Oct042010

Should Government Mortgage Subsidies Be Offered to Cashflow Investors?

In housing markets where a significant number of properties are being converted from owner-occupied to rental status, there is no government program or help for this transition to occur. Without government help, prices fall far below fundamental valuations as the imbalance of supply and demand becomes extreme. The only solution is to reduce supply and increase demand. To accomplish this, I propose that the GSEs promote investor programs that reduce the cost of ownership to small investors and encourage them to keep the supply off the resale market.small_investors

I am about to argue for something that would benefit me personally, so take everything which follows with a dose of skepticism. I would like to think I can set my personal biases aside and propose a solution better than those coming out of Washington. Feel free to disagree.

Should Treasury Help Investors Become Landlords?

Emily Peck — September 27, 2010

The government’s tried a lot of tactics in propping up the housing market: Tax credits for home buyers. Mortgage modifications for distressed homeowners. A program to buy up mortgage-backed securities.

Now, some analysts from Bank of America are proposing another plan: Help investors buy up distressed homes and rent them out.

In a recent research paper, the BofA analysts frame this as the second phase of the Public Private Investment Plan. Funded by TARP, which expires Oct. 3, PPIP offered investors funds and credit to buy up residential and commercial mortgage backed securities. The paper calls that program an unqualified success for driving up the value of mortgage backed securities.

Through their proposed PPIP 2, Treasury would use the same model to help investors to directly buy up foreclosed homes.

The analysts propose funding the purchase of up to $400 billion worth of homes by a select group of property management companies given the task of home oversight. Treasury could provide, they suggest, up to $100 billion in equity, matching the property management companies, as well as up to $200 billion in debt capital.

I like the basic idea of helping investors to purchase homes and convert them to rentals. I really hate the idea of it being done as another form of crony capitalism where the select few chosen by the Treasury department would get to make all the money. There is a much better way to make this happen.

The analysts propose that PPIP 2 investors be required to hold on to these homes for a certain amount of time, to avoid weighing the market down with low-priced foreclosed properties.

The U.S. homeownership rate, at about 67%, is “adjusting to a more natural level of 62-64%,” the analysts write. That means we’re in the process of converting owners to renters–sometimes painfully via foreclosure. The authors write that some of these folks probably never should have owned homes anyway and, since modification won’t (and doesn’t) always help them, the ability to rent distressed properties might do the trick, while also avoiding a flood of foreclosures onto the market.

This is exactly the problem. The home ownership rate must fall. Far too many people who were not prepared for home ownership were given title to property. These people must go back to being renters, but there is no mechanism in place to cost effectively make this transition. in fact, since investors loans carry a higher interest rate and are difficult to qualify for, there are roadblocks to this transition that must be removed.

The authors say that they haven’t seen any proposal along these lines. One possible reason? TARP fatigue. From the paper:

To put it mildly, in spite of its successes, TARP has not been particularly popular. We believe reauthorizing this type of spending on even a limited basis would be next to impossible, at least until after the upcoming election.

I agree; doling out another crony payoff is not going to be very popular either before or after the election. This is a transparent corporate giveaway that people are growing tired of.

The real reason you haven’t seen proposals like this is because everyone in the administration is still focused on owner occupants. There have been no policies implemented or discussed that might hurt the home ownership rate — even is such a policy will help reduce taxpayer losses. A high home ownership rate has become a sacred cow in Washington, and until we admit maximizing the home ownership rate may not be a good thing, our policies will continue to be counter productive.

The GSEs should insure investor loans

Let’s start by acknowledging that the GSEs no longer have any semblance of what they used to be. They were founded to support a secondary mortgage market and make capital available for low and middle income Americans to buy homes. Since they went into conservatorship in 2008, they have been largely used to prop up the housing market. Let’s acknowledge that their primary function is currently to prop up the housing market by providing mortgage insurance at below-market costs to stabilize the housing market.

Once we accept the new role of GSEs, we can then discuss how this can best be accomplished. Our current policies are geared toward keeping owner-occupants in properties and Prop Up the Flagging Owner-Occupancy Rate. This policy will largely fail because many homes have to be converted to cashflow rental properties. If the government and the banks really want to limit their losses on mortgage loans (and GSE mortgage insurance), then they need to focus on how they can raise the property bids of cashflow investors.

If the GSEs offered the same loan insurance to cashflow investors as they do to owner-occupants so that interest rates were similar, and if the rental cashflow from the property could be counted toward the qualifying income, bids from cashflow investors would be much higher. Think about it: if you lower the cost of ownership for investors and make it easier for investors to qualify, you will get higher bids and more investor competition for properties. This in turn will raise prices and reduce the losses both banks and the GSEs will endure on those properties that must be converted from owner-occupied to rental status.

The truth of this fact is plainly obvious when you look at Las Vegas’s housing market. The home ownership rate in Las Vegas is going to drop 25% or more from the 2006 peak. Nearly every household there is underwater, and they have little or no hope of price recovery. Accelerated default is the norm, and a huge number of homes are currently being converted from owner-occupied to rental status. Each time this happens, some lender is losing a fortune, and the only way to stop the bleeding is to raise the bids for cashflow rentals. The only way that is going to happen is to lower the cost of ownership for investors and increase the size of the borrower pool by qualifying more investors.

This is a problem I am very familiar with. I know the math as I face it myself with each property I consider buying personally. I know that investors pay a higher interest rate, face higher equity requirements, and have fewer loan programs that consider the rental income in qualification (it still must be cashflow positive). Each of those barriers lowers my bid for any particular property, and since everyone is facing the same issues, it lowers everyone else’s bids as well. Lower market bids for these properties make for larger lender losses.

If the government and the GSEs were serious about combating this problem, the GSEs could offer relief in these areas (interest rates, equity requirements, and income qualification) to investors who agree to keep the properties off the market as rentals for three to five years. That would keep these properties out of the for sale market (or the loan would have a stiff financial penalty), and the reduced supply would also help stabilize prices.

This doesn’t have to be some crony capitalist handout. It could be a grass roots program for small investors and prudent savers with good credit — you know, the people who have been being screwed at every turn in favor of banking interests and corporations with all the bailouts. I openly admit my personal bias, but I still believe this is a good idea that would be far more effective than any of the programs that have actually been implemented to date.

What do you think? Has the time come for the GSEs to help the small investor clean up this mess?