Property Grunt

Wednesday, August 16, 2006

Heroes of Housing?

With their latest feature on co-op boards, it appears to be a slow news day at the New York Times.

August 9, 2006
David Leonhardt
The Heroes of Housing Just Say No

Correction Appended

THERE’S an old “Saturday Night Live’’ skit in which Eddie Murphy sets out to experience life as a white man in New York. He starts in a dressing room, where makeup artists lighten his skin as he studies up by reading Hallmark cards. Duly prepared, he wades into Midtown Manhattan calling himself Mr. White.

His first stop is a newsstand, where the white cashier conspiratorially tells him to take a newspaper without paying for it. Then comes a ride on a public bus that morphs into a lounge with cocktails and music after the last black rider gets off.

Finally, Mr. White enters the Equity National Bank to ask about borrowing $50,000 even though he has no identification, no collateral and no credit history. But no matter. Such things are mere “formalities,” a loan officer says, while removing stacks of cash from a metal box. “Just take what you want, Mr. White. Pay us back anytime. Or don’t. We don’t care.”

Back in 1984, when the skit was shown on NBC, nobody would have imagined that it was poking fun not just at race, but also at banks’ lending standards. At the time, not even a white man in a gray suit could have gotten a loan without any documents and paid it back at his leisure.

Perhaps but it still was easy to get money, the S&L scandal was an example of that.

But if you watch the skit today on YouTube or a DVD, you can’t help but see another, unintended layer of satire. In the last few years, so-called no-doc and low-doc mortgages — in which loan applicants can avoid formalities like pay stubs and instead simply state their income — have surged in popularity. Critics call them “liars’ mortgages.”

And banks, which often sell a mortgage to a group of investors shortly after issuing it, sometimes seem downright relaxed about how quickly borrowers will repay a loan. The hottest mortgage for the last year has been something called an “option ARM” that comes with a choice of payments on each monthly bill. In California, more than 25 percent of new mortgages this year have been option ARM’s, up from about 5 percent in 2004, according to LoanPerformance, a mortgage data firm.

The main point of these innovations has been to sustain the housing boom by allowing a family that can’t really afford a house to buy it anyway. But clearly, this can’t last. Already, it has raised the risk of a sharp housing downturn and, eventually, of a recession. The Federal Reserve acknowledged as much yesterday by halting its campaign of interest rate increases.

So the housing industry is going to have to find a new business plan. Fortunately, there is one small sliver of the market — here in New York, as a matter of fact — that has kept its wits and can serve as a model. The trouble is that it’s not usually considered to be a model for anything. Indeed, it may be the most hated institution in New York.

Let us now praise the co-op board.

Why? All they do is engage in CYA. There is nothing special about that.

COOPERATIVE living got its start in the 1880’s, inspired by Charles Fourier, a French socialist who argued that cooperation bred efficiency. A French immigrant to New York named Philip Hubert picked up on the idea and built arguably the first co-op, the Hubert Home Club, near the current site of Carnegie Hall.

Despite their utopian origins, co-ops quickly turned into a celebration of capitalism and exclusivity. Soaring new Hubert Home Clubs opened on Madison Avenue and next to Central Park, offering the sort of living space that has always made New Yorkers envious, according to the writer Elizabeth Hawes.

Today, co-ops — which sell shares in a corporation that owns the building, rather than individual apartments — make up about three-quarters of the city’s non-rental apartments. As always, the boards have the right to reject any buyer who doesn’t quite fit, however they define “fit.” More than a few co-op boards would have made good fodder for the Mr. White skit.

Anyone who has ever been interviewed by a board knows what a humiliating process it can be. Its members can demand bank statements from you, ask about intimate details of your life and then reject you without saying why. Or the board can admit you and make life miserable once you have moved in. In the 1990’s, one co-op resident on the Upper West Side was moved to have a party after the board president died.

But say this for most co-op boards: they take their fiduciary duties seriously. They generally require at least a 25 percent down payment, and while the rest of the real estate business has been getting more permissive, co-op boards have been using the sellers’ market of the last few years to crack down. Some Park Avenue co-ops require buyers to have a net worth equal to four times an apartment’s price, up from the old standard of three, said Jonathan Miller, an appraiser.

First of all co-op boards have no other choice but to be serious with their fiduciary duties. They need to do a full body cavity search on any applicant and I mean roto rooter. If they let in somone who can't pay their maintenance and mortgage it will hit the residents very hard because it means the rest of the building will have to bear the burden. Also they have to make sure the person buying isn't some whack job who is going move in 50 cats into their building and drop a load in the lobby.

So thanks in large part to co-ops, the shadiest parts of the housing boom are less common in New York. Less than 8 percent of mortgages issued in the metropolitan area this year have been option ARM’s. The share is closer to 30 percent in most other cities as expensive as New York.

It is possible co-ops played a minor role in this situation but Mr.Leonhardt has forgotten to take in consideration the sophistcation of New York buyers, real estate and mortgage brokers. They all have done the numbers and figured out the best way to get ahead. By stating that co-ops are responsible for this trend is oversimplying the situation. What co-op boards are focused on primarily is how much income you earn, how much liqudity you have and that you are not a douchebag.

In fact the NYT put in a correction addressing Mr. Leonhardt's worhship of co-ops.

Correction: Aug. 12, 2006

The David Leonhardt column in Business Day on Wednesday, about restrictions imposed by co-op boards that have helped limit the use of some adjustable rate mortgages in New York, referred imprecisely to the breakdown of the city’s housing stock. Co-ops make up about three-quarters of owner-occupied apartments, not of all apartments, including rentals, in New York.

It’s hard not to conclude that New York’s high prices are based more on economic fundamentals than those in California or South Florida. (And no, I don’t own property in New York, though I have relatives who do.) The city surely won’t be immune to a downturn, but it does seem less likely to crash. In the last year, price increases here have slowed far less than those in San Francisco, San Diego, Boston, Connecticut or Long Island.

There he goes again. New York's high prices are also based on irrational exuberance, employment and the fact that sellers are dead set in getting as much money as possible. Mr. Leonhardt is exercising his own form of CYA by stating The city surely won’t be immune to a downturn, but it does seem less likely to crash. He is not being definitive with this statement for obvious reasons because the market could go to hell in a handbasket.

Most real estate experts still consider a crash — say, a 20 percent decline — to be unlikely, even in California. But there is now a legitimate risk that the excesses of the housing boom have laid the groundwork for an economic downturn. At the very least, some families are going to regret having taken out such aggressive loans when the higher payments eventually come due.

In coming months, federal regulators plan to issue new guidelines that will remind banks of the risks inherent in their new products and will encourage them to disclose the risks to borrowers. But the guidelines are pretty mild, and they’re not exactly ahead of the curve.

The real lesson of co-op boards, then, will have to fall to those of us doing the borrowing. When you’re about to take on hundreds of thousands of dollars in debt, you will probably do well to be conservative, to ask whether you can make the payments even if something goes wrong, rather than only if housing prices keep rising, interest rates start to fall and you get a big raise. Consider it a mantra for a newly sane real estate market: Embrace your inner co-op board.

As the valley girls says. "Gag me with a spoon." It is simply about common sense or as we in the industry call it due diligence. You break down your numbers and see if yo can cover the spread. If you can't you have to figure out a solution or back out of the deal. It's not rocket science.

Co-ops are more like survialists rather than heroes. They are simply out to protect their own. That's it. There is nothing wrong with that, in fact I think that is something we should all take in consideration in any endeavor in real estate.