Creative Destruction

 | Mar 25, 2014 | 5:30 PM EDT
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All of the technology necessary to allow individual residential real estate properties to be listed for sale, financed, purchased, transferred, titled and recorded similar to the way the same is done for stocks, bonds, commodities and currencies already exists. 

The only reason it hasn't been made available to the public and retail owners, buyers, sellers and mortgagors of residential real estate is because of the technology owners' fear of the political power of the real estate lobby with federal, state and local legislatures.

That looks to be changing though, and investors in stocks of real-estate related companies should be watchful for the signs that the industry will be revolutionized and brought in line with the way all other financial assets are traded today.

The three biggest issues facing the real estate brokerage and mortgages industries are 1) the potential for the elimination of the mortgage interest deduction (MID), 2) the rise of hard money lenders, which are regulated nationally by the U.S. Securities and Exchange Commission (SEC), and by individual states, not by the Consumer Financial Protection Bureau (CFPB), Federal Housing Finance Agency (FHFA), and Federal Deposit Insurance Corporation (FDIC), and 3) the introduction of technology that allows for peer-to-peer (P2P) lending, property brokerage and title transfer/ recording.

The residential real estate and mortgage industries have been regulated, especially since the subprime mortgage crisis, to a point where the inefficiencies being caused are making all three of these issues financially and politically viable simultaneously with business interests coalescing around them now.

The MID, which I discussed earlier this month in the column, Don't Fear Mortgage Interest Deduction Talk, is the linchpin holding the existing income tax structure together. The MID remains because the real estate industry lobby is so powerful. This is due to the perceived economic importance of real estate to the political viability of individual elected officials. That economic and political importance is based on the percentage of first-time home buyers, who are the driving force in the residential real estate market.

Traditionally, and most importantly, prior to the most recent housing bubble, these buyers have made up the largest percentage (more than 50%) of all residential property purchases, for the past several generations.

But that percentage collapsed after the 2008 crisis. It is at about 25% now, as student loan and other debts have risen. This has precluded many in the traditional demographic of first-time buyers, the 25-34 year-olds, to purchase a home. Simultaneously, the percentage of cash buyers and investors has surged from a multiple generation average of about 20%, to more than 50%.

Cash buyers and most investors view real estate agents, mortgage lenders, title companies, and associated as politically supported toll collectors , or rentier capitalists. Cash buyers and professional real estate investors have no desire or need for the toll collectors to protect their interests. Investors needing to borrow prefer liquidity to debt costs so they are willing to borrow at higher rates from hard money providers who can close quickly with little paperwork. As the political power of cash buyers and investors increases and the power of first-time buyers decreases, the support for the MID is eroding.

Changes in technology that are allowing for liquidity in the real estate market are also on the verge of radically altering the real estate industry space, eliminating the vast majority of the of the toll collectors, and dramatically reducing the fees the remainder can charge. From a technical standpoint, all of the technology necessary to allow buyers, sellers, lenders, and borrowers to interact directly and without the toll collectors is already available at the institutional level.

Private companies including bancBoard already facilitate the listing, buying, and selling of financial assets between FDIC member institutions. Other private companies, such as Yachtx, have quietly been working on the development of providing liquidity to other hard assets at the retail consumer level, in preparation for being able to launch into the residential real estate space.

The rapid rise of peer-to-peer lending systems such as Daric, Lending Club, and Prosper Funding, LLC, that allow borrowers and lenders to bypass banks and mortgage companies caused such fear at

Wells Fargo (WFC) earlier this year that the company banned employees from investing in or through them. Management reversed that decision earlier this month, partly due to the mounting political support of P2P by elected officials, such as from Republican U.S. Congressman and House Committee on Small Business Chairman Sam Graves

As the industry changes and the political power base adjusts to reflect the interests of the newly dominant investor class in it, investors should be aware of the potential negative impact on the stocks of companies that are structured around the previous political power base.



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