Saving millions from foreclosure..but how did we get there?

President Obama revealed a plan to save millions of homeowners from foreclosure. His plan involved two componennts: 1) Modifying payment plans 2) Allowing refinancing for properties that are now below value.   The fact that nine million homeowners are possibly going to be saved by this plan is a sign that market devaluation occuring right now is a market correction.   Moreover, this indicates to me that what drove up prices was the influx of demand with little insight into what the “full cost” are entailed in homeownership or investment.  If you understood the risk of buying property, you may not have paid those prices.

I have often seen real estate agents and mortgage brokers provide a cost analysis to the buyer that did not include a “full cost” analysis.  This is not to say that they did not provide the required disclosures, but what I am referring to is a deeper analysis of their clients or the situation. 

We speak from experience, as my property management firm has lost over 40% of my investor units to foreclosure.  Many of our California investors bought property with little insight into the “full cost” or were not prepared to handle a down market. 

What I mean by full cost is that the investors who bought did not fully contemplate their cost of property taxes, insurance, management, and repairs. Additionally, all cost assumptions were based on top end rates for rentals and 100% occupancy all the time.

As I  am a investor and real estate agent, I try to often warn my clients of the difficulty of investing. I do not believe that it is good strategy to oversell or be overly optimistic.  This kind of sugar coated thinking by many in the sales arena (agents, lenders,etc) may have deluded individuals.  People automatically assumed properties would appreciate or rental rates would increase. Additionally, they assumed properties would rent at the highest rent for a area without factoring in the local area factors (Schools, Neighbors, Neighborhoods,etc) all play a role in rents achieved.  

Full cost of a property include slow market conditions, repair costs, slow paying tenants, or tenants who are not careful at the property. Investor sometimes feel that there is a problem with the management company if tenants do not pay on time, however people who are late dodge the property management firm’s calls. Management companies or land lords cannot force payment a la Soprano style, and this means finessing out payments.  Other than screening for rental history, credit history, or income verification, there is no crystal ball to know if a tenant is clean or if they will be noisy,etc. These are only issues that can arise after the fact.  To remove these tenants for those violations would require evictions, which most owners would have to bear the cost of dealing with.

Investors who do not have the ability to absorb these issues should either revise their budgets on the type of investment to pursue or stay out of the real estate investment market.  A business is not guaranteed success, and investors should not beleive that real estate is guaranteed either. If it was guaranteed, then everyone would be doing it.

Wait! Everyone did try to do it (Damn!).  Now, we are all suffering for those delusions.

Do you see a end in sight? Real estate solutions will not be easy for banks, investors, or communities.

Even a stimulus bill creeps to Congress,  bank prices fell yesterday in light of the news.  This is indicative of the fact that investors and banking investors were not confident that the stimulus bill will completely revive the industry.  The fact is that the industry will not find solutions from more money.  These mistakes were created by giving out loans to people who did not have good credit or income.  

Couple these mistakes with the fact that now banks are completely shutting off loans.  It does not bode well that the banks will be rebounding on their own.  If banks do not make loans to quality individuals (credit scores above 650 with solid income history), then how are they planning to increase revenues to offset losses?

If a bank portfolio is filled with bad loans, and you are in the business of making loans (traditionally the bank swere designed to make money off by lending on consumer deposits); then  making good loans would seem to be a long term plan or solution.  What is the long term plan for turning this situation around?  Are they planning to just increase fees on there customers?   This seems like a viscious cycle to driving away consumer deposits. Without those deposits, then how will they create the liquidity needed for loans?

If I were banks, I would cut the losses on the bad portfolios. Keeping the properties on their books trying to artificially keep the prices higher, only keeps the banks hemorraging funds.   How many times have you seen notices of abandonment and foreclosure, but the property is not listed yet?   Obviously, this would be beneficial to investors, but it would help inject back in liquidity for banks.  Banks only spend money or properties lose value while the properties lay vacant.

Additionally, while the property lays vacant it drags down the property upkeep and maintenace; this further depresses prices in a region.

Banks should work with HOA associations to help try to insure regulations are their for maintenance of property.  For those owners in condo complexes, they should work to have regulations in place to possibly deal with maintenance and leasing issues.  To avoid dragging down a community, investors must have regulation in place to insure that the tenants that they bring in are quality people.   Investors often have a short term view, and this short sightedness leads them to make desperate moves (renting to risky tenants,  no vetting for criminal issue, no enforcement of  property cleanliness).   

One way the  Federal government can force the banks to take their medicine is to force them to be in full compliance with maintenance standards of a community.  This way, they full absorb the carrying cost and reduce the delaying and stalling tactics that they use with their REO portfolios.    Banks strategy seem to be predicated that the Government will bail these portfolios at former market prices.

Banks should cut their losses, use whatever funding is received to improve liquidity, and not overreact in the lending arena to remove solid prospects.

Medicine often is bitter, and in this case everyone is taking a dose of it.