Join the Fool for a talk with Chris Mayer, who is the Paul Milstein Professor of Real Estate at Columbia Business School. Mayer is also a visiting scholar at the Federal Reserve Bank of New York. His research has delved into topics such as housing cycles, mortgage markets, debt securitization, and commercial real estate valuation.
Chris Mayer sits down with the Fool for a look at real estate and the mortgage industry. How is the recovery really going? What will get people buying again? What will the government do next? How does technology -- and the data it generates -- affect the industry?
Full transcript below.
David Hanson: Hey Fools, I'm David Hanson, and I'm here with Chris Mayer. He's a professor of real estate here at the Columbia Business School.
First question off the top, Case–Shiller up 12% year over year... what's your first thought when you hear something like that?
Chris Mayer: The housing market fell too far, and it's kind of recovering a little bit.
Hanson: We're not going back into a bubble?
Mayer: I'm not in the "We're in another housing bubble" sort of world. I think the market just really cratered, and we're starting to recover.
Now, we could talk about which places, because I think, if you're living in Las Vegas or Phoenix, I think you should not expect that house prices are coming back to where they were, so do some really simple math.
Take a place like Las Vegas, where house prices fell more than 50%, and then you read a big headline that says, "Gee, house prices are up 30% this year." If you do the math on the index, where did you go? Well, you went from 100 to 50, and now from 50 you're up 30%. That gets you up to 65.
It's not minus 50, plus 30. Actually the 30% is off a much lower base so, effectively... going up 30% makes a lot of headlines. It doesn't mean we're anywhere close to where we were before.
Hanson: Right, so still being down. Some of the narrative out there is that America is moving toward a renter's society.
Hanson: We've seen firms like Blackstone, Silver Bay, American Homes 4 Rent. They're moving into the space as buyers, and then operate as renters. Is this a model that you think could work?
Mayer: I think we should separate the macro headlines about moving to a renter's society -- which I think we're not doing -- with the question of, can these business models work well? Historically, more than a quarter of single-family homes have been rented in some way, shape, or form, but almost all run by mom and pop sort of operators.
If you ask, "Could somebody enter that business, consolidate that, run it more efficiently?" the answer is surely yes. That was already true even with a homeownership rate in the mid to upper 60% range, so these businesses could work whether or not the macro story of "We're moving to a renter's society" works.
I have to say, my own view on that is a little more skeptical, which is... if you ask, at a given point of time, "Is the percentage of people in their 20s, going to be homeowners, is that percentage going to go down?" Absolutely. The percentage of people in their 30s who are going to be homeowners go down? Absolutely.
Over the lifetime, if you ask typical Americans, their lifetime home ownership rate is close to 85%, so the vast majority of Americans have been homeowners at some point in time. I think that's going to change. I still think, at some point in their lives, the vast majority of Americans will still be homeowners.
Hanson: Right. You've done some work on out-of town-speculators coming in, and how that can inflate markets like Las Vegas. Do you see those companies -- like a Blackstone -- do you see that as pushing housing prices too high, or is that the natural force that someone's going to come in and buy the house if it's a good deal?
Mayer: I think any investors coming into the market... what we did in our research basically showed that, when investors come into a housing market, they push prices up. Frankly, for your aficionados, this isn't really news. When a bunch of investors come in, or there's a recommendation to come in, what happens? Prices rise. That's not really rocket science.
Almost surely, the influx of investors has raised house prices off of the floor that they were before. That doesn't necessarily mean that they're a bubble, or that investors are paying crazy prices for things, as well. It really depends what's behind the business model.
If the model was, "I'm going to buy and flip," lots of people have gotten into trouble with buy-and-flip models for housing because you have to time it right and, frankly, it's very expensive to hold them and renovate them and do all this stuff.
If the idea is to build a business that is a long-run operating business, that's a different business model. I think there are going to be people who succeed at building that business as a whole, just because you had so many mom & pop shops who were not terribly efficient, who were doing this before.
Hanson: There's been research done, academic research; Shiller has gone back and said, "Real home prices over the course of time, basically stay with inflation. We shouldn't expect huge gains in home prices."
We're continuing to see that people move away from that. People continue to expect these big prices. Is it always going to be that way? People are going to go on Zillow, go on Trulia and say, "Oh, man, my house is up 10%. This is great. I should expect that, going forward."
Is it always going to be that way?
Mayer: I don't think so, but I'm not 100% sure about that. The surveys that Case and Shiller have done are really interesting. When home prices are rising, people are all about what their home is worth, and their surveys show that. When home prices are flat or falling, and you ask people what their home is about, it's a place to live.
There's always a little bit of... the psychology around this is, "When I feel wealthier, of course, then I talk about price increases."
But I think, at its core, most Americans who buy homes believe they're buying homes to live in them; 19 out of 20 young Americans surveyed still say they want to be homeowners. I don't think that's gone away, in any way.
Hanson: Right. Before we started filming, you mentioned you were down in D.C. talking, I'm assuming, about GSE reform. I guess my questions would be, what do you think the government should do with Fannie Mae, Freddie Mac, and what do you think they actually will do with them?
Mayer: Should do is easy for an economist to answer. Will do, even the best political scientists don't know the answer to that question.
The should do part, I think the Corker-Warner bill is a really good start on the legislative front. It fits the basic principles, which is it's a path for the U.S. government to withdraw its footprint ,and it has it such that lenders who are in the market are going to bear some risk associated with the mortgages that they make.
To my mind, that's one of the big problems, is when you have a lender making a loan where they have no stake in the outcome... we know that the "Heads, I win, tails, taxpayers or somebody else loses" -- even if it's not taxpayers -- is not a very good lending model. To my mind, that's a really good approach to thinking about GSE reform.
Will it happen? At the panel today, Senators Corker and Tester both said, "Yes, we think there's a real shot at getting this out of the Senate, and even having the House pass something." But I'm no prognosticator. I certainly... betting on progress in D.C. strikes me as one of the more challenging kind of bets for anybody to make, especially an economist.
Hanson: We're an investment company, and there's been some investors out there -- Bruce Berkowitz, some retail investors -- that have come out and bought the preferred shares of Fannie and Freddie, and also the common...
What do you say to those people? Do you think that's a reasonable bet, or do you see that as a straight-up gamble?
Mayer: Look, the U.S. government has all sorts of rules about how they can pull all the profits out of Fannie and Freddie.
This is really a bet that you're not going to see GSE reform that wipes them out, and -- and it's a big and -- also that the way conservatorship was set up was done in a way that was not going to pass muster, so their litigation is going to prevent the Federal government from scraping all the profits, and moving it back into the Treasury, so it's a two-pronged bet.
I'm not a lawyer. I have no view as to whether conservatorship was done in a way that would allow this to happen or not. The political process, frankly, I think most Americans do think Fannie and Freddie should be eliminated, so on that vote, I know what the political pressure is.
But if the bet is that nothing will happen in D.C., there are many, many people who have done very well on the bet that, even if something should happen in D.C., that it actually won't. There's always a reasonable chance on that.
Hanson: Right. One of the things that, when they're talking about GSE reform, they say, "We've got to keep the 30-year fixed. That's crucial to the economy, and crucial to the housing market." But if we look outside the U.S., there are countries with higher homeownership rates. Do we need the 30-year fixed mortgage?
Mayer: You are completely correct. If you look globally, very few countries have a 30-year fixed-rate mortgage. Many countries have homeownership rates higher than the U.S.
Do we need it? No. Is it a psychological issue for many Americans? It is, and I think that is showing up in the political process in a way that is going to make it very likely that the 30-year fixed rate is going to stay.
But as an economist, I've actually written a paper, for example, talking about why prepayment penalties can actually be a good thing. I think this crisis has shown us that the 30-year fixed-rate mortgage is really good for people who are well qualified, have lots of money, and when interest rates fall, they're always going to be able to refinance.
If you're a distressed borrower, and watched your home go down in value, there were tens of millions of Americans who could never access lower interest rates to refinance. So if you ask, "Who got the best deal through the crisis on interest rates?" -- it was people who had ARMs.
At the end of the day, what do I advise people? I think an ARM is a good product, and I also think that if we're going to go through this with the 30-year fixed, we have to figure out a way to help people, particularly distressed borrowers, refinance if we're going to have the risk of another crisis.
Hanson: Right. Staying abroad, there's been some talk about Canada, Australia, that their housing markets look a lot like ours did, back in 2006.
Hanson: Have you looked at those markets at all, and do you think that there's potential looming there in the real estate in the banking industry?
Mayer: I'll give you an anecdote. I traveled to Canada last summer. I've spent a bunch of time traveling different parts of the world so -- when you ask about global stuff -- I've become very interested in learning about what other people do, because I think that's really important.
I was traveling last summer to the University of British Colombia to give a talk, and I'm going through customers. The customs officer says, "What are you doing in the country?"
"I'm going to the University of British Colombia."
"What, are you a professor? What are you going to talk on?"
"I'm going to talk on the housing market."
He looks at me and says, "Do we have a housing bubble here in Vancouver?"
It reminded me -- the last time somebody asked me that question was a CNBC cameraman in 2005, who was telling me about the third home that he was about to purchase. It had a little bit of that feel. There's always this... when people are really nervous about a bubble, there's probably at least something there. Not when it's economists; when it's ordinary people.
I think there are a lot of people who are worried about Canada right now, and I think also Australia has people who are concerned about the level of house prices.
In fact, unlike the previous time, when people didn't take into account housing in the banks, you've seen some of the Canadian banks get downgraded, for example, because of concerns about risk in the housing sector.
I do think that there's concern there. I'm not close enough to it to say, "Yes, the bubble's going to crash on this date," but there are enough signs out there that people certainly have to be aware of those issues.
Hanson: Stepping back, and just looking at the broader housing market, there's a lot of metrics that come out. We have housing starts, applications, mortgage rates.
Mayer: Yeah, I get calls almost every other day. Some new statistics come out. It's like, "Do you think this is a really big deal?" Sort of like weekly unemployment claims, they bounce around a lot. Who knows?
Hanson: Is there one that's more important than any other, or are they all kind of just noise, and the long-term trend is really the story?
Mayer: I think the monthly data still have an element of noise to them. Case and Shiller has reported that the seasonality doesn't work so well in their indexes. Zillow, I think, also has very good indexes that -- if you ask me what do I use in my research -- they have very good data that I use a lot, and I don't have any shares in Zillow, for full disclosure.
But I think, in general, it's the putting together all the pieces. If you were asking me, what do I think is going to be a really important issue for housing, it's household formation. We've seen household formation levels that are at... I don't want to say all-time lows, but incredibly low levels.
Even coming out of the recession, people are living at home, doubling up, tripling up. People are getting married later, having kids later, all this kind of stuff. That's really the demand side of the equation for housing.
I still am a straight fundamentals kind of guy, and I worry a lot about that. I do look at the composition of who's buying. If you see a lot of cash purchases, that tells you something, because, ultimately, housing has to be occupied, and you have to work your way through that picture.
Obviously, prices and percentage of people underwater also matters. Those are some of the things that I look at and, of course, housing starts.
Hanson: The formation is the demand side, and housing starts...
Mayer: Is the supply side, yes.
Hanson: Which we've been trending below what we're going to need to keep up with the historical rate.
Mayer: Yes. Housing starts, if you look at the numbers -- and this is one of the things that we talked about this morning on our panel -- the Joint Center of Housing at Harvard tracks some of the data on the construction and household formation side.
I think those are concerns at the moment because ordinarily, coming out of a recession, you would have seen the housing market just completely take off and pull the economy out.
Obviously, this recession looks nothing like what the recovery of a typical recession would be, because housing has been so slow. You can easily account for 1-2% of GDP slower recovery, just based on housing not having done what it normally does.
I pay attention to that, but to my mind, the big things are looking at when we start forming households. That's going to be when we start demanding more housing. That's when prices start coming up to construction costs.
But where they recover, I think a bad benchmark is where they were in 2005 is where they'd expect. If you're in San Francisco, I believe they'll be above that. If you're in New York or you're in Boston, history says they're going to exceed that level.
If you're in Las Vegas or Phoenix or Miami, history does not say we're going to exceed those levels any time in the next decade.
Hanson: You talked about people staying at their parents' house longer, delaying things. One of the things that some people point to is, rising rates will get people off the sidelines, and that's going to keep us going. Is there evidence to support that rising rates really do serve as a motivation for people to come into the market?
Mayer: It's certainly... I wouldn't even call it an urban legend.
Hanson: Just a myth?
Mayer: Real estate brokers and mortgage brokers both say it. There's probably something to that view. I haven't ever seen a study on that.
Obviously, it's not... it can't be a long-run thing, because, obviously, rising rates make housing less affordable, and they're going to push down prices. But in the short run, we all understand, people need motivations to do things.
Certainly your listeners understand that, on the investment side, that there are triggers that push people into things that aren't necessarily... you just don't know when the low is going to hit, so the people who are waiting for mortgage rates just to go down a little lower, and figured they would never go up again, they went up 100 basis points in a pretty short period of time.
Hanson: You mentioned Zillow. I mentioned Trulia earlier. When you look at those type of companies, the tech-type companies, do you think there's a fundamental change in the way we could get mortgages, go through the housing process in the next 10 years, 15 years?
Or is it going to look the exact same -- you're still walking into a mortgage broker, going through that whole process? It just seems like a process that is right for disruption. There's a lot of layers to the process. Do you see evidence of that changing at all in the future?
Mayer: I have to say, I have enough gray hair to remember when people first called the death of the real estate broker industry. That death has been called many times, and it hasn't happened yet.
That does not mean that technology hasn't fundamentally changed how things are going, and you've just got to believe that technology is going to push down the cost of buying and selling a home, and of getting a mortgage.
There's no question that technology could help people a lot. If you look, for example, at refinancing decisions, people who are financially sophisticated do a much better job at optimizing how they manage their finances and their mortgage than people who don't.
This is not rocket science. This is something that technology can and should help them. Do I expect that to happen? I do. I expect those industries are going to continue to be affected to an enormous degree by technology. It already is, but it's going to continue to push down prices, and that's a good thing for consumers.
The upside, the challenges, there are still regulatory challenges associated with the mortgage process that haven't been resolved. I hope with all of the conversation with GSE reform and the top line -- how do we deal with Fannie and Freddie -- I would really love us to go to a system that looks more like the Danish mortgage system, where you have a national Registry of Deeds, where your mortgage bond actually trades on Nasdaq.
You literally look up mortgage bonds on Nasdaq, see where your mortgage bond is, and buy and sell your mortgage inside those bonds. That level of transparency and liquidity makes housing much more affordable for people who live in Denmark.
Hanson: You mean I can't go look at my mortgage on Fannie Mae right now? Not available?
Mayer: Well, they're starting to put some of the data available, but you can literally look, and you can buy your mortgage out of a mortgage bond. If a mortgage broker originates a mortgage in Denmark, they price it off the market that day, and put it into the market.
There's no having this thing sit on a balance sheet, all of these inefficient things. There are real opportunities for us to use technology in ways that I think would make the system more efficient, and would also be very consumer-friendly in helping people make better decisions.
You've got to believe that people are going to be developing systems to do that -- and it's not only the ones you name. There are going to be personal finance sites, which are going to really help people do a better job of managing their finances, and those personal finance sites surely are going to start incorporating mortgages as part of what they do. You've seen Zillow and Trulia jump into this business, as well.
I really think that part of it is just getting started.
Hanson: Great. Thanks for joining us.
Mayer: Sure. Happy to come.