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Thinking About/ The Effects of the Foreclosure Crisis

Thinking About:  Dealing with Private Property Owners

THE EFFECTS OF THE FORECLOSURE CRISIS 

 

Since 2007, millions of one- to four-family properties have gone into foreclosure and been lost to their owners, including both homeowners and absentee owners. This wave of foreclosures, coupled with the larger financial and economic crises that have devastated the country, has had massive consequences. The national homeownership rate has dropped sharply, matching the level from 1997. House prices have plummeted, in some areas by as much as 50 percent or more. Housing vacancies have soared and many neighborhoods have been destabilized, particularly working class and minority neighborhoods hard-hit by subprime lending. Despite a variety of efforts by the federal government and many state governments, the wave of foreclosures continues. It has had two additional important consequences.

 

First, the foreclosure process – from initial filing to the foreclosure sale where the lender takes title – is taking longer and longer. As lenders’ property inventories grow, they may be less eager to take still more properties, and drag out the process, while court backlogs and mandated foreclosure interventions further slow down matters. In many states with judicial foreclosure systems like New Jersey or Florida (where the lender has to get a court judgment before it can go to foreclosure sale), the process can take two years or more from start to finish. Even in speedier non-judicial states like California or Nevada, it can take as much as a year.

 

Since many property owners, once failed with the inevitability of losing their property, walk away from it, the ever-longer foreclosure processes mean that the likelihood of a property becoming vacant – and staying vacant longer – during foreclosure becomes increasingly great. In many cases, the owner walking away is a landlord, leaving a property that still has tenants living in it, but with no one to take responsibility for maintenance and repairs.

 

With the owner out of the picture, the question then becomes: who will maintain the property? Lenders are reluctant to acknowledge a legal responsibility for properties in foreclosure until they actually take title, even though in many cases, particularly in areas where properties have a good deal of value, they will step in to maintain the value of the property. As we discuss below, a growing number of states and cities are imposing a legal obligation on lenders to maintain properties in foreclosure. This is an important tool that cities may need to deal with this category of problem properties.

 

Distressed property investors

The second consequence of the foreclosure crisis, which is particularly important to cities dealing with problem property owners, is that it has spawned a massive wave of purchases by investors taking advantage of low prices for REO (Real-Estate-Owned or bank-owned) properties or buying properties in bulk from lenders or servicers. This activity has its positive side, in that it means that a steady supply of rental properties is being made available to meet the increasing rental demand. It can also cause many problems, however, particularly when the investors are not also responsible landlords.  What determines whether they are likely to be responsible owners is not whether they are good or bad people, but the economic conditions in the areas where the buildings are located. The table below illustrates four different strategies used by investors.

Go to Meeting the Challenge of Distressed Property Investors in American’s Neighborhoods for a range of actions local governments and CDCs can take to encourage responsible ownership.

Go to When Investors Buy up the Neighborhood: Preventing Investor Ownership from Causing Neighborhood Decline.

 

 

 

Investor Typology Table 

PPO Investor Typology

 

 

Rehabbers and holders gravitate toward areas where market prices for distressed properties, while low enough to enable the investment to be profitable, are still high enough to discourage scavengers. In order for a rehabber to make a profit, the market price of a well fixed-up house in the area must be greater than the sum of his acquisition and rehab costs.

 

The same is true of holders. For an investor to justify holding and maintaining a property on a long-term basis while realizing at least some cash flow, she must realistically expect that the property will have a decent likelihood of appreciating within a reasonable time frame. While some investors buy to hold indefinitely in order to build a long-term portfolio, most holders have an exit strategy that assumes the property will be sold, typically within five to eight years.

 

Conditions in low-value markets such as in cities like Detroit or Cleveland are very different. Long-term appreciation in these markets is seen as unlikely because the prices of distressed properties are too low. From a pure investment standpoint, as a result, there is less economic justification for pursuing a long-term holding strategy. Properties in these areas are more likely to attract milkers, who spend little on maintenance, ignore property tax bills and are able to recoup their investment in short order. After making a quick profit, they are likely to walk away from the property after two or three years.  Since they are offering a low-quality product and have no interest in long-term preservation of value, milkers have no motivation to be selective with respect to their tenants, unlike holders, for whom preservation of value is as important as cash flow.  While there are investors pursuing responsible long-term holding strategies in these cities, they tend to be the exception rather than the rule.

 

In order to mount the most effective strategy to maximize benefits and minimize harm from distressed property investors’ activities in a community, those responsible for designing the strategy need to understand both the investors’ motivation, and the realities of housing market conditions in their cities, not only in the city as a whole, but in individual neighborhood sub-markets, where conditions may vary widely from one to the next.

 

Go to Vacant Properties.