From Squatting to Renting: Another Solution to Stabilize Housing

Some housing markets need a tourniquet to stop the profuse bleeding of home equity. In the most beaten down markets, prices have overshot fundamentals to the downside. In Monday’s post I discussed Another Dumb Idea to Shift Private Mortgage Losses to Taxpayers. Today, I am going to look at a much better proposal for dealing with the reality of millions of foreclosures owned by the US government.right_to_rent

GSEs to Lose Tens of Millions

Lisa Marquis Jackson — John Burns Real Estate Consulting

August 28, 2010

While officials were gearing up for the August 17, 2010 meeting on GSE reform, the GSEs were losing millions of dollars every hour. Why? Because home prices are falling again. We have a solution.

Recent Market Changes: When the tax credit expired on April 30, home buying activity slowed 30%+ and hasn’t rebounded much while the number of homes for sale has risen. With lower demand and higher supply, it is once again a buyer’s market, where sellers are forced to drop price if they want to sell. It will take almost 1 year to sell every home on the market right now! According to our proprietary survey of home builders across the country, new home prices nationwide have dropped 3% since the tax credit expiration, with declines in 9 of 10 regions, and we are seeing similar signs in the resale market. Falling home prices hurt almost everyone, especially Fannie Mae and Freddie Mac and the taxpayers that are now backing them.

Falling prices do not hurt buyers who want to see lower prices, but lower prices certainly do harm banks and now the US taxpayer who is backing the housing market.

DC Trip: This month, we spent time in Washington D.C. informing HUD, Treasury, Fed, Fannie Mae and Freddie Mac officials of what was going on. While most were not surprised about the price declines after we laid out the facts, we were pleasantly surprised at how much traction our proposal to help alleviate the problem received.

Proposed Rental Housing Solution: Falling home prices don’t help anyone, and anyone who says we can let the free market take care of things is saying that it is ok for taxpayers and the banking system to lose many more billions of dollars, virtually assuring another recession and maybe worse.

Falling home prices do help sidelined buyers, and yes, it is okay for taxpayers and the banking system to lose billions of dollars. I don’t think anyone really gives a crap about the banks, and if the taxpayers lose money perhaps those in charge that made taxpayers liable for losses they shouldn’t be covering will be punished. Probably won’t happen, but Ms. Jackson needs to recognize that not everyone shares her view that lower prices are the root of all evil.

To boost housing demand and limit supply, we propose the following:

1) Create an Apartment REIT: Distressed sales need to be kept off the market. Rent out the Fannie, Freddie and FHA REO (owned properties through foreclosure). These properties currently comprise 42% of the 562,000 REO and a large percentage of the 5.1 million homes currently in the foreclosure pipeline (already 90+ days delinquent or in foreclosure). This is best accomplished by contracting with an outside firm (competitively bid of course) to manage local property management firms. The rental income will be self-sustaining and the properties will be financeable in the public markets, just like publicly traded REITs are financeable. The GSEs will benefit from future price appreciation too, as opposed to being damaged by further price deterioration. The Banks, who currently own 22% of the REO, should also be allowed to contribute properties to the REIT. The Administration can keep pushing for loan mods if they want, and we heard over and over again how government doesn’t want to foreclose on people. All we ask is that you keep the distressed sales off the market.

Some form of toxic turd fund as described above is the most likely solution to this problem. Renting a property is a far superior form of asset utilization than long-term squatting. People who are paying neither a mortgage nor rent need to be forced out or converted to rental status. In the post How Gaming Interests Could Save the Las Vegas Housing Market, and Why They Should, I laid out a private market solution that keeps owners in their homes and allows them to buy the property back at a later date. If this rent-to-own feature is added to the above proposal, I think the final piece to the puzzle will be in place. Of course, banks will resist the rent-to-own idea because it will encourage accelerated default, but if the government was really interested in keeping people in their homes they could do that. (Which shows where the government’s allegiance is.)

Consider this: any loan requires some steady stream of payments to pay interest and recover the original capital. Since the loan balance is already set by the oversized loan of the bubble, and since the only available income stream is property rent, the GSEs could modify the interest rate on the loan to be as low as necessary to have the rental income stream pay off the loan over a 30-year term. In this fashion, the “loan” could be kept alive on the GSEs balance sheets and the debt can be retired over time by the rental income stream. There is no need to write down the loan balance if they have a steady income stream and if they control the interest rate. The taxpayers would avoid any paper losses backstopping these loans because the capital is preserved.

Once properties go REO, the GSEs can (1) keep the loan alive, (2) pay it down with the rental income from the property, (3) and offer the property to the former owners with an option to repurchase. This allows the GSEs to avoid costly write-downs, keeps people in their homes, and prevents a wave of foreclosures from pounding prices back to the 1990s like they have in Las Vegas. Isn’t that what they are trying to accomplish?

2) Loans to Landlords: To stimulate demand and restrict supply on non-GSE distressed sales, have the GSEs make very safe loans to individuals or corporations who will promise to rent them out for an extended period of time. The GSEs should make a tidy profit on these loans, while also helping provide affordable rental housing to those who need it.

Sign me up for 10 of those loans. I want to buy cashflow properties in Las Vegas, keep them off the resale market, and provide an affordable rental. If they want to loan me cheap money to accomplish this, I will take all they want to offer.

3) Keep Mortgage Liquidity Flowing: Housing is extremely affordable right now [except in Coastal California], but the uncertainty in the mortgage industry is making underwriting more challenging, and uncertainty in the economy is hurting buyer confidence. Stop changing the underwriting rules so everyone knows what is required, and keep the fantastic financing environment. Once the economy turns around, real buyers will return to the market.

That is a fallacy. Many people who want to buy real estate will not be eligible to obtain a loan regardless of their income. The rent-to-own solution I outlined above will help alleviate this problem, but to suggest that buyers with good credit and a substantial down payment will suddenly emerge once the economy picks up is wishful thinking. It is a delusion everyone in the industry suffers from, particularly lenders.

We believe that the solutions above will also help restore home buyer confidence that prices won’t plunge, which will boost demand.

That is a strong acknowledgement of the deflation psychology that rules the markets; although, I believe qualification standards create more problems then buyer psychology.

GSE Reform: As far as GSE reform goes, the answer is simply to turn back the clock. Fannie Mae was formed in 1938 to create mortgage liquidity, and the GSEs have played a very useful role in preventing another Great Depression, so we still need them. However, the GSEs need to be told ASAP that elected officials are not going to pull the rug out from under them so they can focus on helping manage us through the remainder of this crisis. Turn back the clock to:

  • 1967, which was the last year before Fannie Mae became a publicly traded corporation. It is impossible to serve two masters, and allowing the entities formed to assure mortgage liquidity to have their strategies dictated by shareholders was a grave mistake.
  • 1998, which was the last year before elected officials mandated that Fannie and Freddie grow homeownership by making more aggressive loans to low income households.

You can’t go back. That simply isn’t going to work. I discussed these issues in Can the GSEs Exist Outside of Government Conservatorship? We need to have a secondary mortgage market because it is the only way banks can manage asset-liability mismatch, but the GSEs are not the only method for maintaining a secondary mortgage market. As they are current structured, there is no way they can exist without the explicit backing of the US government. Any attempt to pretend they don’t have this backing will be a joke.

We are sure this will create some controversy, particularly among extremists. I am staying out of the politics and making recommendations that we believe are sound business advice. For those who are running the troubled balance sheet of The United States of America, you need to act quickly to make sure that your asset values don’t plunge. Only those who want to see you go bankrupt will oppose these ideas.

Sorry, but there are many reasons to oppose these ideas that are not extremist nor do they require a desire to see the United States go bankrupt. Give me a break.

Despite the occasional hyperbole, the ideas presented are good. If we add in the ability to keep owners in their homes with a rent-to-own arrangement, I think this proposal has real merit. If some solution like this is not implemented, we will see a repeat of the Las Vegas experience in every housing market in the country.