate Bubble Myth”, which has earned me an interview on local TV and that has been praised by many for its thoroughness and, now, rightfulness. The Consumer Confidence Index is now at the highest level since March, 2002 {figures released by Statistics Canada, incidentally, are equally positive). Finally, in line with the inflation-targeting approach announced by Prof. Bernanke in February, the Feds has raised interest rates again by a quarter of a percentage point to 4.75 percent. Rates have increased from 1 percent over the past 20 months, and are now at the highest level since April, 2001. And, finally, the Greenback rose against most currencies on the prospect of higher borrowing costs, which tend to enhance its attractiveness to foreign investors. This signals a renewed influx of foreign capitals into the United States and, by reflection, Canada – both still the most economically secure, politically stable, most trusted and better defended investment arenas of the entire world.
A note of caution was made by the Feds’ Chairman, to the extent that “while prices at the pump have yet to impact confidence, further increases (of gas prices) could dampen consumers' mood". Should that come true, however, and should cost of crude and prices at the pump hamper spending and reduce – or even halt growth, that would have nothing at all to do with a real estate bubble bursting, since the whole economy would be affected. In fact, all world economies would be affected.
So therefore, there is no valid reason to believe, under the circumstances, that consumer confidence applies to everything but real estate and that an economic bubble would affect only real estate markets and nothing else. It is furthermore evident now, in light of the foregoing deluge of statistical data, that all those bubbleologists, Sunday-afternoon crystal ball readers and part-time economists out there have been completely wrong. So much so, in fact, that merely to cite another example, in the Summer of 2004 the long-term bond treasury yield was 5 3/8 percent, whereas right now it is 5 1/8 percent. This is another clear indication that the US Treasury does not envision rates to climb much higher, contrary to what the bubbleologists have been prophesying all along.
It is, therefore, pretty difficult to foresee a collapse of the real estate market with interest rates which, in the long run, are actually dropping.
Perhaps some of those Hollywood big movie producers should ask Leonardo Di Caprio to star in “The Bubble”, a sequel to “The Titanic”, where one could enjoy watching another transatlantic ship sink right to the bottom of the ocean, with all those bubbleologists jumping overboard to meet their destiny into the frigid waters of their economic ignorance.
Luigi Frascati
Real Estate Chronicle
