Morning Report: REO-to-Rental trade earned 9% over the past 5 years

Vital Statistics:

Last Change
S&P futures 2718.5 -4.5
Eurostoxx index 394.21 1
Oil (WTI) 72.15 0.66
10 Year Government Bond Yield 3.10%
30 Year fixed rate mortgage 4.65%

Stocks are lower this morning on bad earnings from Cisco. Bonds and MBS are down small.

The US and China will enter trade talks over the next couple of days. Both sides have signaled willing to make some compromises, so this could potentially be good for interest rates.

Initial Jobless Claims came in at 222k last week, while the Philly Fed improved to 34.4 which is a strong reading. The Index of Leading Economic Indicators rose a respectable 0.4%.

One of the reasons why starter homes have been so tough to find has been the REO-to-rental trade, where professional investors scooped up REO properties early in the crisis and rented them out. CoreLogic crunched the numbers and it turns out the trade made about 9% per year for the past 5 years. Impressive return in an environment of financial repression. Most of the return came from home price appreciation however, so if prices begin to level out, some of these professional investors will turn sellers. This is especially true if they had these properties in funds with a life. As short term interest rates rise, the low single-digit rental return will have more competition.

rental return

While longer-term bonds can be used as a proxy to estimate future inflation, Treasury Inflation Protected Securities represent a direct measure of inflationary expectations. The Fed invariably mentions TIPS in their meeting minutes. The breakeven rate of inflation has hit a 4 year high in this market at 2.2%. This means that an investor would need 2.2% in the consumer price index to be indifferent between buying Treasuries and TIPS, which pay a return equal to the interest imputed in the bond plus the consumer price index.

2/3 of the mortgage originated in April were purchase loans, according to Ellie Mae’s Origination Insight Report. Fewer loans in the pipeline is speeding up processing times, as the average time to close fell to 41 days. The average FICO score ticked up to 723.

CSFB thinks 3.5% on the 10 year will be the level to trigger a stock market exodus, although rates could stall out somewhere south of that for a while.

The hits just keep coming for Wells. The WSJ reports they added or changed information for some business customers during an anti-money laundering audit. Wells states that it was an internal matter only: “This matter involves documents used for internal purposes. No customers were negatively impacted, no data left the company, and no products or services were sold as a result.” This is only going to increase the voices in DC calling for the bank to be broken up. It already is not allowed to increase its balance sheet. At some point, it might make sense for Wells to spin off Wachovia and its securities unit.

GoBankingRates calculated what you can get for $300k in every state. The best value? West Virginia, where $300k will get you 3,347 square feet. Worst? Washington DC, which gets you 581 square feet.

The CFPB recently issued new rules to fix the TRID “black hole” issue.

CFPB Interim Chairman Mick Mulvaney reiterated his commitment to tame the CFPB by ending regulation by enforcement at NAR’s Legislative Trade Meeting and Expo. Student loan debt was also discussed, and while the CFPB doesn’t have a magic wand to make the debt go away they will continue to ensure that students understand the risks they are taking and also will go after predatory student loan collection practices.

Morning Report: Initial Jobless Claims lowest since 1969

Vital Statistics:

Last Change
S&P futures 2652.75 8.25
Eurostoxx index 382.29 2.12
Oil (WTI) 68.61 0.56
10 Year Government Bond Yield 3.00%
30 Year fixed rate mortgage 4.62%

Stocks are higher this morning on strong earnings from Facebook. Bonds and MBS are up.

The ECB maintained its current policy and made some cautious comments, which is pushing up bonds in Europe. US Treasuries are following along on the relative value trade.

The 10 year has made a pretty sizeable move over the past month or so, and mortgage rates typically lag. So don’t be surprised if mortgage rates continue to tick up, even if the 10 year finds a home at the 3% level.

The homeownership rate was flat in the first quarter at 64.2%. It is up from 63.6% a year ago however. It bottomed in the second quarter of 2016 at 62.9%.

Durable Goods Orders increased 2.6% in March, following a strong February. Ex-transportation, they were flat however and core capital goods, which is a proxy for business capital investment, fell slightly. February’s already strong numbers were revised up slightly.

Retail inventories fell 0.5% while wholesale inventories increased by the same amount.

Initial Jobless Claims fell to 209,000 last week, which is the lowest number since 1969. When you adjust for population growth, the number becomes even more dramatic:

initial jobless claims divided by population

Deutsche Bank is scaling back its US operations to focus on becoming a more Euro-centric bank. It is hard to believe, but almost 20 years ago, the bank decided to make a big foray into the US market by buying Banker’s Trust and Alex Brown.

Moody’s is worrying about the next area of opportunity in the mortgage market: cash-out refinances. As many CLTVs are approaching 75%, homeowners may choose to do a cash-out to either consolidate higher rate debt, or perhaps do home improvements. The other opportunity remains refinancing FHA loans that have accumulated enough equity to qualify for a conforming loan without MI. Finally, those who still have ARMs might find the relative attractiveness of a 30 year fixed to be a compelling switch. In an environment of rising home prices and rising interest rates, these will be the only game in town.

Homebuilders are facing rising input costs – sticks and bricks, if you will. Framing lumber prices are up 16% this year, and plywood is up 33%. Inventory is so tight that builders are able to pass these costs onto homebuyers. A tight labor market remains an issue for the industry as well. All of this points to higher home prices going forward.

For those wondering if we are indeed at the end of the credit cycle, here is WeWork’s bond offering, which came in at $700 million with bonds paying 7.875%. Borrowing money at 7.875% for 5% cap rate office space? Set that aside for the moment. They introduced a new financial concept, called “community-adjusted EBITDA,” which not only strips out interest, depreciation and amortization, and taxes, but also ignores general and administrative, marketing, and design / development costs. That has to be the first time I have ever heard this term before, and it should just be renamed EBBS – or earnings before bad stuff.