South Florida is Hot for Houses: Taxes, FOMO and the Fear of a Bubble

FineMark Radio: Episode 4 Transcription

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David Scaff: Good afternoon. This is David Scaff, the market president for FineMark in Palm Beach County. Today I have with me FineMark Senior Vice President and Senior Lending Officer Doug Parkey. Welcome, Doug.

Doug Parkey: Thank you, David.

David Scaff: Doug, today’s topic is going to be something that you know a lot about, kind of a double topic. We’re going to talk about the real estate market in general, the real estate market in Palm Beach County, and then some lending trends that you see supporting real estate. I was getting myself ready for this, and I did a little bit of homework on home prices and I’m talking now home prices in general, nationally. And I noted that from the fifties, which is as far back as the data that I saw went, until the nineties, home prices pretty much stayed around the rate of inflation, increasing at their rate of inflation with little blips up and down. But by and large, they stayed with inflation, but then sometime in the nineties and continuing until 2008, we had a big divergence from inflation home prices. Can you shed some light on that for me as to why that would happen?

Doug Parkey: Sure. I have been in banking as a lender since 1985, and when we first started to make loans in the banking and S&L period in 1985 to the mid-1990s, we were doing what it’s called portfolio lending, where the bank would make the loan, and they’d keep it on their balance sheet, and they would service the loan. They lived with that loan for as long as the loan was on the books. Then at some point after that, there was the securitization of loans that provided liquidity to banks, such that if you could underwrite a loan, you could close it. And then, at some point, whether right then and there or later in the life of the loan, you could sell it, thus giving the bank the liquidity to make more loans. That ultimately became problematic in that it eased the amount of credit standards that banks used because they didn’t have to have the loan on the books.

It got a little sloppy as far as verifications underwriting, and it created the problem that ultimately manifested itself in late 2007 and 2008. We had the financial crisis where at that point, banks were doing what was called stated loans, where you didn’t even verify income. They stated a number, and banks weren’t necessarily doing the deep dive due diligence that we do today. In my eyes, that was the time where we went from being probably too restrictive to not paying attention enough. It’s come full circle now again; I think in a good way for everybody.

David Scaff: So, what you’re saying is, like a lot of other things in life, money fuels sometimes good and sometimes bad behavior and has unintended consequences. Absolutely. A lot of liquidity flooding into the housing market during those times spiked prices. Continuing on, as a result of what you were just saying, in 2008, we had the financial crisis. It started as a liquidity crisis, but it bled over into housing. Talk to me about what you witnessed and saw during those times.

Doug Parkey: Sure. In the banks that I worked for at the time, The Office of the Comptroller of the Currency, which is the regulator of the banks, forced us to do more than what I call the shadow banking system, where you had a lot of mortgage brokers out there that were underwriting paper. They were a hundred percent selling everything they originated. There was no impetus upon them to dot their I’s and cross their t’s. As a matter of fact, I heard of people using white-out on tax returns to get the numbers to work. It became the Wild West. However, speaking from working in a bank, we still underwrote cash flow. We checked credit. I look at it as kind of two different things. The banks continued to follow pretty decent rules. The shadow banking system is where I think a lot of the problems existed in that they weren’t bankers. They were just putting packages together, selling them to the secondary market, getting paid, going out and making more. The unfortunate thing for the banks is that they wound up seeing the yield on those loans because they weren’t considered A-paper. And somewhere in the asset-liability committees and investment committees of these banks, they thought it was a good idea to buy tranches of that type of paper, because it was better than “the A paper” that they were used to underwriting. The banks got pulled into the dilemma because then they now had exposure to what was non-A-paper, and thus, it helped the problem with the banks. While the banks weren’t necessarily the originators of the loans, at least in my experience, what became their problem was that they bought into pools of loans and they didn’t truly understand the underlying credits that were in them.

David Scaff: 2008 was a big change. We had an end to the increase in house prices, a pretty dramatic end, and through about 2011, prices declined. Now, did you see that here in Palm Beach County as well as what we saw in the national data?

Doug Parkey: Yes. Palm beach county had some great growth, primarily due to folks moving to Florida from the Northeastern United States. And it was for various reasons. It was retirements, the weather and playing golf. And then there are the real tax implications of being a resident of Florida, where it was advantageous for people in the Northeast to leave the higher tax states that they live in and come to Florida, where there was no income tax, and there was no estate tax. It became a strategy for people that if they stayed six months in a day in the state of Florida, they wound up having a tax advantage over living six months and a day in Northeastern states. We had that going for us and they were selling at Northeastern prices, bringing quite a bit of equity capital into the Palm Beach County market. And prices started to go up because you just had that demand for the type of product that we’re doing.

The other thing that was happening at the time was just the fact that money was so easy to get that people who weren’t necessarily moving from down here could own several homes because the true underwriting wasn’t being done. It wasn’t uncommon for people to speculate on second homes and third homes in the same market that they were in. So it just, it ran up the price. Then, once there was so much exuberance in the market, it just collapsed because it just couldn’t keep pace. And there was a good bit of problems in Palm Beach County, well, like the rest of the country. We were not immune from the downturn to the point where we saw anywhere from 25 to up to 50% declines from the highs. Sure. We’re hoping obviously now to never relive that.

David Scaff: So yes, we did take a break from that speculated lending with people owning homes that they should have never owned, certainly multiple homes that they should not have owned. So we did pause from 2008 until 2011. You said that as a result of the financial crash and the real estate crash, there was a change in the regulatory environment. Tell us just briefly about how that change came about.

Doug Parkey: In 2010, Dodd-Frank was legislation that was passed that required lenders to do more due diligence and make sure that all of the i’s are dotted and t’s are crossed on one’s ability to repay the loan. And what it did is it allowed, if you did not do that job well, it allowed for your loan to be in a precarious position, such that if you do that due diligence, you could potentially lose their mortgage on the property, which would mean a horrific loss to the bank. It has teeth to it, as it should, and that’s corrected a lot of the reckless lending that’s happened in the market.

David Scaff: Thank you. We’ve seen since 2011, I’m now focusing more on Palm Beach County, although it’s a national trend as well, we’ve seen house prices rebound again and really shoot up. I hear people ask all the time, are we in a housing bubble? Are we going to go through another 2008? And if so, what are your feelings about that?

Doug Parkey: Sure. The migration pattern has continued, and COVID just took it to the next level with all the people considering retiring from their jobs in the Northeast. And now you have some from the Midwest, California, out west states. People are moving to Florida because of the tax environment and the advantage you have here. Technology has helped to create an environment where you do not necessarily have to live in some of these places that you lived before to conduct business. Airline flights from Palm Beach County to New York or Boston are fairly inexpensive most of the time, and there’s a number of flights so that executives can live down here. They can still have their businesses up north, and now with what we call zoom calls, video conferencing, and what you can do with a laptop in your home.

You’re just seeing people migrate down here who were on the fence, in addition to the people who would naturally decide this. So, what it’s done is it’s taken most of the inventory down to a level where the supply just cannot exceed the demand. You have people paying prices that are above asking. We see that all the time, and it’s become a bit of an issue for our borrowers because it puts a lot of emphasis on banks: Being able to look at financing packages quickly and make a determination of pre-qualifications or pre-approvals such that a realtor now will not take a bid in a lot of cases where they don’t have some type of pre-commitment to financing. If financing is required, we still enjoy in Palm Beach County a very healthy cash market. Anywhere from 50 to 60% are cash deals. But for the ones who want credit, bankers are there to help do that, and they’re doing it much quicker than they used to.

David Scaff: It sounds to me like in a market like this, if I am going to borrow money to buy a house, I’m pretty interested in speed in terms of being able to get an answer about whether you’re going to lend me the money to buy my house. Talk to me about what you see in terms of turnaround time and that sort of thing.

Doug Parkey: Well, it can make or break a purchase for clients, prospects or borrowers. To give you an example of something that recently happened, we had a hedge fund manager move out of the north to run his hedge fund out of Palm Beach, and he needed to purchase a home to do that. Like I said before about the demand, on the day these listings go public, they’re selling and selling at a premium. There are multiple bidders on $5M+ properties that you’ve never seen before. We had a gentleman call us as a referral from an existing client. And they had our cell phone numbers as though they called on a Sunday. And we said this is what we need to look at a potential credit for you Monday. They got us most of the information we needed to do some kind of back-of-the-envelope underwriting. And by Wednesday, we were able to tell them that, yes, FineMark could lend this amount of money towards your purchase. And it allowed him to move forward on his contract. We wound up closing 45 days later. We had a very happy client, a very happy seller and a very happy realtor. Being nimble in today’s market has never been more important.

David Scaff: So Doug, talking about a hot real estate market, a high-end builder friend of mine told me a story that illustrates this, that I still have a hard time believing, but a local ocean-front home was listed for 25 million, with multiple people looking at it. One guy offered over asking price 25 or 26 million for the home. A very disappointed gentleman who also wanted the house found out that he didn’t get it, had his broker call up the successful bidder and offer him 20 million for his contract. Have you seen that in the market before?

Doug Parkey: I have not ever heard of that. That takes the cake. That’s incredible.

David Scaff: It seems so to me as well, just to tell you how high things are. I guess, in summary, you’re not terribly worried, at least in Palm Beach County, about a market bubble bursting as in 2008, largely because of regulation changes and largely because of new demand from people moving here above and beyond what even the historical pattern was.

Doug Parkey: Yes, exactly. This feels different today than it did over 10 years ago. I would say bankers are a lot more careful, and while there can always be a drawdown in the real estate market, I don’t think it would be as large as what happened in the 2007-2008 time period.

David Scaff: That’s great, Doug. I guess we’ll just wrap it up there, and I really appreciate your observations on the market and sharing a story with us about what’s going on there. David Scaff signing off. We’ll talk to you again next time.

Doug Parkey: Thank you, David.