In September, Toyota’s year over year auto sales plummeted 16.5%, Honda down 14%, and Nissan down almost 18%. The severity of the slide stokes fears that a long-anticipated car sales collapse may be arriving. Why should you care about Autos in real estate? Autos are one of the leading economic indicators of consumer confidence (or lack thereof) and can provide insight into the upcoming fall real estate season. What does the recent drop mean for real estate the remainder of the year?
Two major economic indicators
In the United States, it seems that there are two major economic indicators when assessing financial health. The two traditionally largest purchases a consumer makes are for their car and their house. When one (or both) of these economic indicators make large movements this can foretell a change in the broader economy. For example, as auto sales began cooling consumers spending pulled back sharply in Q1 of this year (see NY times article). Real estate looks tame compared to what is occurring and will likely transpire in the auto sector.
What is happening with Autos
There are two major trends occurring with autos that are closely intertwined. First, sales are cooling quickly. In September, Toyota year over year sales plummeted 16.5%, Honda down 14%, and Nissan down almost 18%. American automakers also declined with Ford down 5%. While sales are declining, at the same time delinquencies are up on auto loans. Both items are working to slow the auto sector significantly with all the major automakers announcing furloughs, job reductions, and plant closings
Auto lending crisis
Along with demand softening. Auto lending looks like the last mortgage crisis. Over the last 7 years auto sales increased to historic levels. One of the drivers of the large increase was loosened auto lending. Like the housing boom, lenders packaged loans and sold various tranches to investors.
As more auto loans were originated, standards were loosened. According to a recent Bloomberg article a major subprime auto lender checked income on just 8 percent of the loans originated. Furthermore, 20 percent of borrowers admitted that their applications for debt contained inaccuracies. Sound familiar? There are still lawsuits today against banks for this same practice during the mortgage mess.
According to the office of the comptroller: “Auto lending risk has been increasing for several quarters because of notable and unprecedented growth across all types of lenders. In the last two quarters, delinquencies on auto loans have begun to increase and net losses have also reflected non-seasonal increases. As banks competed for market share, some banks responded with less stringent underwriting standards for direct and indirect auto loans” (OCC.gov)
Who cares about auto lending?
The loosened standards are leading to higher charge offs on auto loans both at banks and within securitized pools. Auto delinquencies have hit their highest level in seven years. Furthermore, 32 percent of all trade ins during the first 9 months of 2016 were “underwater” meaning the car was worth less than they owed which could lead to further delinquencies.
According a recent Morgan Stanley report previously owned cars are predicted to decline by 20% over the next 4 years (and they might plunge as much as 50%). Even on the low side of the 20% decline auto loan losses are set to explode.
Who will be left holding the bag when it explodes?
It is going to be a large bag ! The total balance of auto loans outstanding just reached 1 trillion dollars, the highest amount ever recorded. The million-dollar question is who will take the hit?
The easiest suspects to identify are the automakers. For example, in recent SEC filings Ford increased its loan loss reserves to 449 million a 34 percent increase and GM set aside 864 million, a 16% increase. Between these two auto makers the anticipated loan loss reserves is almost 1.3 billion dollars!
Banks will also be hurt. Many banks have built substantial auto lending portfolios to increase their returns. As defaults increase, banks will no doubt be impacted.
The increased losses will trickle through the economy in unique ways. In the last mortgage crisis, finding out who was holding the bag when the **** hit the fan was an interesting question. As mortgages were “stripped” meaning different buyers bought different pieces (tranches) of a mortgage nobody really knew what they had until the music stopped. Yields are extremely low by historic standards and therefore there is a huge desire of investors to increase their returns. Many pension funds, hedge funds, retirement accounts, etc.. have invested in auto loans and I would suspect that many individual investors also have exposure in their portfolio
What about real estate and mortgages?
The large drop in auto sales are one of the leading economic indicators for consumer confidence. This lack of confidence will be felt throughout the real estate market as we are already seeing sales begin to cool. With consumers becoming a bit weary and sales of major purchases softening, the federal reserve will continue its rate cutting. On a positive note this will lead to much lower mortgage rates.
The looming auto crisis is a good reminder of the risks within the economy. The consumer was the last leg holding up this economy. Unfortunately, auto sales are a stark reminder that consumer confidence is starting to show cracks. Autos will be one more drop of water on the real estate party to “cool” the market.
What does this mean for the general economy?
Make sure you are wearing your seatbelt! We likely will be driving into the next recession. Two major impacts will occur. Losses will undoubtedly happen on auto loans with various players in the economy. As losses mount risk appetite decreases so lending in turn tightens not just on autos, but mortgages, credit cards, business lending, etc…. As we saw in the last mortgage bust it took almost 8 years for lending to normalize for mortgages which crimped demand for multiple years.
The second major impact is consumer confidence will get bruised. As consumers pull back the rest of the economy will suffer with less spending, etc… The “contagion effect” begins to occur as a result of decreased lending and lower consumer confidence. Real estate will be impacted as the consumer pulls back leading to a slowdown in sales, mortgages, home remodeling, etc.…. This million dollar question is how quickly, deep and widespread the “auto flu” travels to other sectors of the economy.
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
Fairview is a hard money lender specializing in private money loans / non-bank real estate loans in Georgia, Colorado, Illinois, and Florida. They are recognized in the industry as the leader in hard money lending with no upfront fees or any other games. Learn more about Hard Money Lending through our free Hard Money Guide. To get started on a loan all they need is their simple one page application (no upfront fees or other games).