AIPIS 251 - Insure Your Equity with Value Insured's Joe Melendez

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It's my pleasure to welcome Joe Melendez.

He is CEO of Value Insured. Today we're going to talk a little bit about where the market is going. The question everybody is always asking, but also about a pretty unique product that his company offers to actually, well, the way I said it is provide mortgage insurance. Not for the mortgage really, but for the equity the homeowner has in the property equity insurance. So we'll talk about that. Joe, welcome. How are you?

Good. Thank you so much for having me. I look forward to chatting with you.

It's good to have you on the show. So you've got a pretty unique product. We'll talk about that in a moment. But Joe, the $64,000 question everybody always wants to know is where is the market going? You know, what's going on with this inventory shortage in the lower priced rental property market that all our clients want to buy and they struggle because there's just so little inventory.

I think that we have a disruption in what has been the normal process of home buying over time. We've seen entry level homes move up homes, downsize homes, and what we're seeing right now is that that entry level market is completely shut out. There's no new home construction out of the previous market decline. Institutional investors came in and bought up large segment of that housing stock that's not coming back. So there is a true shortage in that entry level point. And then to top it off, people who are in entry level homes either paid too much for them and now are stuck in them or they're fearful of buying that trade up home because of the price increases that have occurred and the Affordability of that trade up.

One note on that, Joe, and I'd love for you to expand on this idea. I think there's one other element that's pretty unseen by a lot of people. That is the concept that now that we have rates going up off such a low rate environment, I think it's almost like the way rent control distorts markets. And what I mean by that is this. You know, people have it too good. A lot of people, they have these mortgages that are just nothing short of phenomenal and they find it hard to rationalize trading up because even if they had the same price home, the new mortgage is going to be significantly more expensive than the artificially low mortgages we had for so many years. So that low rate mortgage keeps people in kind of like a rent controlled apartment nobody wants to move out of, right?

I think you're exactly right, Jason. I mean, you know, I'm old enough to be able to share. My first mortgage was at 14 and 7/8 and I was happy to get it. I think what we have today is somebody who's looking at a monthly payment of X dollars and then looking at X plus of the higher interest rates, they're saying, you know what, we'll figure out how to expand the home that we're in or put the bunk beds in so that we can fit the other kids in. So I agree with you. I think it is a collar that keeps people in place. But again, in the bigger picture, it's all about affordability. So while we may have higher or lower rates, it's really at a given point in time, what is the affordability of a particular home? And if you can address the affordability, then the only other component that comes into play is the fear. Am I buying too high? Am I putting my assets at risk? And if you can remove that risk out of the equation, then you're able to move ahead with the emotional and financial decision to buy a home.

Okay, so let's talk about the institutional component for a moment that you mentioned. And that's another market distortion. It's something we've never really had before. This time, you know, post great recession, institutional investors like invitation homes, you know, the biggies have purchased up and just gobbled up thousands, tens of thousands of these entry level rental property type homes all around the country. And they have taken a big chunk of that inventory away from the marketplace. Right. They're obviously very bullish on long term buy and hold rentals as we know. Just expand your thoughts on the impact of that if you would, as you.

Said, those homes are gone. They're not coming back into the market. And if they do come back into the market, they're being repackaged again as single family investor homes. So they're not coming back in for the average homeowner to buy. I think the larger issue is how do we incentivize builders to build those entry level homes. And it for me, I happen to have spent 10 years as a builder myself, I can tell you it's all about regulation. If I'm buying a lot and my cost of improving that lot before I put the house on is so high, then I can't possibly build an entry level priced home because I'm not going to be able to cover my cost of improvement on the raw land. So a big chunk of this can be solved through regulatory relief from community building departments where they can relax regulation to encourage builders to come in and build.

Okay, so that's interesting, by the way, about our HUD secretary, Ben Carson, who by the way has been on the show before when he was running for president and you know, the philosophy of the Trump administration versus the Obama administration, very different when it comes to, I don't want to say fair housing because it's not exactly fair housing, but just housing availability, if you will. And Obama administration wanted to like mandate, you know, let people of all races and affordability levels and socioeconomic levels move into, you know, higher end neighborhoods. Like, let's legislate that by fiat, which I think is a crazy idea. But Ben Carson says, well, we just want to encourage more development to make homes more affordable. We're not going to legislate it, we're just going to encourage it. And I think that's an interesting approach. I think that's a pretty good approach actually. Thoughts?

It's the core of what governs our economy, right? It's a supply and demand economy. So we know that we have a demand. We know that we have family formations that were not occurring during the recession that are now occurring at a rapid rate. And we need to house these new families. Agree that if we can add more supply, you're going to have more of an equilibrium in price than we have today. Because what's been forcing up price is the fact that we have this disequilibrium that's going on with respect to inventory at all categories. And if we can bring more supply to market, we will return to equilibrium. And that equilibrium will be more in line with the affordability index of where interest rates and wage growth are at any particular time in the cycle.

Yeah, it's amazing to me, and I was talking to one of my Venture Alliance Mastermind members the other day about this is how so many things in our economy have just deflated in price. You know, whether consumer products, automobiles, they're really. You get a lot for your money nowadays and that's due to technology. Right. But certain things have only inflated. Health care, college tuition, housing, and you know, there's a few more on the list, obviously. And it's incredibly, really amazing how expensive construction is. It's truly amazing, especially in the highly regulated areas, you know, like my former home, the Socialist Republic of California. It's just incredibly expensive to build anything, you know, or Socialist Republic of New York is the same. I always have to take a little jab. Okay. And when are we going to see if ever the cost of construction come down? You know, Amazon is a major investor in, you know, like these prefab houses. It's just amazing how slow that seems to be to reach the real world marketplace. You know, we see this stuff on social media, we read articles, 3D printed houses, etc. But where are they? Like, you know, the manufactured housing isn't. It doesn't really seem to have any real like impact on the marketplace, at least not yet. It's very slow.

Again, putting on my builder hat, I agree, I do have to. I still keep in touch with the industry and there are a lot of new building methods out there that have significantly reduced construction costs. I mean, we're not using a lot of wood products anymore where we used to use wood products. We're using all different types of products today that do reduce the overall construction cost of the project. The two variables that are still influencing cost in a negative way are labor and regulation. So labor we can deal with because we can make incentivize visas for people that have trade skills to come in and help satisfy the shortage of talent to build homes. During the last crisis, we saw a major exodus of talent that went back to Eastern Europe, that went back to Mexico. These were folks that were talented tradespeople that were the backbone of the building industry that have left. And they didn't lose those skills, they're just not applying them here. So I think there's again, a combination of regulatory reform or relaxation of regulation coupled with some incentives for immigrant labor to come in and help fill that shortfall or that void in the labor pool would be very helpful in solving the problem of being able to construct more affordable housing.

And then of course, there's the land cost. But getting cheaper labor, that's sort of an incremental gain. It's not going to be hugely significant. I mean, houses are just expensive things, aren't they?

There's a lot of materials that go into a house. You know, I can remember telling people that I was building homes for. Are you ready to make 40,000 decisions? Because there are 40,000 parts that go into a home.

Wow, 40,000 decisions. That's.

Yeah, so. And that's true. That's not an exaggeration. You know, you take something simple as a faucet and it may have 20 decisions just to pick out one faucet.

Sure.

So again, I think at the entry level, what we have to do is we have to employ new building techniques, we have to look at labor, we have to look at regulatory relaxation. And I do agree with Ben Carson, which is let's bring as much supply into the marketplace as we can, which will keep prices in check versus where we have a huge number of people chasing a very small supply of homes.

Yeah, no question about it. No question about it. Let's switch gears for a moment. Maybe we'll circle back to a little bit of the future. You've got some interesting stuff on your blog, but tell us about ensuring equity in one's home. You know, look at lenders get mortgage insurance many times, whether it be PMI or mmi, private mortgage insurance. What about the owner? Can the owner insure their equity?

Well, they can now. I mean, after the crisis I set out, I was a builder. I've been in the insurance business most of my life. I spent 10 years as a builder and after the crisis I had sold my last home. People who are investing their life savings in the form of a down payment into a home need to have the same type of protections that a lender has. They need to be able to insure that money against risk of loss. If they buy a home today, and through no fault of their own, they have to move in two, three, four, five years and the market is down. Why should they have to lose their entire life savings that they put in their home? Let's provide them an insurance policy that works. And that's what we set out to do. And we've been offering that product in the market for the last two years, has been extremely successful.

Care to share how many people you've insured equity for?

Well, let's put it this way. Today we have over 23 lenders, over 4,000 loan officers who are offering loans that have down payment protection as a Feature of those loan programs, whether they're Fannie Mae loans, Freddie Mac loans, FHA loans, Ginnie Mae loans, we're agnostic to the loan type. All we care about is somebody who's buying a home. We want to show them how to the risk out of home ownership, how to own a home and take on that risk the same way the banks do when they're lending you the money and recognizing that they have an exposure and ensuring their exposure against loss. Now the homeowner can ensure their exposure against loss. Basically the best investment in the world, a house and part of the American dream, because 8 out of 10Americans want to own a home. You've now been able to basically say, look, you've had this leverage capability of using a mortgage to get 100% of the appreciation, and the only money you had at risk was your down payment. Now that you can ensure that down payment against risk of loss, you are virtually getting 100% of the appreciation on that property with very little risk because you are insuring your risk exposure against loss.

Okay, so let's unpack how this all works. It's pretty interesting. This is a seven year term, right? And then it only ensures the actual down payment, not the equity. For example, if you, if they pay down the mortgage faster or, well, there's a little bit of mortgage pay down no matter what, or the property increases in value, you're not insuring that, I assume you're just ensuring the down payment they originally made, right?

That's correct. We're taking that money that they took from wherever, if it came from the bank or whatever, and writing a check and it shows up on the closing disclosure statement as the down payment. That's the amount that we're insuring.

Okay. And I'm guessing this is just for home owner occupied homes, not investors, right?

Currently it is only for single family condominium owner occupied properties. We're actually just going to be introducing an investor program very shortly because the investor segment of the market is growing rapidly also.

Yeah, okay, interesting. Now let's take a $300,000 home as an example. Someone is moving into this home, it's owner occupied, and they put 20% down. So they've got a $60,000 exposure, a $60,000 down payment in that property. The lender has taken an 80% exposure. How does it work? How do we insure our $60,000?

So you would select a loan product from your lender that has down payment protection as a feature. And in that particular instance, the premium for that coverage is going to be $1,500.

It's.

It's basically 50 basis points of the purchase price of the home, because that is an ADLTV loan. So in other words, you put 20% down, the bank has 80%, and so the price is $1,500. That $1,500 is going to be built into the APR of the loan, which means you're going to pay a slightly higher interest rate. And in the case of. If you take $1,500 and you amortize it over 360 months, it's not very much money. So looking at that, at about $5 a month, you're insuring the value of your $60,000 against risk of loss in the event that you have to sell in the next seven years.

So only certain loans offer this. I mean, you can't put the insurance on any loan.

The insurance can go on any loan provided that there is a down payment. So typically, VA loans, USDA loans, they don't normally have down payments. So in that instance, there's nothing to insure. But we're agnostic to the loan type. It just depends on each individual lender that we work with. They select the loan programs that they want to offer the down payment protection on.

Okay, so are those loan programs, like, less competitive or sort of special in any way? I mean, and when I say special, I kind of naturally think negatively, like, oh, this is the crummy loan, but we'll offer the protection on it. Am I wrong about that?

No.

Okay, all right.

No, it's not. As a matter of fact, you know, they're using this as their lead product because they want to differentiate themselves against the competitors that are all competing on points and rate. And they may be at the same exact rate as somebody else, but they're saying, look, we provide this benefit to you that you can't get down the street. We offer it. So it is. It has been something that both the realtors have gotten behind because, again, it makes it very easy for a Realtor to talk to their buyers about, you know, moving ahead and signing a contract, because the now the risk of that money that's going into the home is protected. Right? So Realtors have been, you know, tremendously supportive. Same story with builders. You know, typically our builders say, look, I build a great home, you love it. I'm going to give you a great warranty on the home, and now I'm going to give you financial protection. I'm checking all the boxes for you to move ahead and buy this home, right? So our builder channel, our realtors, and certainly our loan officers who work hand in hand with the professionals, whether they're realtors or builders, in making that dream of homeownership come true, are critical.

Okay, okay, so they don't really pay a higher interest rate per se. Then they just pay for the insurance policy. So give us that example. Work through the math, and then let's talk about making a claim on this insurance. So we've got $60,000 down payment. We want to insure it's over the course of seven years. You divide it up, just go through that math real quick.

It's 50 basis points on the purchase price of the home. Okay? So if we look at 50 basis points on the purchaser's price of the home at $300,000, that's $1,500. If we divide $1,500 over the life of the loan, which is 360 payments, then we're basically going to wind up with about $5 a month.

So five bucks a month to insure 60 grand, that seems like a pretty good deal. What happens next? So we pay this for seven years, right?

So let's just say in year three, you have to move. You decide that you want to go sailing or you got a new job at the other side of the country and you now have to move and the market is down. And the most you can sell that house for that you bought for 300,000 is 280,000. As long as you sell the house, which is a requirement. Right. You must sell the house. As long as you sell the house. Once you sell the house, you have one page claim form. It says, fill out the information. You provide a copy of the closing disclosure statement from the sale, and we pay the claim in 30 days. And what we look at, we go back in the record and we say, how much did you buy the house for? What did you sell it for? How much was your down payment? And we look at one other element, because we don't go out and inspect the house or look at appraisals or anything like that. We use the Federal Housing Finance Agency's home Price index. We look at that index value on the day you bought the home and the day you sold the home. And let's say the index was down 10%. So that means that the market went down 10%. So in the example that I just said, $300,000 house, the market says that house should only be worth 270. You were lucky. You sold it for 280. You're going to recover your entire $20,000.

Okay. All right. So you must sell the house. So you can't foreclose on the house, you can't let it go into foreclosure, you can't walk away, you can't do a strategic default. You can do a short sale though, right?

Yes, you can. Okay, you can do a short sale. And again, if you recall, I just said we need a copy of the closing disclosure statement to close the claim in the instance where it's a short sale. Avoidance. In other words, you need the proceeds so that you can pay off the underlying mortgage. We have a different form and we actually will send a check before the house actually closes. Except it's going to be made out to two parties. It's going to be made out to the.

You and the bank.

Yeah, that's correct.

Interesting. Gosh, the lenders must love this.

And again, it's. The decision is all in the control of the borrower. The lender has no control over filing a claim on this policy. The policy belongs to the borrower.

Yeah, very interesting. I just said that the lender must really like this, but in a way, I don't know, maybe not. Because, you know, the lender wants the borrower to be at stake.

Right.

They want them to have as much stake as possible, as much skin in the game, if you will, as possible. But when there's an insurance policy, I mean, you don't pay if they walk away, if they allow it to go into foreclosure. So the lender would like it from that perspective. But in a short sale, I don't know about the motivation. It could be sort of hard to ferret that out. Right.

Let's take that same scenario. A customer who has a $300,000 home, they have a $270,000 mortgage because they put down 10%. Right. So let's say $270,000 loan, instead of selling the house for 280, they can only sell it for 260. So they need $10,000 to be able to pay off the loan. They're entitled to recover the whole 30,000. So in that instance, yes, they're going to use part of the proceeds to pay off the balance of the loan. But they're still going to get $20,000 that if they didn't have the down payment protection, they wouldn't get when they sell the home. Even in a short sale scenario.

Yeah, yeah. So they've got another. Well, really, it's kind of like litigation. You know, they've got another settlement party, if you will. That's you guys. Yeah, interesting.

Right. And if you think about the bigger picture, right. At the end of the day, if we can keep a consumer or borrower from going into foreclosure, who are the net beneficiaries of that? Obviously the borrower. Yeah. And the borrower, the lender, the mortgage insurer. If it's a Fannie Mae or Freddie Mac or FHA loan, it ultimately goes down to the taxpayer who's not paying a claim because that house went into foreclosure. So it's good for the entire ecosystem of credit in the mortgage channel.

For $60 a year, five bucks a month. In this example you gave Joe, you can insure a $60,000 down payment. That seems like pretty cheap insurance compared to other things that are $60,000 worth of insurance, certainly auto insurance, homeowners insurance. If you want to insure 60 grand, it's going to cost you more than 60 bucks a year for sure. So you must think that there's not going to be very many claims or very high claims on this. Right. Does that indicate that you're bullish on the market?

We're not trying to look and call the market either way, whether we're up or down. What we're looking at and what we look at as insurance people is the historical price movement of homes. How have homes performed over the last 30, 35 years and during peaks and valleys of home prices, what has been the severity of price movements? So all we're looking at is to say if history is a dictate of the future, we expect a certain number of homes to be underwater. We expect those homes will have claims of X dollars and we price the risk to reflect that loss. So overall we are going to pay claims. I can tell you today we have insureds with us today who have their home values have declined now they haven't sold, so they haven't filed claims. But we know just by keeping track of the homes that home prices have come down in certain markets.

Now are those the higher priced cyclical markets, the high flying markets? I mean we certainly have seen things soften in those markets. Markets.

Actually a large number of these homes happen to be in the mid south.

I'm surprised. Yeah.

Okay, so these are homes that are $200,000 and less.

Interesting, Interesting. So nobody's filed a claim yet though. But you are just looking that there is a decline in value, right?

Correct.

Yeah. Okay, so, so you're, you're obviously monitoring your portfolio for risk, right? Yeah. Good. Interesting.

Absolutely. Robert Schiller was on yesterday talking about home values and he was talking about that there is a deceleration in home prices and in certain markets we're actually seeing more inventory come on market. And we're also seeing price reductions which we hadn't seen before. Those, as you point out, have tended to be in the higher value market. Seattle, Oregon, San Diego. These markets that have really been on fire are now starting to experiencing some retrenchment.

Yeah, very interesting. Okay, good, Good stuff. Any more thoughts on the market in general? You know, what we were talking about earlier and let's wrap it up, give out your website and tell people where they can find.

I think the most important thing is that homeownership is part of the American fabric. It's part of the American dream. I want my children to own their own homes. I think what we have to do is be smart about how we buy homes. I think having a product like down payment insurance from Value Insured is a step in the right direction. It's taking that risk out of the equation. And I would encourage all of your listeners to visit our website at www.valueinsured.com. there's tons of information there. And we also have a list of all of our preferred lenders. And you can reach out to any one of those lenders. If you're thinking about buying a home, they can help you.

When is the investment property product coming out?

I think that it'll be out in December.

Interesting. I'm guessing you're going to price that a little higher. You know, the common. It's kind of funny, and this is always. I almost think the lenders ought to think counterintuitively about this, but they generally think, oh, investment property, you know, the interest rate's going to be a little higher, the down payment requirements are going to be a little higher. Because it's more likely in a crisis, someone will walk away from an investment property and try to keep their own home. But, you know, the investment property produces income. Well, hopefully the home is just a cost. So it's sort of.

You're exactly right. An investment property that's owned by a true investor, they're buying it to get a certain capital. And as long as they're getting that return on their capital, they're probably not going to walk away from the investment because if the market is down, they have to sell it at a better cap rate. Which means why would I do that? Because I can't reinvest the money at that rate. I'll just stay where I am and I'm in the same place. So you are 100% correct. The attributes of an investor are more about cash flow than they are as shelter. Right?

The walk away potential for the lender and the down payment insurer, that's you guys. And you made the important distinction there, though. You said a true investor, right? Not a hobbyist. I think the likelihood of them walking.

Away is actually lower.

It's kind of counterintuitive, but it's a true investor. That's the distinction. So we can ferret that one out on a future episode. We'll have you back on. Good stuff.

I would love to. I would love to. Thank you so much for having me.

Yeah, my pleasure. It's been very interesting. Joe, thank you for joining us.

Us. Thank you.

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