34th Annual Real Estate & Economics Symposium

1. 34th Annual Real Estate & Economics Symposium understanding & managing real estate finance and risks Michael Bykhovsky

2. Real Estate – The Safest Investment(now) • Rents are CONSIDERABLY above the costs of ownership • Affordability index in the highest ever. It went up from 100 in 2006 to over 190 in 2011 • Mortgage rates are at the historic lows of 4% • CAP rate is generally considerably above the financing rate. • Jumbo-Conforming spreads are a bit above 40 basis points – not much higher than the pre-crisis 25 basis points – sign of normalizing markets.

3. Economics • The FED is promising a 2% inflation, at some point they will deliver. Real Estate offers a 3X multiplier on the inflation (assuming a 66% LTV). Given a positive CAP rate over financing costs spread, it offers a high double digits expected return. • Banks have TOO much cash. The loans to deposits ratio is lowest it has been in a long time – one of the reasons the FED has a problem getting the economy going with the monetary expansion – the monetary multiplier and the velocity have collapsed. The banks are gradually earning their way out of their negative net worth (effective bankruptcy). The banks will have to start lending soon –– keeping cash is costing them some. The credit spreads are coming down; the insane credit requirements are getting to be a bit less so as well. • Construction has stopped. The population is growing. • BUT

4. REO will keep on going up for another 3 years

5. The new defaults will come down from the recent spike

6. FHFA Proposal Will Have an Effect • If fully implemented, will significantly decrease new defaults • Removing of most the put-back provisions will remove many of the institutional obstacles to the refinancing • Removing the LTV limit will remove the need for appraisals • The new FHFA program will generate considerably more prepayments than acknowledged in the general press.

7. FHFA Proposal effect (Continued) • Decreasing defaults will provide some support for the housing market. The resulting overall default rate may end up being noticeably lower than the projection above. • Elections will be over in a year. The need to block all economic stimulus will (hopefully) also pass. Economy is likely to do considerably than better the current projections two years from now.

8. But…. • Overly strict loan requirements will take a while to become more reasonable • It will take a while for the households to build up assets needed for down payments • It will take a while for the economy to heal and unemployment reduce • Which means – things a looking up!

9. History of Wall Street – A Revised Version  • 1981 – Regan closes metal institutions. Mental patients numbers living on the streets skyrocket • 1982 – Wall Street begins to hire large numbers of workers • 1982 – Number of homeless mental patients on the streets begins its slow decline. • Mental patients’ common delusion is that they are “Napoleon, the French Emperor” • Wall Street traders’ common delusion is that they are “Masters of the Universe” • Mental patient common drug – crack • Wall street traders common drug – coke • Mental patients common reason for lock up - danger to society, misuse of their boner • Wall Street traders’ reason for employment – misuse of their bonus, danger to society • Did Reagan really start the financial revolution, and these are same people !?