Can a house be worth less than zero?
When construction or renovation costs exceed the resale value, a house literally is worth less than zero.
In Coastal California, the sticks-and-bricks construction cost is only a small portion of a house’s resale price. The rest is residual land value. In Coastal California it’s common to see small houses in beach towns demolished and replaced with a large mansion. In the rest of the country, residual land values are usually too low to justify such activity.
With far fewer restrictions on land use in most of the US, land values are much lower. The construction cost of a new house is generally about 80% of the final resale value of a home, leaving 20% for the cost of a finished lot. The raw land value is a small portion of that amount.
However, in some areas the resale value of a home is less than the cost of construction. In those areas, new construction is a rare luxury item not justified by economics. When the cost of construction exceeds the resale value, the residual land value for housing is less than zero. In such instances, land rarely trades hands for residential use.
When house prices crashed from 2007-2012, residual land values went negative in much of the country, which is one of the reasons new home construction ground to a halt. It was so bad that in many instances even the renovation cost of a dilapidated house exceeded the after-repair value. In a real sense, like a heavily damaged car, these houses were a total loss.
When a house can’t be renovated, some investors buy them and sell them to low-income people on a land installment contract (See: Land contract sales: helping the poor, or screwing them?). But some properties are stuck in the foreclosure system, and neither the former owner or the banks want anything to do with them. These are zombie foreclosures.
Bill that would establish new rules for lenders and servicers
Mortgage lenders and servicers could soon have a whole new set of responsibilities for maintaining foreclosed homes, as Sen. Bob Menendez, D-NJ, introduced a new bill on Friday that would address what his office calls the “zombie foreclosure crisis.”
Zombie foreclosures are homes that are vacant or abandoned during the foreclosure process, and in the last several years, several states have undertaken efforts to stem the rising tide of abandoned homes.
Banks have been allowing delinquent mortgage holders to squat while prices rebound because rising prices allows them to recover more on their bad loans. In many cases, the delinquent borrower moves on with their lives and leaves the property vacant with the assumption that the bank will finally foreclose and resell the property.
However, banks are under no obligation to foreclose; it’s merely a contractual right. In cases where the house is in a bad neighborhood or in need of extensive repair, it’s more cost effective for banks to write the loan down to zero and leave the property alone. When that happens, title remains with the delinquent owner, and even though they may have long since moved away, they are still on title, and the property won’t let them go.
In many cases, the town or city in which the property is located is left on the hook for maintaining the abandoned property due to the property being left in “legal limbo,” Menendez’s office said. …
According to Menendez’s office, New Jersey had the highest foreclosure rate in the nation in 2015 with over 35,000 foreclosure filings. Menendez also noted a recent report from RealtyTrac, which showed that he state has the most vacant zombie foreclosures in the nation with 4,003.
“Zombie foreclosures threaten our communities and scare away new homebuyers and investors, which leads to neighborhood blight and plummeting values of surrounding properties,” Menendez said Friday.
The reality is that the zombie foreclosure is a symptom of blight, not a cause of it. If these neighborhoods weren’t already worthless, investors would buy up these homes, demolish them, and build new homes in their place. We see this all the time in Coastal California. In fact, these tear-down listings are among the most amusing as the prices don’t match the appearance of the house.
“We need to do all we can to keep families in their homes and ensure mortgage lenders are invested in the communities they serve,” Menendez added. “This legislation stands up for New Jersey’s struggling homeowners, and prevents the banks from turning their backs on borrowers, on their neighbors, and on the community at large.”
Every word of Menendez’s statement above is complete bullshit. Nobody wants to live in a dilapidated shack. By definition, zombie foreclosures are not occupied, so this legislation does nothing for struggling homeowners. Banks are turning their backs on these properties, but this is just good loss mitigation as foreclosing on these properties would cost them more than they would recover.
But Menendez’s legislation wouldn’t just address the zombie foreclosure “crisis” in New Jersey. The legislation would establish a host of new rules for zombie foreclosures nationwide.
According to Menendez’s office, the “Preventing Abandoned Foreclosures and Preserving Communities Act of 2016,” would:
- Require mortgage servicers to tell borrowers at the beginning of the foreclosure process they can remain in the home until state law requires them to leave
So now we are encouraging squatting. Nice.
- Require the servicer to make clear to the borrower he or she remains responsible for the payment of any taxes, assessments, and other fees during the foreclosure process
- Require the mortgage servicer to make prompt notifications to both the borrower and the municipality where the property is located when it walks away from the foreclosure
This is a reasonable requirement. Once they decide not to act, they should tell someone rather than leave it a mystery until some distant statutory period lapses. Of course, if notifying a municipality triggers costs at the bank, they will pretend they are going to do something until the statutory time lapses anyway.
- Prohibit mortgage servicers on loans backed by Fannie Mae and Freddie Mac and insured by the Federal Housing Administration from walking away from an initiated foreclosure unless the servicer releases the lien on the property and provides proper notice to the borrower and municipality
Again, this sounds good, but banks simply won’t acknowledge they are walking away.
- Require the Government Accountability Office and the CFPB to study and report on the prevalence and impact of abandoned foreclosures …
“Our neighbors and neighborhoods are still trying to recover from the foreclosure crisis and the outbreak of zombie foreclosures that have menaced our communities,” said Staci Berger, president and chief executive officer of the Housing and Community Development Network of New Jersey.“Zombie properties are a drag on our economy and a danger to our neighborhoods,” Berger continued. “We applaud Senator Menendez for his leadership on this issue by introducing policies that would help our communities fight back.”
It’s a drag on municipal budgets, and they want to shift this burden to the banks, which is probably where the burden should be. Something has to be done to prevent the blight of vacant properties persisting until foreclosure timelines are exhausted.
A zombie title in Las Vegas
I came across a property in Las Vegas being offered for $60,000. It would have rented for about $850 per month in good condition, so it piqued my interest. The property was inherited by four children of the former owner who lived there for over 40 years. They had no idea the condition of the property, but they were eager to sell to get their inheritance. After inspecting the property, I was astounded that it was occupied at all.
The foundation slab was crumbling so badly that flooring could not be installed on top of it. The interior hadn’t been updated in 40 years, the wiring was bad, the plumbing leaked, the roof was shot, basically everything needed to be replaced. It would cost more to renovate than the property was worth, and with prices below replacement costs in Las Vegas, it would cost more to demolish and rebuild than the property was worth. The people would need to pay me $25,000 for me to take this off their hands. In short, the house was worth less than zero.
I don’t know what became of the property. I imagine the absentee inheritors kept it on the market hoping some fool might actually buy it from them. It would never pass an inspection, so the purchase would need to be all cash. Nobody with cash and any understanding of real estate would touch this property. The inheritors are likely going to have to spend $20,000 demolishing the property and hope someone will pay them enough for the vacant lot to recover their costs. If they don’t do something with it, the property will be condemned, and they will face mounting fines. Unfortunately, they can’t just walk away.