Article in April 18, 2007 Wall Street Journal

An Endangered Dream

By SCOTT C. SYPHAX
April 18, 2007

What a difference a year makes. Just last spring newspapers and policy makers across the country were hugging the dream of homeownership closely to their collective breasts and touting what a marvel the financial-services market was for making homeownership possible for every black, Latino, female-headed family in the country.

Today the headlines scream about a "subprime crisis," bankruptcies and the discovery of loan products that are "predatory" and harming our citizens -- especially minorities. In response, Congress is holding hearings, regulators are investigating, and the press's righteous indignation is at full fury. Before our solons get too far down the path of making decisions that they believe are in the best interests of those low- and moderate-income (LMI) families, they should think about the consequences of their actions and please calm down.

The mortgage market is not in a meltdown. People continue to buy and sell homes and mortgages continue to be originated. What has changed is that people who should know better -- namely the financial services industry leadership and those who cover it in the press -- are in panic mode. Instead of directing a reasoned national conversation on fixing how America provides homeownership opportunities to minority and LMI families, they are running for the exits -- and in the process rewriting history and telling the world that America's homeownership experiment of the past 10 years was a failure for all but the rich.

Recently I heard the following statement: "These families would be better off just being renters. They were forced into homeownership and were set up for failure."

I can accept that some people will never be and do not want to be homeowners. However, the statement that LMI families are better off as renters astounds me. Many made the case that sharecroppers were much better off farming on some wealthy landowner's plantation rather than being set up for failure by owning 40 acres and a mule.

Last month, speaking to a reporter from this newspaper, Angelo Mozilo of Countrywide said that 81% of his subprime borrowers are making their payments on time and are successful homeowners. Think about that for a moment. In virtually any other context or industry, a four-out-of-five success ratio would be seen as a major victory. But in the context of lending to borrowers who would otherwise be shut out of the market, it's a meltdown?

My nonprofit's down-payment-assistance program, The Nehemiah Program, has given away over $880 million in grants to working families, resulting in the creation of more than 224,000 new homeowners since 1997. Most received mortgages insured by the Federal Housing Administration, the government agency formed during the Great Depression to regulate the mortgage industry and provide home loans to borrowers who might otherwise have little access to capital.

Nehemiah has been criticized for default rates equal to Countrywide's, even though our own analyses by Experian showed default rates lower than the FHA's. Nonetheless, the important statistic is a 2004 study by the Milken Institute, concluding that LMI homeowners who used Nehemiah assistance on average gained $19,000 in net equity wealth.

We have fallen into a dialogue of blame and paternalism. Imagine removing a cancer-fighting drug from the market because it had a success rate of 81%, or ending access to college for low-income students because only four out of five graduated with a degree. If government regulators proposed such a thing there would be an uproar so loud that they would be transferred to some lonely outpost before Congress could organize a hearing roasting the entire agency.

What strategies could support greater homeownership success for LMI families? First, we should reward the market for empowering and protecting LMI home buyers. Ratings agencies assign ratings for loans purchased by investors in the secondary market based on product and borrower characteristics. Lower the ratings for subprime loans that do not require completion of a standardized pre-homeownership education and counseling program. Studies show that there are clear linkages between education and lower incidence of default. Post-homeownership counseling and monitoring for 24 months would also help.

Second, we need to provide 24-month mortgage-payment-protection insurance. Divorce, job loss, illness and disability are among the biggest contributors to mortgage default. Quality mortgage-payment protection is a low-cost way of mitigating default associated with the above risks.

Third, we need to make the FHA competitive. Subprime needs strong competitors to keep the market honest. Under Commissioner Brian Montgomery, the FHA has taken several positive steps in reviving an agency that had nearly sunk into obscurity due to lack of leadership and neglect. The FHA has streamlined some of the processing burdens that made its financial products unattractive in the marketplace. Many families currently at risk of foreclosure because of bad products should have applied for and received an FHA loan. We can do better. In short, the following three obstacles must be addressed for the FHA to regain impact-player status in the LMI marketplace:

• Get rid of down payments. Down payments are unnecessary. Our success at Nehemiah has proven that. We exist only because there is no alternative. Currently, Nehemiah-type down-payment assistance represents almost 40% of FHA's single-family portfolio. Without a down-payment assistance answer, the FHA cannot fulfill its historic role and will continue to shrink.

• Raise the loan limits for FHA to the conforming limit. Without this change, FHA is dead on arrival on both coasts and in other high-cost areas.

• Send the Inspector General of HUD to charm school. The market left FHA for the reasons above plus one -- the Office of Inspector General, the watchdog set up in 1978 to oversee Housing and Urban Development funds and projects. No one has the guts to say this publicly, but going to the FHA for financing too often means subjecting oneself to a famously public and potentially harmful investigation by the OIG. While the OIG has a duty to vigorously protect the public, this vigor should not be so strident that industry views its regulator as an oppressor. Ironically, I am told that internally the FHA feels equally oppressed by the OIG and knows it is harming them in the marketplace. If the OIG problem is not fixed, nothing Mr. Montgomery does will matter.

Finally, I believe both government and private industry have roles in improving the success of low-income home buyers. Government should act as convener and regulator in prodding industry to holistically support sustainable homeownership. Industry should continue innovating not only in new products, but with new support systems if only to keep government from legislating solutions that frustrate homeownership. However, if industry is not willing to face its own shortcomings, it deserves whatever government imposes.

Ultimately, everything comes back to risk. The risk I fear is the risk of deferring the dreams of another generation of Americans by cutting short their access to what I call the Great American Prosperity Race. Where you enter and when are important to where you end up. However, if we as a nation lock out low-income families from homeownership opportunity because we know better than they what is best for them, not only have they lost the race, but, more sadly, we never even let them on the track.

Mr. Syphax is president and CEO of the Nehemiah Corp. of America, a nonprofit group that provides assistance to low-income borrowers.

Article in April 10, 2007 Wall Street Journal

Why Investors
Should Consider
Real Estate

Though Many Flee, Strength
In Some Segments Makes Case
For REITs and Other Vehicles

By JEFF D. OPDYKE
April 10, 2007

With housing prices softening and subprime lenders tanking, investors have been running from anything that smells of real estate. But they may be bailing too quickly, as some parts of the sector are still doing well.

New money going into mutual funds that own real estate has plunged to just $2 million a week, on average, from nearly $400 million a week as recently as mid-February, according to AMG Data Services. Investors in droves are also selling off their shares in real-estate investment trusts, the publicly traded stocks of companies that own everything from apartment buildings to medical centers and shopping malls.

But in some cases, jittery investor sentiment isn't a good proxy for the strength of the underlying assets. It is true that residential real estate is struggling in many parts of the country. But commercial real estate is driven by job growth and the economy, and both are relatively healthy. In fact, commercial-building occupancy is growing nationally, while rents are up about 4.25% in the past year, according to Los Angeles-based CB Richard Ellis Group Inc. Midtown Manhattan set a record in March for the city's highest rents ever: $69.99 a square foot, on average.

There is another reason to think twice before fleeing the real-estate sector. From a financial-planning perspective, real estate is an asset that investors should have in their portfolios over the long term. That is because real estate serves as a counterweight to inflation, while REITs, according to data from research firm Ibbotson Associates, have a low to moderate correlation with stocks, meaning Wall Street's trends tend not to impact REIT trends.

Investment pros routinely agree that a portfolio should have between 5% and 20% invested in real estate that isn't a primary residence. But "real estate" encompasses everything from single homes and duplexes, to skyscrapers and apartments, to strip-malls, medical offices and assisted-living centers scattered around the country.

So where to invest, given the meltdown in some parts of the sector? The options are growing. Just last year, the Chicago Mercantile Exchange began trading futures and options tied to the movement of the S&P/Case-Shiller Metro Area Home Price Indices that track housing prices in the U.S. as well as a variety of cities, including New York, Miami, Chicago and Las Vegas. Meanwhile, just last month, Santa Monica, Calif.-based Dimensional Fund Advisors launched an international real-estate fund that provides investors access to markets where REITs are growing in popularity, including Singapore, Hong Kong, Japan and Turkey.

Here are some of the options to consider:

Real-Estate Mutual Funds and ETFs

The easiest means for creating instant diversity across regions and property styles is to buy a real-estate index mutual fund such as Vanguard's REIT Index fund, or an exchange-traded fund such as the iShares Dow Jones U.S. Real Estate Index fund. Both are low-cost options for owning broad exposure to various types of REITs, and both have fared well over the past year, though each has fallen off in the past couple of months as real-estate woes have mounted.

The drawback: You won't see the potentially big price pops you could by owning individual REITs or even the stocks of home builders.

Sector REITs

Not all real-estate sectors fire on the same cycle, since different sectors play off different economic drivers. Office properties, particularly in urban locations, currently offer the best opportunities, says Bob Gadsden, portfolio manager at New York's Alpine Woods Capital Investors, which runs the Alpine mutual funds. He says companies such as Vornado Realty Trust, in Paramus, N.J., and Boston Properties Inc. are examples of the REITs investors should consider.

Those companies operate in land-restricted markets such as New York City, San Francisco, Boston and Washington, D.C., cities "where there's limited ability to create new supply," says Ken Heebner, portfolio manager for the Boston-based CGM Realty Fund who singles out the same two REITs.

Apartment REITs also offer some potential, as former homeowners slip back into the rental market in the wake of the subprime debacle and the exploding number of foreclosures. The increasing legion of renters is pushing demand higher, allowing apartment companies to raise rents. That is a good combination for leading apartment REITs such as Home Properties Inc. in Rochester, N.Y., and Denver's Archstone-Smith, says Mr. Gadsden.

Yet the foreclosure woes are dumping increasing numbers of homes into the residential property market at marked-down prices, and some are certain to land in the hands of real-estate investors who will turn them into rental properties. That means affordably priced rental homes will be competing against apartments for tenants. That is potentially bad for apartment REITs, says Mr. Heebner. Moreover, once the subprime crisis abates and interest rates fall again, renters will again become homeowners.

International REIT Mutual Funds

These operate just like domestic REIT funds, but they own real-estate trusts in various countries. A number of financial planners are now including them in client portfolios because "they provide another level of diversification," says Lance Alston, vice president at JWA Financial, a Dallas planning firm that in the past month has begun putting about half of its clients' real-estate exposure in the Dimensional Fund Advisors' International Real Estate Securities Portfolio.

Just like the U.S. commercial property market, commercial real estate globally is doing well amid a strong world economy. CB Richard Ellis global data show that rents are moving up by as much as 30% in some markets, while vacancy rates are falling.

Jeremy Mitchell, a financial planner in Sun City, Ariz., says his firm this year has been buying shares in Cohen & Steers International Realty Fund for clients because "you're putting a ceiling over yourself by focusing just on domestic REITs."

The risk: The REIT market in many countries is nascent, as is the local real-estate market. If global economies crumble, real-estate prices -- and REIT prices -- will come down.

Private REITs

Unlike REITs that trade on Wall Street, private REITs are generally available only through financial planners, advisers and brokers. These REITs typically maintain a constant share price -- often $10 a share. And they generate income through their yield, often in the 5% to 7% range, and provide capital gains only when the portfolios are liquidated, sold to other real-estate companies or go public.

Dean Harman, a financial planner in the Woodlands, Texas, has been putting clients into a handful of private REITs, such as KBS, Wells and Hines real-estate investment trusts.

The benefit: income as well as price stability. When the Dow Jones Industrial Average fell more than 400 points in February, "the value of my clients' REITs didn't move," Mr. Harman says.

The drawback: a lack of liquidity. Private REITs allow withdrawals only occasionally, often once a quarter. Moreover, they generally require a holding period of at least one year, and for a few years after that the REIT generally redeems the shares at a discount to the original purchase price.

Home-Builder Stocks

These stocks have been hammered in recent months, yet companies like D.R. Horton Inc., Toll Brothers Inc. and KB Home might not be such a bad play for long-term investors. Their business doesn't need escalating home prices to succeed. They just need volume.

It will take some time, but once the subprime and foreclosure shakeout has passed, the builders' stocks -- all down roughly a third in the past year -- could be fashionable again, says Ernie Ankrim, chief investment strategist at Russell Investment Group in Tacoma, Wash. "If housing prices stay soft, you'll see price declines in land and raw materials, giving the builders stronger margins."