Mortgage note investors have been patiently waiting to see how the current coronavirus crisis unfolds. With record high numbers of loan refinancing and mortgage originations while at the same time, mortgage defaults and unemployment rates continue to climb, it's a volatile, somewhat confusing time to be a note investor.
Some note investors believe we're on the brink of another mortgage and real estate collapse, while others take a more positive outlook for how the crisis will play out. In reality, the outcome can go either way. If you're an investor in this sector, here are five things you need to know about mortgage note investing in 2021.
New administrational policies will determine the outcome
The government authorized unlimited quantitative easing in late spring of 2020 to help alleviate liquidity concerns for the secondary mortgage and bond markets while authorizing government-sponsored entities (GSEs), Fannie Mae (OTCMKTS: FNMA) and Freddie Mac (OTCMKTS: FMCC) to purchase loans in forbearance. This undoubtedly has kept many lending institutions and servicing companies from going belly-up, as 5.54% of all servicers' portfolios are in some stage of forbearance as of the beginning of December 2020.
Mortgage moratoriums have also provided protections to borrowers in default up to this point, but maintaining a loan that isn't paying isn't sustainable. Banks and servicing companies will eventually be forced to foreclose on the borrower, if possible, or sell off nonperforming debt to stay afloat.
President Biden has widely advocated for more extensive support for homeowners and financial institutions in distress by offering further funding and new protections. Recently, the FHFA extended the foreclosure moratorium and forbearance extensions until Feb. 28, 2021. Until we have a better understanding of the policies or protections the new administration plans or hopes to put in place, we have to assume large sell-offs, particularly of nonperforming loans, will soon come to the market. I'd imagine this will happen around mid-summer to fall.
Prepare for increased regulations
Investors should prepare for new policies that will provide new protections to borrowers who fell behind due to COVID-19 and should properly document all communication and loss mitigation efforts for the likely litigation cases relating to foreclosures that will occur in the future. The Consumer Financial Protection Bureau (CFPB) recently released their new rules regarding debt collections, meaning proper servicing and loan compliance efforts are extremely important now.
Higher-quality nonperforming loans means higher pricing — to a point
Despite 2.2 million residential borrowers being seriously delinquent on their loans as of November 2020, loan quality for defaulted mortgages is better than ever. Higher real estate values mean more homeowners have equity in their property, leaving them with the option to sell their home and pay off their balance if facing foreclosure.
This, coupled with the generally better underwriting criteria for loans originated over the past decade, mean delinquent loans today are a much better quality than loans that were in default in the previous crisis. Thus, pricing will reflect this.
Right now with quantitative easing and the opportunity to sell and package loans to GSEs, the pressure to sell at a steep discount isn't there. However, the longer high unemployment, default rates, and foreclosure moratoriums remain in place, the need to sell will increase. If investors and servicers can't foreclose, discounts will be given for the increased regulatory restrictions.
Commercial nonperforming notes will hit the market first
Real estate investors and the commercial mortgage market have received very little assistance, despite many sectors being decimated this past year. According to the Mortgage Bankers Association (MBA) commercial mortgage survey completed in September 2020, 10.9% of all commercial mortgages are in some stage of delinquency, with retail and lodging having the greatest share. Experts believe there will be a large number of distressed commercial sales, including nonperforming loans hitting the market in the next few years, as more investors struggle to maintain their debt obligations as the economic crisis plays out.
Market correction could be on the horizon
Supply and demand is seriously out of whack today, putting the market at risk for a major correction. Record low mortgage rates paired with low inventory has pushed home prices up to new highs. Since the CARES Act prohibits servicers from identifying a loan as delinquent if the borrower has requested forbearance, I think the current crisis is far greater than anyone wants us to think or believe. When foreclosure activity can resume to normal levels, there will be a flood of properties hitting the market to prevent foreclosure or as a result of foreclosure, and all of that appreciation will likely come tumbling down. It's unlikely values will fall as low as they did in the previous crisis, but investors should be prepared for a pull-back in pricing over the next few years.
The Millionacres bottom line
I personally believe big opportunities are coming for note investors, but it's too early to tell when or to what extent. I am preparing for a new wave of inventory, getting liquid, and tightening up my current portfolio of notes. Knowing the extent of regulations and state of the housing market will help me assess my risk as an investor and price investment opportunities accordingly.
