Jurassic Park in housing

Common wisdom suggests that home ownership is a good thing or are at least correlates to something positive, which explains the widespread concern about the depressed home ownership rates in the aftermath of the Housing Crisis. What happened to approximately 5 million formerly home-owning households as the rate dove from over 69% to under 65%?

As it turns out, many migrated into the Single Family Rental (“SFR”) market, a $3 to $4 trillion segment that has grown by over a third since home ownership rates reached their apigee, and which together with its near-neighbor of two-to-four unit properties, make up over half of the entire residential rental market.This growth in SFR maps well to the departed homeowner class, providing evidence of a neutral zone that separates dyed-in-the-wool renters from the confirmed homeowners, filled with consumers who could go either way.

Here is a key front in the battle for the future of housing-an opportunity to reboot the notion of home ownership, and a veritable Jurassic Park where proptech insurgents face off against dinosaurs, incumbents in their habitat.  Like the movie’s humans, busily engineering spinoffs of the traditional dinosaur in their labs, these insurgents have been hard at work innovating to provide consumers in this neutral zone options for attaining and maintaining their homes.

In the process, they are moving the current binary state of dwelling (i.e., own vs. rent) towards a consumer preference-driven continuum with schemes like pathways to home ownership (e.g., Divvy), fractional equity (e.g., Point, Unison) or evolved sale-leasebacks (e.g., Figure).  Common across these schemes have been their customer-first focus, supported by technology that transforms the relationship.

But the movie showed that the humans did not fully anticipate the dinosaurs’ dominance on their home turf. Equally, don’t be lulled by the plodding banks and agencies, for alongside the brontosauri are their more cunning cousins, the velociraptor equivalents who have thrived due to their adaptive skills and are gunning for that very same neutral zone.

These velociraptors, also known as private equity (“PE”) firms, have also been busy restacking residential real estate in the aftermath of the Housing Crisis to create entirely new market categories. Starting with opportunities found in distress, they ended up constituting non-bank mortgage companies that taken a sizable chunk of the business. They have also institutionalized Single Family Rental as an asset class, having, as a group, purchased 300,000+ homes since 2010, over 60,000 in the past two years alone.

Powered by access to capital and a willingness to deploy it at high velocities, the PE firms are focused primarily on the asset and not the customer.  They may lack a holistic consumer-driven vision or leading edge tech stacks, but, run by traders, they are adept at seizing the inside of the OODA (“Observe-Orient-Decide-Act”) loop and scaling up.

Just as in Jurassic Park, hiding in the cupboards from these velociraptors is not an option. We already see a blurring of the lines between them and the insurgents with examples including Amherst’s Bungalo, a tech-forward consumer facing brand that markets homes for purchase, and Home Partners of America’s leases with “right to purchase” options.

Viability for our intrepid insurgents will require dramatically scaling up towards the levels of the leading private-equity players, several with portfolios of 25,000+ units. They must achieve some manner of flywheel effect to drive the transaction volumes need to derive data/insights to fine tune their product-market fit. But how? Here are some ideas:

Imitate.  PE firms are judged by their operational/financial effectiveness in accomplishing their trades and best have enviable track records on both fronts. Insurgents don’t need to disrupt everything and instead find areas to follow the PE roadmap, enhanced with technology.

Collaborate.  Insurgents can find areas where mutual agendas do not come into conflict. One that comes to mind is the use of PE firms to drive better execution as seen in the adjacent iBuyer category where they are a prominent sales channel.

Rescope.  Sometimes it takes a T. Rex to get rid of the velociraptors. However scary, remember that the leading PE firms together occupy only about an eighth of the entire market. Partner selectively with those of substantially larger scale can be a power reset button.

Outflank.  In optimization parlance, the PE firms are constantly angling for local optimas while the best insurgents are on search for a global optima. This could be an advantage because PE firms do not think in terms of strategic vision, total addressable markets, or lifetime customer values. An advantage provided you survive to see tomorrow.

To the proptech insurgents engaged in rebooting the notion of home ownership, we’re all rooting for you. Are we increasingly a nation of renters or are we a nation of those yearning for differentiated housing executions that provide us a sense of belonging and hope?

After all, in the words of Laura Dern’s Dr. Sattler, “Dinosaurs eat man…  Woman inherits the earth.”  Victory (eventually) goes to the insurgent humans…

This piece originally appeared in The Financial Revolutionist.

Unsettling statistic of the day... or is it?

With much Sturm und Drang, the press has eagerly pounced on a seemingly staggering 7.4% month-to-month increase in mortgage application defects this past December, as announced by First American Title.  Are we seeing the sudden activation of the fraud setting amongst the the hive-mind of home buying mortgage customers?  Is the mortgage bubble ready to burst (again)?

The trends driving the growth in defects, as detailed in a related First American blog post, are more mundane, but still stunning for a different set of reasons.  They are: (1) the rising share of purchase transactions; and (2) the impact of natural disasters

For the many attempting in vain to divine the relationship between these two trends and defects, a clue is Fannie Mae's list of loan defect categories.  For every "misrepresentation" defect that may indicate ill intent, there are multiples of defects that provides indication to the difficulties along the path towards getting a mortgage - the requirements around documentation and proper compilation of data.  Referring back to the two trends... (1) it's more difficult to amass the proper docs for a purchase transactions than it is for a refinance; and (2) naturals disasters tend to render invalid prior appraisal details.

Hence, is it any wonder that those holding the promise of improved customer processes for mortgage origination are getting their moment in the sun?  Better Mortgage, for one, who just announced a rather sizable $70 mm Series C haul.

Of course, one only has to spend a few more moments with the Fannie list to realize that there is another sizable category, those defects that are underwriting constraints, that knock a customer out of contention for a mortgage.  These speak to the limitations of the mortgage product itself.  In Fannie's case, it's the essentially the Qualified Mortgage, the same product that commands roughly four out of five mortgages originated these days.  It's also the same product that's displaying an increasing mismatch with the product, including evidently failing the self-employed.

Until Better can do better for those running afoul of this last category of defects than knocking them out of contention more quickly, is it truly better?

#TBT: Primordial Mobile Commerce Platform

I ran across an old MRD for a mobile-optimized commerce platform that I created 18 years ago when I was at a two-bit startup, Cellmania.  Impressive was my prescience, although the timing was more than a bit bulloxed from both technology (WAP phones over GPRS networks) and market (on the eve of the dot-com crash and 9/11) perspectives.

In retrospect, the use cases held up relatively well while the enterprise software-centric execution comes across as highly anachronistic.  I had previously been shilling Sun OS products where, in deep denial of open source, we developed half-measures like Sun Community Source Licensing, which, akin to Gorbachev's policy of Glasnost, only highlighted our inadequacies.  While we had the makings of a decent tech stack, we clearly hadn't picked up on the trend towards developer-focused execution.

A skill I evidently did bring over from my Sun days was the ability to market the road map.  While the stack was mostly developed, the frills and support models were pure brochure ware.

As for Cellmania, the deep freeze post 9/11 put the place on a reduced footing.  From that point, it survived for quite a while longer with a focus on a proto-app store concept until it was picked up by Research in Motion/Blackberry.

Is the Mortgage Market Failing the Self-Employed?

 "The Continued Impact of the Housing Crisis on Self-Employed Households," recently published by The Urban Institute provides some eye-opening stats regarding self-employed households...

• 10.6% of 40-59 yr old households
• Median income 30% higher than salaried households
• Home ownership rate 16% higher than salaried households
• But are 9% less likely to take out a mortgage. a sustained divergence that has appeared over the past decade

The reasons given included higher income volatility, the lack of W-2 and other documentation standards.  In other words, requirements baked into QM ("Qualified Mortgage") standards.

BCG's US mortgage industry whitepaper, powered by Blend

BCG's US mortgage industry whitepaper is worth a gander for its succinct delivery of the impacts of digital solutions in this space. Wielding my editorial prerogative, the keys...

An intense focus on the customer experience

"one-third of applicants apply using a mobile device, and over 50% submit their application outside working hours"

 A product management approach to creating/maintaining solutions

"Ideating is easy, but implementation is hard."

"a minimum viable experience in order to get to the market within 6 months, making continuous iterations based on customer feedback"

"dedicated cross-functional team of sales, operations, technology, and compliance personnel working on design and implementation"

A holistic view of the customer home-buying journey

"We will see many more digital transformations across the mortgage process and the home-buying experience more broadly." as both incumbents and emerging players try "to create end-to-end home-buying experiences for customers."

• The challenge to the industry is that none of these are capabilities are inherent strengths, which brings us to Blend, the platform used by the paper's authors to extract some of the consumer insights.
• Blend has deservedly received a fair amount of press over the past 2 years, and has been at the top of the digital mortgage origination league tables. Dimensionalizing its share of the origination market...
• "the platform processes more than 100,000 applications per month and $1 billion in loans every day." This translates to roughly $360 billion in loans annually, the vast majority from the Retail channel.
• The Retail channel in 2017 (last full year data) accounted for ~$1 trillion in mortgage loans, out of a total market of $1.8 trillion.
• The Top 7 Retail players combined to account for ~$350 billion in mortgage loans in 2017

Blend has been able to aggregate detailed transaction records of roughly a third of the loans flowing through the Retail channel, a volume greater than the top 7 Retail originators combined. An impressive accomplishment, potentially raising questions around "fintechs bearing gifts."

(More) millennial mismatching in housing finance

"Cheer up, millennials! It will become easier to buy a house... The snag? It’s because your parents are going to die"  -  The Economist (January 2019)

On the whole, a bit morbid even after considering the humor endemic at the grand old newspaper. Reality seems better, at least on this side of the pond. After a rather glacial ramp, home ownership rates amongst the cohort have picked up dramatically, to 47% for those between the ages of 28 and 31 according to a recent EY survey and in line with historical averages of recent prior generations. So, what's the big deal?

General improvements mask different market pricing dynamics

LendingTree recently published a ranked list of the top 50 metro regions for millennial homebuyers as defined by new purchase requests from the cohort as percentage of total new purchase requests. Disregarding the popularity contest portion of the data set...

• While "nearly one-fourth of all mortgage purchase requests in this period came from millennials," this list of metro regions encompassing 55% of the nation's population goes from 51% (Salt Lake City) down to 30% (Tampa).
• At issue is either the lack of millennial home shoppers outside the enumerated regions or LendingTree's customer acquisition strategy.

Assuming LendingTree's competence in this arena...

• We see a massive disparity between the requested loan amounts in the most and least expensive metros. The average requested by millennials in the top 5 most expensive metros is 3.3x that of a similarly populated group of the bottom 14 metros. ($457k v. $138k)
• Even if we let California, which accounts for 4 of the top 5 metros, secede along with New York City, we're left with a 2x disparity between the 7 top similarly populated non-CA/NYC metros and the bottom 14. ($276k v. $138k)

These rather sizable deltas cannot certainly cannot be explained away by income differentials. In fact, using a recent survey as rough benchmark, millennial incomes in the top states are less than 20% higher than incomes in the bottom states.

One-size-fits-all product amidst disparate needs

Most astute market actors would consider altering products to provide choices tailored to customer needs. KFC is renown for tailoring its menu to different tastes the world over. Domestically we even see this dynamic at play with mayonnaise.

Yet, home ownership is typically executed using one a single dominant product - the 30-year fixed-rate mortgage.

For most of the past century, the 30-year mortgage has had a role in helping improve the economic well-being of the US consumer, but it doesn't take much to wonder if the disparities highlighted above will materially impact the prospects of large numbers of those just entering the housing market.

Returning the the LendingTree data set, the differences in mortgage payments between those living in the top 5 most expensive metros and those in the bottom group are substantial - $28k v. $8k per annum using a 4.75% rate for illustration. And that's before accounting for the necessary down payment, which is 4.9x higher in the top group ($95k v. $19k).

When the average salaries even in the most expensive states are in the low $40k range, is it any wonder that "More First-Time Home Buyers Are Turning to the Bank of Mom and Dad?" But how about those who have no "Bank of Mom and Dad?"

Early last year, I penned my initial piece on Millennial Mismatching in Housing Finance. In the time since, the disparities have only become clearer.

Predictions for 2019...

Since everyone and her mother has been putting forth predictions, allow me to jump into the fray with a few...

Consulting firms are the new "arms merchants"

In a world where commerce and tech has been weaponized, the major consultancies are becoming increasingly entangled in shadier aspects of the affairs of state. These firms are light years removed from their situation when I plied the trade at Arthur D. Little (the "World’s First Management Consultancy") in the 1990's. McKinsey, the alpha male of the pack, has grown ten fold in staff since those days and has come under attention for its international exploits. While the "arms merchant" label may be a touch melodramatic, it's not a stretch to suggest that these shops are the Bechtels of the next chapter of the Information Age.

Cloud platform announces penetration by a "state-level actor"

In the aftermath of the Marriott breach terrifying travelers the world over, it’s only a matter of time before a major cloud platform confirms something similar for their assets. While corporate valuations will certainly suffer, this may also lead to a general reconsideration of the blithe acceptance of the off-prem/public cloud deployment model. Much like our current Cavendish monoculture banana bind, which may lead to yet another refrain of “We Have No Bananas,” heterogeneity, genetic or otherwise, would be a prudent course of action.

Mortgage companies: beware of fintechs bearing gifts

This piece originally appeared on The Financial Revolutionist on May 18, 2018

It’s 2018, and Quicken Loans, the consensus tech darling of major mortgage companies, has surpassed Wells Fargo to be the top originator during the preceding year. In rapid succession, both Bank of America and Suntrust announced digital origination platforms. Not to be outdone, LoanDepot debuted a $100mm HQ for its mello digital brand, complete with a 30-foot slide.

The incumbent mortgage companies seem to be finally finding religion around fintech and are now deeply engaged in a mutually beneficial trade. The former secure new technology and processes that enhance the customer experience, tightened feedback loops and the promise of lowered network costs. The latter obtain data streams, which in many cases are broadly cross-company and horizontal in nature.

On the surface, this is a good deal for the incumbents, who are using the “gifts” from fintechs to serve up “better,” secure in their ownership of the customer and distribution channels. But what if the “gifts” presented are of the Trojan horse variety?

The mortgage fintech challenge

Fintechs have been forensically honing in on slices of the mortgage value chain, digitally enabling loan applications over existing channels, disrupting home valuations with #BigData and #MachineLearning, consolidating the disparate parts of the closing process into one coherent platform and reinventing title insurance.

As they learn, the fintechs are driving better systematic customer insights, enabling the creation of toll-gates at critical junctures of the value chain. Blend, for example, has deployed its solution in over 30 mortgage originators, including Wells Fargo. In essence, these fintechs have the potential to transform into the rapacious “Greeks” of Trojan horse-fame once their partners have let down their guard.

What is an established player to do?

Incumbents must realize that the game is changing and that they must adapt to the new reality. Indeed, owning the customer and distribution channels, hitherto an advantage, is no longer a sufficiently protective moat.

A few get it. One such player is Dan Gilbert of Quicken Loans, who recently explained that the corporation he founded was more of a data acquisition business than a mortgage company. But not everyone can be Quicken Loans...

Here are some potential steps to be taken for those mortgage companies that may not be in position to follow Gilbert’s lead:

1. Build a data-centric culture internally: This needs to become part of your corporate DNA. Don’t rely on drive-bys from your favorite consulting firm. 
2. Add a dose of external talent: Face it: the mortgage sector is an impressively insular one. We can all benefit from some fresh eyes. At the same time, a 30-foot slide in the common area is completely unnecessary… unless you really want one.
3. Get to know your customer: We start with a level of data about a customer and tend to keep it for a duration that other consumer finance segments would die for. Driving increased insights by systematically engaging customers across the lifecycle is a defensible counter to the insurgents’ moves in consolidating horizontal data streams.
4. Break free from the tyranny of the 30-year: Now that you are mastering the generation of insights through the above moves, do you really need to continue limiting yourself to mainly agency or Qualified Mortgage products? Can you, for example, start offering other credit products that map to your customers’ living/spending requirements during the lengthy interims that often exist between primary mortgage needs?

Don’t build that wall

More than any other consumer credit product, mortgages are complicated by pervasive idiosyncrasies that require a multitude of partners to weave together a full customer journey. Shrewd fintechs have been catalyzing the type of innovation promising to enhance that journey, so a strategy of insulation from their promises is a strategic loser. At the same time, traditional mortgage originators need to roll up their sleeves, get engaged and not expect their friendly neighborhood fintech to bail them out. Just like their customers, they need to take ownership.

Millennial mismatching in housing finance

This piece originally appeared on The Financial Revolutionist on March 23, 2018

Fellow NPR nerds likely spent this past week eagerly awaiting excerpts from an interview with Messrs. Bernanke, Paulson and Geithner (the “Committee of Three”) marking the 10th anniversary of the financial crisis that precipitated the Great Recession. As if to underscore its proximate cause, Paulson remarked that “mortgages are ground zero of, you know, the crisis…”

A decade on, US housing seems to be in decent shape. The ratio of housing debt-to-equity is well within secular bounds, and the total value of the market has finally surpassed the 2006 pre-crisis peak. But things are not quite as peachy with the mortgage market, a $15-trillion business that accounts for over three-quarters of home purchases.

Fannie and Freddie

Dominating the mortgage market with half of new mortgages originated under their auspices are Fannie Mae and Freddie Mac (Note: this pair was mentioned 36 times in the aforementioned NPR interview). Along with Ginnie Mae and together known as the “Agencies,” the troika have an 80% share of new mortgages. Fannie and Freddie have lately been on a winning streak, driven by the housing recovery of the past few years. Yet, both are still effectively nationalized under conservatorship and required to deliver nearly all earnings to the Department of the Treasury and, hence, are structurally impeded from assuming the risks attendant with innovation.

Richly ironic is how the new lowered corporate tax rate has forced the duo to write-down a combined $15 billion in deferred tax assets, which, in Fannie’s case, has compelled another multi-billion-dollar federal bailout. The infusion, while temporary, only serves to highlight how this unhealthy situation must be remedied for the industry to move on. Treasury Secretary Mnuchin has stated, repeatedly, that housing finance reform is a “top priority.” He has also reaffirmed support for traditional mortgages, saying, “I think the 30-year mortgage has been a fundamental part of our mortgage finance for as long as people can remember.” Assuming this administration can execute on this priority, another issue rises to the fore.

Dominance of the 30-Year

Does the primacy of the 30-year mortgage, mainly of the fixed-rate variety, make sense anymore? The product that arose from the Great Depression solved the need for stability, defined as staying put for decades. This solution, however, gave rise to a host of complications around the mismatch between the long-lived mortgage loan asset and shorter-term liabilities needed for funding that has resulted in the occasional catastrophe.

The mismatch that must also be considered these days is the one between the product and the needs of the Millennials, the largest single cohort of recent home buyers and now just entering their prime nesting phase. Despite the buzz about co-living and the sharing economy, 85% of Millennials still expect to own a home.

Millennial Mismatching

At a time when Millennials are looking for affordability, engagement and flexibility, this mismatch is increasing. This generation is entering a robust housing market later than previous ones and burdened financially by the detritus of the Great Recession: weak wage growth, tougher mortgage standards, and soaring student loan debt. Is it any wonder, then, that despite their substantial presence in the home purchase market, Millennials’ home ownership rates are still lower than those of prior generations?

This cohort, which came of age prioritizing experiences over possessions and quality of life over pay, will continue to demand flexibility even as they gain career momentum and move into their nesting/home ownership stage. Other generations are twice to three times more likely to define homeownership as permanent. These are not ones to settle for 30-year commitments.

Millennials seeking delight invariably suffer disappointment from the mortgage loan, a product that emphasizes “widget-making” over experience. As I discovered from a group of MBA’s while lecturing at a business school last month, not even market-leading Quicken Loans escaped criticism for its “old-school,” phone-heavy contact model. Worse yet, the prime directive during the repayment phase, to drive down costs, generally through minimizing customer contact, also alleviates opportunities that may arise from continued engagement. A 2017 Accenture study showed that “mortgage costs are a fraction of the money in play during the first three years of home ownership.”

Solving for Affordability

There are plenty of efforts to make the mortgage more affordable. Among established lenders, we have seen increased appetite for sub-20% down payments. Bank of America’s CEO Brian Moynihan stated last year that lowering the down payment requirement to 10% from 20% “wouldn’t introduce that much risk but would help a lot of mortgages get done.”

Meanwhile, fintechs have sought to reduce mortgage production costs, currently averaging $8,000 per loan, by both innovating the tech to streamline the fulfillment process and reducing loan officer compensation, which makes a major impact since commissions are typically at 1% of total loan amount.

What About Engagement and Flexibility?

The drive to innovate on engagement and flexibility highlights not only the limits to what can be done within current product boundaries, but also the poverty of imagination afflicting the space.
What can be done during the repayment phase to increase engagement? Loan Depot, for one, has aggressively pursued cross-sell opportunities into personal loans and home improvement financing. It’s a start, but the customer needs more than an occasional sales pitch to value the attempt at engagement.

As for flexibility, we need to think beyond the 30-year standard. But so far, creative financing-based solutions, including equity-sharing arrangements (e.g., Unison and Point ) or lease-to-ownership programs (e.g., Divvy Homes), represent a tiny drop in the bucket.

Where’s the Fire?

The blunt truth is that, over the past decade, the mortgage business has been defined by increasing scale, low rates, and an aversion to product innovation. Consumers with the requisite credit quality have become acclimated to nearly free money, inured to constraints of the standard product. So, why change now?

Looking toward the horizon, there is increasing likelihood that the need for innovation outlined above will match with catalysts of actual market change, in the form of housing finance reform and a more normal rate environment that will spur greater mortgage product differentiation.

Change will come. But, until then, the 30-year mortgage remains the standard.