Real Estate Research provides analysis of topical research and current issues in the fields of housing and real estate economics. Authors for the blog include the Atlanta Fed's Kristopher Gerardi, Carl Hudson, and analysts, as well as the Boston Fed's Christopher Foote and Paul Willen.
January 14, 2015
The Effectiveness of Restrictions of Mortgage Equity Withdrawal in Curtailing Default: The Case of Texas
As an economist who has studied the causes of the recent mortgage default and foreclosure crisis, I am often asked how to design policies that will minimize the likelihood of another crisis. My typical response to such a question is that one of the most effective ways of lowering mortgage defaults would be to limit borrower leverage by either increasing down payment requirements at the time of purchase or limiting home equity withdrawal subsequent to purchase.
The reason behind my belief is twofold. First, economic theory tells us that being in a situation of negative equity (where the remaining balance of the mortgage is greater than the market value of the property) is a necessary condition for default and foreclosure. Homeowners with positive equity will almost always have a financial incentive to sell their homes instead of suffering through the foreclosure process, while borrowers who are “under water” have a difficult time refinancing or selling (since they would need to have enough cash at closing to cover the difference between the outstanding balance of the mortgage and the sale price/appraisal of the house) and have less of a financial incentive to continue paying the mortgage. Second, numerous empirical studies in the literature have confirmed the theory by documenting a strong positive correlation between the extent of negative equity and the propensity to default on one’s mortgage.
New evidence on preventing defaults
An important new paper by Anil Kumar, an economist at the Federal Reserve Bank of Dallas, provides new evidence that shows just how effective restricting leverage can be in preventing mortgage defaults. His paper confirms many of the findings in previous studies that have shown a positive relationship between negative equity and default. However, it goes a step further by using plausibly random variation in home equity positions created by a government policy that placed explicit restrictions on home equity withdrawal.
Kumar's paper is a significant contribution to the literature because it seems to overcome a serious identification issue that has plagued most empirical studies on the topic. The major challenge is that a homeowner can partially control his or her equity position through decisions about initial down payments on purchase mortgages and decisions about cash-out refinancing and home equity loans or lines of credit subsequent to purchase. As a result, it's unclear whether homeowners with more negative equity are more likely to default because of their worse equity positions or because of other reasons (unobserved by the researcher) that happen to be correlated with the decision to put less money down at purchase or to extract more equity over time.
Both theory and empirical evidence tell us that more impatient individuals tend to borrow more and are more likely to default on their debts. Thus, it might simply be the case that more impatient borrowers who are less likely to repay any type of debt choose to put less money down and extract more equity over time, creating the observed correlation between negative equity and the propensity to default. To put it in the language of econometrics, there are both selection and treatment effects that could be driving the correlation that we see in the data, and the policy implications of restricting borrower leverage are likely very different depending on which cause is more important.
Do home equity restrictions cause lower default rate?
The paper focuses on a policy enacted in the state of Texas that placed severe restrictions on the extent of home equity withdrawal. The Texas constitution, enacted in 1876, actually prohibited home equity withdrawal. The prohibition was eventually lifted in 1997 and the restrictions were further relaxed in 2003, but even in the post-2003 period, Texas law placed serious limits on equity withdrawal, which remain in effect today.1 Subsequent to purchase, a borrower cannot take out more than 50 percent of the appraised value of the home, nor exceed 80 percent of total loan-to-value (LTV). For example, if a borrower owned a home worth $200,000 and had an outstanding mortgage balance of $140,000, the borrower would be allowed to take out only $20,000 in a cash-out refinance. It is important to note that this LTV restriction does not bind at the time of purchase, so a homebuyer in Texas could take out a zero-down-payment loan, and thus begin the homeownership tenure with an LTV ratio of 100 percent (we will come back to this issue later).
Here's a nice quote in the April 4, 2010, issue of the Washington Post crediting the cash-out restriction for Texas weathering the foreclosure crisis better than many areas of the country.
But there is a broader secret to Texas's success, and Washington reformers ought to be paying very close attention. If there's one thing that Congress can do to help protect borrowers from the worst lending excesses that fueled the mortgage and financial crises, it's to follow the Lone Star State's lead and put the brakes on "cash-out" refinancing and home-equity lending.
At first glance, the data suggest that such a sentiment may be correct. In the figure below, we display subprime mortgage serious delinquency rates (defined as loans that are at least 90 days delinquent) for Texas and its neighbors (Arkansas, Louisiana, New Mexico, and Oklahoma). We focus on the subprime segment of the market because these are the borrowers who are more likely to be credit-constrained and thus more likely to extract home equity at any given time. It is apparent from the figure that Texas had the lowest subprime mortgage delinquency rates over most of the sample period. While the paper uses a slightly different data set, a similar pattern holds (see Figure 1 in the paper). The figure is certainly compelling and suggests that the home equity withdrawal restrictions in Texas had an important effect on default behavior, but a simple comparison of aggregate default rates across states really doesn’t tell us whether the policy had a causal impact on behavior. There could be other differences between Texas and its neighboring states that are driving the differences in default rates. For example, house price volatility over the course of the boom and bust was significantly lower in Texas compared to the rest of the country, which could also explain the differences in default rates that we see in the figure.
The paper uses a relatively sophisticated econometric technique called "regression discontinuity" to try to isolate the causal impact of the Texas policy on mortgage default rates. We won't get into the gory details of the methodology in this post, so for anyone who wants more details, this paper provides a nice general overview of the technique. Essentially, the regression discontinuity approach implemented in the paper compares default rates over the 1999–2011 period in Texas counties and non-Texas counties close to the Texas borders with Louisiana, New Mexico, Arkansas, and Oklahoma while controlling for potential (nonlinear) trends in default rates that occur as a function of distance on each side of the Texas border. The paper also controls for other differences across counties that are likely correlated with mortgage default rates (such as average house price appreciation, average credit score, and more). The idea is to precisely identify a discontinuity in default rates at the Texas border caused by the restrictions on home equity withdrawal in Texas. This strikes us as a pretty convincing identification strategy, especially in light of the fact that information on actual home equity withdrawal is not available in the data set used in the paper.
The estimation results of the regression discontinuity specification show that the equity restriction policy in Texas lowered overall mortgage default rates over the 13-year period by 0.4 to 1.8 percentage points depending on assumptions about sample restrictions (including counties within 25, 50, 75, or 100 miles of the border) and functional form assumptions for the “control function” (that is, whether distance to the border is assumed to be a linear, quadratic, or cubic polynomial). At first glance, this may not seem like a large effect, but keep in mind that the average mortgage default rate over the entire sample period was only slightly above 3 percentage points in Texas and 4 percentage points in the neighboring states. The paper also restricts the sample to subprime mortgages only and finds significantly larger effects (2 to 4 percentage points), which makes sense. We expect subprime mortgage borrowers to be affected more by the equity restriction since they are more likely to withdraw home equity.2 The paper implements a battery of robustness checks to make sure that the results aren’t overly sensitive to functional form assumptions and adds controls for other types of state-level policy differences. Based on the results of those tests, the findings appear to be quite stable.
But is it a good policy?
So the paper appears to confirm what previous research on the relationship between equity and mortgage default has found, although it uses methods that aren’t quite as clean as the regression discontinuity approach employed in this analysis. However, it doesn’t mean that such a law change is necessarily good policy. While it seems to be effective in reducing defaults, it may also have some real costs. The most obvious one is the decrease in the volume of low-cost secured credit that many borrowers used to improve their circumstances during the housing boom. An unintended consequence of the policy might have been to push financially distressed households into higher-cost credit markets like credit cards or payday loans. A second drawback of the policy may have been that it increased homeowner leverage at the time of purchase. As there were no restrictions on LTV ratios at the time of purchase, many homebuyers may have decided to make lower down payments, knowing that their access to equity would be restricted in the future. It’s also possible that this may have resulted in a larger volume of subprime mortgage lending in Texas. Households with relatively high credit scores who could have obtained a prime mortgage with significant down payments (say, 20 percent), may have turned to the subprime segment of the market, where they could obtain loans with low down payments but with much more onerous contract terms.
While it’s not clear whether the actual Texas policy of restricting home equity extraction is welfare-improving, it might seem from the research that restricting borrower leverage is an effective way to reduce mortgage default rates. But limiting borrower leverage is very unpopular. In fact, it probably isn’t too much of an exaggeration to say that the vast majority of market participants are adamantly opposed to such policies. After all, it is perhaps the only policy upon which both the Center for Responsible Lending (CRL) and the Mortgage Bankers Association (MBA) share the same negative view.3 Thus, while such policies have been adopted in other countries, don’t expect to see them adopted in the United States any time soon.4 To the contrary, policy is more likely to go in the opposite direction as evidenced by the Federal Housing Finance Agency’s announcement to relax down payment requirements for Fannie Mae and Freddie Mac.
By Kris Gerardi, financial economist and associate policy adviser at the Federal Reserve Bank of Atlanta
1 Before 1998, both home equity lending (loans and lines of credit) and cash-out refinancing were explicitly prohibited in Texas. A 1997 constitutional amendment relaxed this ban by allowing for closed-end home equity loans and cash-out refinancing as long as the combined LTV ratio did not exceed 80 percent of the appraised value (among a few other limitations that are discussed in the paper). In 2003, another constitutional amendment passed that further allowed home equity lines of credit for up to 50 percent of the property’s appraised value, although still subject to a cap on the combined LTV ratio of 80 percent.
2 The effects are actually smaller for the subprime sample when compared to the average default rate over the entire sample period, since the average rate is significantly higher in the subprime segment of the market (10 percent subprime default rate compared to the 3 percent overall default rate in Texas).
January 06, 2015
Bringing Foreign Investment into Economically Distressed Markets: The EB-5 Immigrant Investor Program (Part II)
This is the second post in a two-part series on the EB-5 Immigrant Investor Program. EB-5 is a federal program designed to attract foreign investment to real estate projects in economically challenged markets. Part 1 provided an overview of the mechanics and impacts of EB-5. This post discusses some of the projects in the southeastern region and discusses four major issues facing the program.
EB-5 in the Southeast
The Southeast is home to more than 100 approved immigrant investor regional centers and more than 25 successfully developed and financed EB-5 projects. A recent report from the Initiative for a Competitive Inner City profiles the EB-5 program and describes the projects. Click on the map to see details of seven projects financed at least in part through the EB-5 program.
Anniston Senior Housing Development involves redevelopment of a former army facility into a senior living community. Expected to open in 2015, this $30 million project includes $6 million from 12 international investors.
Homewood Suites by Hilton Hotels, opened in October 2014, is adjacent to Hartsfield International Airport. This $18 million project was financed primarily with EB-5 capital from 30 international investors.
Via Mizner Golf and Country Club is currently in the third phase of development, which is using EB-5 investment. The overall project cost is approximately $129 million, with 88 international investors providing $44 million in subordinate debt.
Fairfield Inn & Suites and Courtyard by Marriott opened in 2012 and 2014, respectively. These projects combined into a $35 million development cost, with $7 million provided by international investors.
AJIN USA and its subsidiary WOOSHIN USA are auto body frame suppliers for Hyundai and Kia. The overall project cost for a manufacturing plant expansion was approximately $112 million, with EB-5 investors providing $41 million.
Mountain Lakes Medical Center was renovated in 2012 using EB-5 financing. The second phase of the project will involve building a new hospital nearby and repurposing the existing hospital into a senior living facility. Overall, 31 international investors have provided $16 million.
A Sonic fast food restaurant opened recently on Fort Lauderdale Beach. This project was financed with $4 million from 8 international investors.
Harbourside Place river walk, entertainment plaza, marina, restaurants, and hotel. The $144 million Harbourside Place facility was built with partial EB-5 financing.
The University of Miami Life Science and Technology Park phase I opened in 2011 and included a 250,000-square-foot life science building. The overall project cost for phase I was $107 million, with $20 million from 40 international investors.
EB-5 successes are balanced by at least as many stories of failure, delay, unmet expectations, or, in the worst cases, fraud and litigation. One such project was the Green Tech Automotive project in Tunica, Mississippi, where a start-up car company had plans for a plant expansion to manufacture a new line of fuel-efficient vehicles. So far, promises of job creation and foreign investment in rural Mississippi have gone unfulfilled, and the federal government is investigating the transaction.
The experience of New Orleans with EB-5 offers another cautionary tale. In 2006, the city created a public regional center through partnership with an out-of-state real estate developer. According to legal complaints, investors have alleged that principals at the regional center committed fraud and diverted funds. The city has been entangled in litigation for several years now.
Four major issues facing EB-5
Last summer, the Initiative for Competitive Inner City (ICIC) hosted a conference on EB-5, "Impact Investing in Inner Cities: Putting Foreign Capital to Work through EB-5." Four major considerations facing the program emerged in presentations and conversations with experts attending the conference.
- First is the limited availability of data on EB-5 projects, according to Brookings Institute and ICIC researchers, which impedes their ability to fully assess the program's impact. The U.S. Citizenship and Immigration Services annually collects data on EB-5 projects including which industries receive EB-5, the number of jobs each project creates or maintains, the total number of green cards approved, and the total number of petitions filed to remove immigration restrictions. But access to the data is limited. Many efforts are under way to centralize EB-5 data and to subject the program to more rigorous analysis.
- Second, despite limited data being available to accurately assess the program's impact, some have observed that the communities envisioned as the targets of the EB-5 subsidy have benefited only marginally from the program. This argument takes two main forms: the first focuses on the impact of EB-5 on a particular place, and the other looks at the quality and quantity of jobs created. As to the first, EB-5 is intended as a finance tool for projects that create jobs, and especially projects that target economically distressed communities in rural areas or inner cities. In theory, EB-5 provides capital for projects where other financing options are not available. However, there is a perception that more projects than not are using EB-5 in questionably distressed places, including chain hotels in major urban markets and drive-in restaurants along major highways. Some projects—such as one building a golf club in Boca Raton—are taking place in areas that are clearly thriving. In terms of job creation, the program does not include specifications regarding the quality of jobs. Any job counts, including minimum wage-level retail, service, or construction jobs, for example. In addition, EB-5 specifies a threshold of 10 jobs per investor, which some perceive as too low, given the upside potential for foreign investors and their families.
- Third, there seems to be limited alignment of local economic development priorities and EB-5 projects. EB-5 investors prefer public-private partnerships with local governments because, in addition to the leveraging effect, the public partner encourages greater transparency and accountability. Public-private partnerships also allow an investor to count jobs created by any public infrastructure improvements associated with private real estate financed with EB-5. For example, if a public road or sewer line must be extended in order to serve a new development, then the jobs created by public investment can count toward the EB-5 investor's job-creation requirement. So there are several incentives for EB-5 investors to support economic and community development priorities at the local level. However, according to Brookings Institute research, "regional centers and local economic development agencies lack coordination in their work, even though they share many similar goals." Such a lack of coordination may limit the deployment of subsidized capital into critical local improvement.
- Finally, a complex network of unregulated intermediaries and brokers are driving up costs and fees and, according to some, discouraging investment. From the perspective of potential investors, the process is wrought with the potential for misdirection and fraud. For example, intermediaries and brokers typically receive a commission for every investor they attract to a project. Aggressive promotional tactics, misrepresentations, and exaggeration regarding the safety of an EB-5 investment are commonplace, according to Brookings.
As part of the Atlanta Fed community and economic development program's efforts to promote the availability of capital in economically distressed communities in the Southeast, we will be examining specific tools and policies—like EB-5, and others—and sharing what we learn in this blog.
Will Lambe is a senior adviser with the Atlanta Fed's Community and Economic Development program, focusing on community development finance.
November 18, 2014
Can the Atlanta Fed Construction and Real Estate Survey Predict Home Sales?
The slow recovery in housing remains an item of note in statements from the Financial Open Market Committee. That it's still something of a concern means that many people pay attention to housing-related data releases, several of which are due out this week, because they can shed some light on the direction of housing and the economy. The builder confidence index, released today, got things off to a good start by showing a four-point rise, from 54 to 58 (values greater than 50 mean that more builders view conditions as good rather than as poor). House starts and existing sales are due Wednesday and Thursday, respectively.
At the Atlanta Fed, we conduct a monthly survey of regional builders and real estate brokers to get their perspectives of the market. In August, we began to look at the results a little differently to see if they could tell us anything about subsequent housing-market data releases. In that exercise, we investigated the correlation between the expectations of our homebuilder contacts for construction activity and subsequent housing starts. We found that our builders are on point, more or less, and we reported on that discovery in an August post. We recently repeated the exercise, this time to explore the predictive power of the outlook for home sales of our homebuilders and residential brokers for subsequent new and existing home sales data releases. We report on our findings in this post.
Brokers and builders expect new home sales to rise
The September home sales data showed us that existing single-family home sales increased by 1.9 percent from the year-earlier level and new home sales increased by 22.6 percent. This news is fairly consistent with the reports we received from our real estate business contacts about September sales activity; more brokers and builders noted an increase than noted a decrease in home sales activity from the year-ago level.
But what exactly did our survey respondents tell us about their outlook for home sales? Diving deeper into the data, we find that brokers' and builders' outlooks remain mildly positive and that the two groups have tracked each other fairly closely in recent years. (In the pre-2011 period, brokers and builders diverged more sharply.) Specifically:
- Of builder respondents, 40.0 percent indicated that they expect new home sales to increase over the next three months, 32.0 percent expect activity to decline, and 28.0 percent expect home sales activity to remain about the same. The home sales outlook diffusion index value for builders was 0.08.
- Of broker respondents, 22.5 percent indicated that they expect new home sales to increase over the next three months, 27.5 percent expect activity to decline, and 50.0 percent expect home sales activity to remain about the same. The home sales outlook diffusion index value for brokers was -0.05.
The chart below features two scatter plots of the diffusion index value for the broker and builder home sales outlook on the horizontal axis and the year-over-year change in the three-month moving average of single-family home sales (for Alabama, Florida, Georgia, Louisiana, Mississippi, and Tennessee) on the vertical axis. Given that we are asking contacts to be forward-looking, we lag the contact responses.
Do home sales expectations correlate with subsequent sales data?
Three things stand out on this chart. First, if builders and especially brokers (who tend to be an optimistic lot) predict a decline, the subsequent home sales data release will probably be poor. Only a modest bit of net optimism is of little comfort—some of the worst declines occurred in years with net positive (albeit small net positive) outlooks.
Second, for builders, if the index is greater than 0.3, we find that sales generally grow—except for between August 2012 and April 2013, when sales did not match builders' optimism. When the broker index is above 0.3, sales either grow or decline by a smaller amount than when the index is negative. Like the builders, the broker panel missed the sales declines from August 2012 and April 2013. The brokers also missed the declining real estate market in 2006 to early 2007 (see the green triangles in the chart above)—despite a declining market, the broker index remained lofty until May 2007.
Third, the official statistics on housing sales could go either way when index values are between ‑0.1 and 0.3. This shouldn't come as a complete surprise, particularly because a diffusion index value near zero (regardless of whether that value is positive or negative) indicates that responses from contacts were mixed. And as we can see in the scatter plot above, large declines were much more likely given the time period covered.
A simple regression indicates that the outlook could explain just under 50 percent of the variation in sales measure, which indicates that our poll does a decent job of predicting subsequent sales. Given this finding, what do we now expect home sales to look like? The most recent downward trend in respondents' outlook puts the diffusion index in the center, suggesting that declines in seasonally adjusted sales over the next several months are just as likely as increases in sales.
The poll was conducted October 6–15, 2014. Sixty-five business contacts across the Southeast participated (40 residential brokers and 25 builders). To explore the latest poll results in more detail, please visit our Construction and Real Estate Survey page.
By Carl Hudson, director for the Center for Real Estate Analytics in the Atlanta Fed´s research department, and
Jessica Dill, senior economic research analyst in the Atlanta Fed's research department
October 15, 2014
Bringing Foreign Investment into Economically Distressed Markets: The EB-5 Immigrant Investor Program (Part I)
The saying goes that all real estate is local. But investment from overseas—real dollars for both residential and commercial projects—is becoming a more common opportunity for developers, especially those working in economically challenged markets. Some euro zone countries—Greece and Spain, for example—offer visas to wealthy Chinese home buyers.
One source for commercial projects that is gaining the attention of community and economic development practitioners is the Immigrant Investor Program, called EB-5, a federal program designed to attract foreign investment to real estate projects in challenged markets. The EB-5 program provides residency status (green cards) to foreign investors in exchange for personal capital investments that create jobs in the United States.
EB-5 has been around since 1990, but growing wealth overseas (largely in China) and the financial crisis of 2008 created more demand for the program. More recently, the program has attracted the attention of a variety of economists, academics, and the media. In July 2014, for example, the unlikely political tripartite of mega-investors Sheldon Adelson, Warren Buffet, and Bill Gates endorsed the program in a New York Times op-ed. A few short months later, a Fortune Magazine piece referred to the EB-5 program as "a magnet for amateurs, pipe dreamers, and charlatans, who see it as an easy way to score funding for ventures that banks would never touch."
In this first of two posts, I present the rough mechanics of EB-5 and some of the trends and challenges facing the program. In the next post, I will address the program's impacts in the southeastern region and further assess its strengths and weaknesses.
The mechanics of EB-5
A recent report from the Initiative for a Competitive Inner City (ICIC) profiled the EB-5 program. The ICIC report has a detailed infographic on the anatomy of an EB-5 investment. According to authors Kim Zeuli and Brian Hull, the major components of the EB-5 program are as follows (we've summarized their information in this flow chart):
EB-5 investments can be made either directly into projects or through third-party entities called "regional centers." The city of Miami, for example, was recently authorized to act as a regional center. These regional centers can source deals, pool investment capital, and provide a number of other advantages, including the ability to count indirect and induced employment toward the program's job requirement. (Direct EB-5 investments can count only direct job creation.) Note that EB-5 investments can be used anywhere in a project's capital stack. Regional centers usually have the finance expertise to leverage EB-5 for additional equity or debt, or to reduce risk for more traditional finance.
The United States has more than 575 regional centers, up from 13 in 2007. The ICIC, citing data from the U.S. Department of State, reports that from 2003 to 2013, 85 percent of all EB-5 visas were issued to investors from China, South Korea, Taiwan and the United Kingdom; 65 percent of them were issued to Chinese investors.
Impacts and challenges
Since Congress first authorized the EB-5 program, it has captured about $5 billion in direct investments and created more than 85,000 full-time jobs, according to a recent report by Brookings. But the Brookings report also points out that the scarcity of reliable historical data makes it very difficult to evaluate the entirety of the program's impact. The ICIC report includes a summary and analysis of several hundred EB-5 projects. According to ICIC, the largest challenges facing EB-5 are uncertainty around the immigration approval process and the up-front capital and technical knowledge required to execute a project with EB-5 investment.
The next installment of this series will address the program's impacts in the southeastern region and further assess its strengths and weaknesses.
As part of the Atlanta Fed Community and Economic Development program's efforts to bring attention to economically distressed communities in the Southeast, we will be examining specific tools and policies—like EB-5—and sharing what we learn, sometimes in this blog.
Will Lambe is a senior adviser with the Atlanta Fed's Community and Economic Development program, focusing on community development finance.
- The Effectiveness of Restrictions of Mortgage Equity Withdrawal in Curtailing Default: The Case of Texas
- Bringing Foreign Investment into Economically Distressed Markets: The EB-5 Immigrant Investor Program (Part II)
- Can the Atlanta Fed Construction and Real Estate Survey Predict Home Sales?
- Bringing Foreign Investment into Economically Distressed Markets: The EB-5 Immigrant Investor Program (Part I)
- The Economic Effects of Urban Renewal
- Real Estate Business Contacts on Target
- Signs Point to Slow but Steady Construction Growth
- Are Single-Family Rental Securitizations Here to Stay?
- Two Views of the Involvement of Credit Rating Agencies in the Mortgage Crisis
- Limiting Property Tax Assessments to Slow Gentrification
- January 2015
- November 2014
- October 2014
- September 2014
- August 2014
- June 2014
- May 2014
- April 2014
- March 2014
- February 2014
- Affordable housing goals
- Credit conditions
- Expansion of mortgage credit
- Federal Housing Authority
- Financial crisis
- Foreclosure contagion
- Foreclosure laws
- Government-sponsored enterprises
- Homebuyer tax credit
- House price indexes
- Household formations
- Housing boom
- Housing crisis
- Housing demand
- Housing prices
- Income segregation
- Individual Development Account
- Loan modifications
- Monetary policy
- Mortgage crisis
- Mortgage default
- Mortgage interest tax deduction
- Mortgage supply
- Negative equity
- Positive demand shock
- Positive externalities
- Rental homes
- Subprime MBS
- Subprime mortgages
- Supply elasticity
- Upward mobility
- Urban growth