Mortgage Mess and Real Estate Investing

I bet it would be impossible to find a real estate blog that didn’t post anything about the mortgage mess today / over the weekend. It’s not that the credit crunch / mortgage industry collapse hasn’t been on everyone’s mind since a year ago. But a new wave of panic is sweeping us today, after IndyMac failed on Friday, and Freddy and Fannie are so unstable (after a precipitous slide in their stock price) that they need to be propped up by the government. So naturally, I ponder what that means for the real estate investor.

First of all, let’s take a step back. Why did IndyMac fail? Well, because like other banks in a similar situation, a large portion of their business was subprime loans. If you make loans to people who can’t afford the house, as long as they say they can and state that they make enough money to buy it, which part of this approach is sound strategy, exactly? Unfortunately, the mortgage markets weren’t too concerned with the future.

So as the market started crumbling and the bottom fell out from under, why did the banks still refuse to do short sales?  (A short sale, for those who don’t know, is a deal that a buyer (retail buyer / investor / etc) negotiates with the bank, for a sale of the property for less than what’s owed on the property).  This was a very necessary step, in my opinion, as values had dipped under the amounts that were owed.  If only banks worked with these buyers to do these short sales, along with mortgage workouts, it would have largely mitigated the mess, and banks would be straddled with a lesser inventory of houses. And as we all know, banks need liquidity, not houses, to exist. The idiotic thing is that these same properties, if no one buys them, get foreclosed on (huge expense for the bank), get seized and get auctioned off for less money than the proposed short sale. If I have an outstanding loan of $10, wouldn’t I rather take $7 from a buyer today, than sell it for $5 tomorrow?  Duh! Instead the banks made it so difficult for an investor to do these short sales, with the process dragging on for months. With such an abundance of foreclosures and deals to be had, no wonder so many properties end up going to auction. From my personal interaction with real estate investors, the frustration with the banks’ loss mitigation departments (those who end up working out the short sale deals) has been palpable. I spent some time perusing blogs and blog comments written by investors, who lamented that IndyMac exhibited many of the same behaviors. IndyMac had a chance to recoup some of the money they ended up losing due to the bad paper, and they squandered it. I am not, in any way, suggesting that short sales are a cure-all. I believe that it was important to pursue all avenues, one of which is short sales, one is mortgage workouts / loan modifications, and other steps. Hopefully, the next bank straddled with foreclosing properties, will be a bit better at short sales.

So now that IndyMac failed, and other banks with similar patterns are likely to fail, for the same reasons as stated above, the credit problem is only going to get worse, and the panic is going to get out of control.  Which concerns me as an investor and as a technology entrepreneur building a web-based resource for investors. If there are no funds available for investors to buy investment properties, the investment industry is going to go the way of the mortgage industry.  But not so fast! Investors, the good ones at least, are extremely creative, nimble and entrepreneurial ; they find opportunities at times when everyone runs and screams that the sky is falling. The deals are abundant. And yes, prices will likely keep decreasing, especially as the mortgage mess shrinks demand (many homebuyers who were in the market for a house, now will have to go back to renting, because they can’t get a loan). However, an investor who is good at doing the short sales, and other such strategies, can max out the deal anyway by getting it at very low prices. To finance these properties, a creative investor will look to non-traditional avenues, such as seller financing and private money. As far as my business, MeetMOJ,O is concerned, we are going to do just fine, as we extend our matching model to private money lenders and other alternative sources of capital.

So next time someone asks me what I am doing, and I answer “I am building a web-based community for real estate investors”, and that person looks at me like I am insane, I am going to insist that this is a great time to be an investor. If you know what you are doing, of course.

Top U.S. Cities for Real Estate Investment in 2008

HomeVestors (the “We Buy Ugly Houses” folks) has named the top 10 cities for real estate investing and 10 junior markets for real estate investing in the first quarter of 2008 (Junior markets are cities with a population of 150,000 or more). They are as follows:

1. Dallas, TX
2. Houston, TX
3. Atlanta, Ga
4. Fort Worth, TX
5. St. Louis, MO
6. Philadelphia, PA
7. San Antonio, TX
8. Denver, CO
9. Minneapolis, MN
10. Phoenix, AZ

Top 10 Junior Markets

1. Columbus, GA
2. Panama City, FL
3. Springfield, MO
4. Brevard County, FL
5. Greensboro, NC
6. Lubbock, TX
7. Columbia, SC
8. Ft. Walton Beach, FL
9. Kent/Sussex Counties, DE
10. Michigan City, IN

These findings are based on the number of houses bought in each market by HomeVestors in Q1 of quarter of 2008 (source http://www.homevestors.com/inthenews)

As the Dallas-based franchise company specializes in buying, rehabbing and selling single-family houses and rescuing homeowners from ugly houses and ugly real estate situations, the current downturn in residential real estate makes for a fantastic acquisition environment. As I mentioned in a previous blogpost, this climate of falling prices, inventory oversupply, and resulting homeowner desperation to get rid of their houses, is a prime time for smart investors to go heavy on property acquisition. As long as your exit strategy is to buy and hold, and not to flip (which is going to be very very difficult in today’s climate), and as long as you can afford to hold the property for at least 5-7 years, you should definitely take advantage of these conditions.

I have to admit that I don’t completely trust this data. I mean, I do not doubt that these are the areas where some of the best bargains can be had: HomeVestors does enough volume to observe significant trends. But there are so many other factors that make a city a hot investment market, which can not be ignored; the HomeVestors press release doesn’t address those factors explicitly. For example, the city’s economic development plans, jobs growth outlook, and other macroeconomic factors must be considered. Also, the rental outlook must be considered. As you buy a property, the low acquisition price is only one factor that determines whether you will see positive cash flow (or at least break even). Rents must also be strong and in demand. Overall, there is strong rental demand right now across the nation, as many homeowners lose their homes to foreclosure and many other hopeful homeowners can’t get a mortgage due to tougher standards. But some cities are definitely hotter rental markets than others. If people are fleeting a city due to lack of jobs, rental market will suffer. The HomeVestor list seems to be very TX-centric. By a sheer coincidence, the company is based in Dallas. Hmmm….. I would be very interested in hearing from our readers what they consider to be the top cities for investing.

Another question for the readers: would you consider investing away from home? What are some factors that you consider whether or not you feel comfortable with investing away from home? What resources do you use? Do you work with another local investor to show you the ropes? We are working on a tool that can connect investors to each other, based on area of interest, as well as other investing goals. As various areas of the country may become attractive to investors than their own home turf (Gulf Region GO Zone, for example), we see more and more people venturing outside of their own backyard. And we would love to help investors make the process a smooth one.

More on “Project Lifeline”

Well, project Lifeline was formally announced today by Treasury Department and the Department of Housing and Urban Development. As mentioned before, it halts for 30 days foreclosure proceedings for homeowners in default for over 90 days. The idea is to give homeowners and lenders some additional time to work out better loan terms.

It looks like so far it’s a pilot involving 6 of the largest players in the mortgage industry: Bank of America, Citigroup, Countrywide, JP Morgan, Washington Mutual and Wells Fargo. The hope here is that the rest of the lenders will follow suit. These 6 lenders have already been involved in the Hope Now alliance, an effort organized by the Bush administration, to keep subprime ARMs from resetting. The Hope Now alliance states that it helped 7.7% of 7.1 million subprime borrowers (or 545,000 borrowers) during the back half of 2007. This was done through permanent loan modifications (such as lower interest rates) and negotiation of repayment plans.

Unlike Hope Now, Project Lifeline addresses all mortgages, not only subprime. Project Lifeline does not apply to vacant properties, investment properties, or homeowners in bankruptcy proceedings or facing a foreclosure date within 30 days.

So the whole thing makes me wonder: If this actually a viable solution or is this a “photo op” for our politicians? After all, perception is everything, especially in this election season. And we are, after all, headed towards a recession… So it’s important to at least look like we are doing something.

Project Lifeline just may be a logistical nightmare for the lenders. How will they handle all these homeowners calling them over the next 30 days? And how will anything actually get resolved in 30 days? Borrowers and investors negotiating on their behalf have already been having a difficult time getting lenders to respond; short sales take “forever and a day” to negotiate. There are just too many foreclosures. And there will only be more.

And will homeowners actually take action? The real issue here is that there is limited incentive for those in foreclosure to do anything about it. Now that home values have plunged, many homeowners are “upside down” on their mortgages, owing more than their homes are worth, and having withdrawn all equity during the “boom times”. It’s becoming easier and more rewarding for the homeowner to just walk away. The proverbial ATM is empty.

As we all know, “what goes up, must come down”. By some accounts, home values are down for the first time since the Great Depression. Home values had skyrocketed over the past number of years, growing at a rate far exceeding average salary growth. So to afford the American Dream, citizens of America had to get into mortgages that overextended them, often getting into ARMs with low initial rates that were scheduled to reset, only delaying the inevitable. All for a chance at the American Dream! Can we blame them? And can we blame the lenders for trying to help (not saying that all lenders are selfless).

Even more disturbing is the natural propensity of our culture to use home equity as an ATM, forsaking all reason. It is not all lenders’ fault, even though it has become popular to point fingers at these “unscrupulous” bankers. These are just some of the reasons why we are in this mess. Call me cynical, but I really doubt that a 30-day time-out will do a whole lot.

Henry Paulson to Announce a Foreclosure Rescue Plan

Within the hour, Secretary of the Treasury Henry Paulson is due to announce the Foreclosure Rescue Plan. This plan is aimed at temporary relief to homeowners in foreclosure.  It mandates a 30 day “time-out” for those who are 90+ days behind in their payments. These 30 days will give the homeowners in default time to negotiate a win-win solution (or any kind of solution) with their bank. For now, Bank of America Corp., Citigroup Inc. and four other U.S. lenders will announce their alignment with this new plan.  It is not yet clear if other lenders will follow suit.  My guess is that they most certainly will.

More on this tonight!

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