Perfect Storm for Foreclosures – Obama’s Katrina?

Get ready for a perfect storm — a Category 5 foreclosure tsunami.  The first wave was launched on February 17 when FannieMae announced an extension of the temporary halt to foreclosure sales (Lender Letter) to March 6, 2009.  The second wave came on February 18 as President Obama announced the Homeowner Affordability and Stability Plan (HASP).  This Plan included the start of the third wave of this storm — the announcement that Guidelines will be released on March 4, 2009.  When these three events collide on or around March 4 – 6, hundreds of thousands of homeowners, investors and tenants are going to wake up to find themselves adrift in a stormy sea of chaos with no life preserver.

Unless the Federal government comes up with a miracle when it releases the much-anticipated Guidelines on March 4, we can anticipate a sharp increase in the number of foreclosures that will be filed and/or processed.  Moreover, the sheer number of foreclosure actions currently pending in the nations’ State courts will have to be processed off the books.  The same day as President Obama announced his plans for mortgage relief, the WSJ carried an article about a Judge in Lee County, Florida, running a “rocket docket” to clear the backlog of pending foreclosure actions.  He only had two questions for the homeowners:  Are you current?  Do you still live there?  For those who answered “No” to the first and “Yes” to the second, he gave them 60 days to work out a deal or move out.  President Obama, in his Feb 18 speech, pretty much left only one option for those who were not current on their payments — Bankruptcy court.  Although lenders generally would like to avoid this option, borrowers have little hope that the results will be any more favorable.  There is very little sympathy for the borrowers in these situations, and therefore very little political will to launch a rescue effort.

Adding to the chaos of this bleak forecast is the fact that hundreds of thousands of borrowers are being swindled by loan modification scams promising to “stop foreclosure now” and “save your home.”  Although these so-called “loan mod experts” have been around for years, their business took off in the past couple of years as the Federal government put pressure on lenders to voluntarily work out new terms in order to keep people in their homes.  Unfortunately, approximately 60% of the loan modifications that were worked out have gone back into foreclosure.  The blame seems to fall evenly between the lenders’ meager concessions and the economy’s continuing decline.   It doesn’t matter what new terms you agreed to in January if you got laid off in February!

Unless the HASP Guidelines includes a miracle and not just a placebo of unrealistic conditions, and unless Fannie Mae and the lenders extend the moratorium on foreclosures, we can expect foreclosure hell to break loose in early March.  Sadly, the impact will be devastating on families, neighborhoods and communities across the country that are already suffering from the blight of foreclosures.  The Obama Administration must recognize that this situation is akin to a Category 5 economic storm that will rage across the entire country, and must respond accordingly.  Failure to do so will make the Bush Administration’s response to Katrina seem benign in comparison.

New Homeowner Mortgage Relief Plan Announced

President Obama has announced his new initiative to provide relief for homeowners caught in the mortgage crisis.  Summaries have been posted by the WSJ and the Washington Post.  What is clear is that President Obama is attempting to walk a thin line between arresting the foreclosure spiral while trying not to upset those outraged by bailout abuses.  The focal point of the Homeowners Affordability and Stability Act (HASP) is to help the homeowner who has been trying to meet payments but cannot qualify for refinancing because their home values have been shattered by falling housing prices.  What the Act does NOT do is address what will be done for those already behind in their payments or who have already entered the final phase of the foreclosure process.  It will be interesting to see what happens when the current foreclosure moratorium announced by several lenders expires next month.

Clearly, the mortgage relief is NOT aimed at “the unscrupulous or irresponsible speculators who took risky bets” or “dishonest lenders.”  However, in the text of President Obama’s speech, he makes it clear that the Administration will continue to “support reforming our bankruptcy rules so that we allow judges to reduce home mortgages on primary residences to their fair market value — as long as borrowers pay their debts under a court-ordered plan.  That’s the rule fo rinvestors who own two, three, and four homes.  It should be the rule for ordinary homeowners too, as an alternative to foreclosure.”  In other words, the newly announced Act will not provide any direct relief for homeowners or investors facing bankruptcy, but President Obama has send a strong signal that his Administration supports the authority of Bankruptcy Judges to reduce mortgage debt by court order.  The Lending industry will undoubtedly see this as incentive to continue to negotiate loan modifications.

Yogi Berra said it’s tough to make predictions, especially about the future.  The Plan announced today will be followed up by the release of guidelines which will go into effect on March 4th that will affect the entire mortgage industry.  As the President said, “Any institution that wishes to receive financial assistance from the government, and to modify home mortgages, will have to do so according to these guidelines.”  The target is to get lenders to reduce interest rates and make other adjustments so that the mortgage payments will be no more than 31% of a borrower’s income.  If you’re a mortgage broker, you’re going to be very, very busy.  If you are a Lender, you will be looking closely at how you can conform your program to the new guidelines.  If you are a homeowner who is behind in payments and trying to negotiate a loan modification, you may find a more cooperative attitude.

I will post updates as the picture becomes clearer.  One tip from the Washington Post — if you are already involved in a loan mod workout, notify your lender or loan mod representative that you want to be considered for eligibility under the terms of the Homeowner Affordability and Stability Plan.  If nothing else, this should buy you some time while everyone attempts to sort it out and figure out what it is.

Fannie Mae says Ten Okay with Reserves

Starting on March 1, 2009, Fannie Mae will allow individual real estate investors once again to refinance up to ten (10) properties, relaxing the stranglehold limit of four that kicked in during the Summer of 2008.  According to the Announcement (09-02) issued February 6, 2009, the borrower will be subjected to some new requirements, including no history of bankruptcy or foreclosure within past seven years, no delinquencies on any mortgage loans in past 12 months; rental income must be fully documented; and borrowers must have six months reserves on the subject property and on each other financed second home or investment property.  In addition, the real estate investor or borrower must have a minimum credit score of 720, and the maximum LTV will be 70%.

Fannie Mae is expanding the definition of “reserves” to include all components of the monthly housing expense (PITIA), including principal and interest, insurance premiums, property taxes, special assessments, association dues, and any monthly cooperative corporate fee.

The Effective Date for multiple mortgages up to ten financed real estate properties will be March 1, 2009.  Fannie Mae has encouraged all lenders to implement the reserve requirements immediately and will apply them to all whole loans purchased by Fannie Mae on or after June 1, 2009.

Loan Mods and Deep Breathing

Upside down on your home loan?  Real estate investment property vacant?  Don’t know what advice to follow?  Should you walk away or let it go to foreclosure? File bankruptcy?  Hire a loan mod specialist?

Homeowners and real estate investors are scrambling to cope as the economic crisis hits home — literally.  Even in California, property owners are waking up to the harsh reality that their homes and real estate investments are worth less than what they owe on their mortgages.  Add the misery of a layoff or news that an investment has gone sour, or the fact that your 401(k) has suffered a 30% drop in value, and you cannot make the payments.  What can you do?

Three steps to get out of the muck

First, CALM DOWN, don’t panic.  The threat of losing one’s home is certainly grounds for concern, but if you panic, you are more inclined to do do the wrong things.  People who panic tend to listen to bad advice, especially when it comes in the form of a promotion making ridiculous promises.  Most of this advice comes from people who are trying to make money, not people who are trying to help you.

Second, GET BUSY!  The process of working through a loan modification takes time, and requires a lot of hard work on your part.  You will need to demonstrate that you will be able to make the payments if and when the real estate loan modification is approved.  This will require you to make some tough financial decisions, get your financial records and documents in order, and probably make some adjustments to your plans.

Don’t blame yourself or others.  It only serves to waste time and energy that you will need to develop a solution.  Instead, make a Plan.  Ask yourself, “What do I want to do?”  “Where do I want to be?”  Chances are, if you are facing the prospects of a layoff, or have been unable to make mortgage payments, or are facing the prospect of foreclosure, you’ve been caught up in the chaos of the moment, and haven’t taken time to focus on the future.  Working through a loan modification process only makes sense if you have a clear idea where you want to end up.  In the end, it may make sense to short sale a property, or let it go into foreclosure, but only if it helps you to get where you want to end up.

Third, take ACTION.  Get help now!  Consult with a professional and explore your options.  I recently received a call from a distraught individual reporting she had been evicted that morning by the Sheriff from the home she had owned for 20 years.  Not an ideal time to start getting legal help!

Before you sign up with someone advertising loan modification services, find out exactly what they will do for you. Look for a real estate attorney or a specially registered real estate broker.  Pursuant California law, in many instances real estate brokers cannot charge you a fee in advance unless they have been approved by the Department of Real Estate (DRE).  Attorneys licensed to practice in California are exempt from this requirement, but make sure they are experienced in real estate law. For more information, see the Consumer Alert by the DRE: http://budurl.com/DREAlert

Fourth, reread step three and take ACTION.  Too many individuals become paralyzed by worry.  Your circumstances will not improve without action.  So, take a deep breath and pick up the phone. Contact a professional experienced in loan mods who will get started right away.  The sooner, the better.  It may cost you some money, but with the right help, you will be able to avoid even more costly mistakes.

The Five “P”s of Prudent Real Estate Investing

or, How to Avoid Legal Problems in Real Estate Investments

(c) 2009 by Jeffrey B. Hare, Attorney at Law

The only sure way to avoid legal problems associated with real estate investments is do nothing.  However, if you want to get involved in real estate investing, you need to follow Rule Number One:  do your Due Diligence.   Although many investors and real estate professionals are familiar with the term “due diligence,” they don’t always follow through.  Many real estate agents limit their “due diligence” to a series of checklists concerning the property, such as confirming the zoning, evaluating the condition of the buildings, and looking for evidence of hazardous chemicals, earthquake faults, or underground tanks.  These are important considerations, but for the real estate investor, “due diligence” involves a lot more.

To keep this simple and easy to follow, I have summarized the key points into a program that I call the “Five P’s of Prudent Real Estate Investing.” The Five P’s are:  Plan, Property, People, Payment, and Patience.  If you take the time to understand what each of these five stages involves, you will have taken a major step towards avoiding most of the legal and financial problems that can overwhelm the real estate investor.  Let’s get started.

PLAN

There are two aspects of the planning stage:  Personal and Financial.  You should carefully evaluate your Personal Goal — what do you want to be doing in a few years?   Stop.  This is a critical step in the process. What do you envision yourself doing in, let’s say 8 – 10 years from now. If you don’t know where you’re headed, you won’t know how to get there.  Form a mental picture of what you see yourself doing in a few years, and hold that vision while you proceed with this article.  Then come back and re-evaluate your vision.  Ask yourself, “Is it realistic?”

One additional note about the importance of having a clearly defined and realistic personal goal is that it will help you quickly and efficiently identify and eliminate distractions that will NOT get you to where you want to be.  Thanks to the Internet, you will be quickly overwhelmed with opportunities, options, and deals, each one promising to be “The Deal You Can’t Miss!”  If you know where you’re headed, you will be able to quickly evaluate and eliminate many of these distractions and focus your energy and resources on those deals that will help you reach your goal.

The second aspect of the Plan stage is looking at your Financial Goal. Part of the process of evaluating your Personal Goal is figuring out how to make sure you can afford to do what you want to do:  cover the cost of your lifestyle, provide financial security for your family, earn enough to live comfortably.  You need to plan for contingencies, medical conditions, and of course, changes in the economy (if the recent downturn wasn’t enough of a lesson!).  You should consult with a qualified, professional financial planner.   Each and every person’s situation is different, but your Financial Goal should be designed to support your Personal Goal.

STOP: Keep in mind that you should periodically reevaluate your personal and financial goals.  They are targets, not prison sentences.  You can modify them to suit your circumstances.  But you should keep them both in focus, and know if you are on track to reach them.  If you stray from your path, make the necessary course corrections or reconsider your Plan.

PROPERTY

As I mentioned earlier, most real estate agents focus their due diligence on the property, which is important.  The investor should also evaluate the property as well.  There are three key aspects to consider.  They are Purpose, Location, and Condition.

Let’s start with “Purpose.” Is the property you want to invest in suitable for the intended purpose? Does it comply with existing zoning regulations?  Does it meet building and fire code requirements for the intended occupancy?  Is the lot large enough to allow for sufficient parking, ingress and egress, signage, and even expansion?  Does it have adequate sewer, water and access to utilities?  Just because a property is available at a good price does not mean it is suitable for your investment purposes!

Next, let’s consider the all important “Location, Location, Location.” Here, you should consider both the environmental and economic factors.  While it is important to consider such factors as the proximity to transportation routes, good schools, convenient shopping, and other amenities, do not overlook the importance of other significant factors.  For example, is the property subject to natural hazards, such as flooding, wildfires, tornados,  or other extreme weather?  Equally important (for the success or failure of your investment objectives) are factors such as the diversity of the local job market, stable housing prices, and rental rates.  Does the area have a history of relatively low unemployment based on a diverse economy, or is it overly focused on a single industry that could suddenly collapse? (think Detroit).  Is there an overabundance of housing driven by development rather than housing demand? (think Stockton).  As the saying goes in the Music Man, you “gotta know the territory.”

The third aspect of the Property consideration is, of course, the Condition.  Here, you should focus on the cost to bring the structure to “rent ready” condition, whether the improvements will be paid by the owner or the tenant.  One word of caution:  many older residential and some commercial properties may be eligible for listing on local, state or national historic registers, and may be subject to strict regulations governing modifications of historic buildings.  Modifications can be exceedingly expensive, and local officials may require that the structure be restored rather than remodeled.  Last, but not least, do not rely on disclosures.  Always insist on conducting your own inspection as a contingency under any purchase and sale agreement.  Watch out for mold, asbestos, vermin, termites, dry rot, and other evidence of deterioration that can be very expensive to repair.  Don’t forget to look for nearby drainage channels, sewer or septic hookups, possible easements, overhead high voltage wires, and possible neighborhood nuisances (under a flight path? backs up to a shopping center or night club?).

STOP: Reality check — this is real estate investment property, not your dream home.  It doesn’t have to be perfect.  If it was perfect, you wouldn’t be getting such a deal, right?  Also, at the right rental rate, your tenants will be happy to have a safe, secure and clean place to live — they probably don’t expect or want to pay for a Palace!  Be practical — but keep your eyes open and be prepared to deal with these issues.

PEOPLE

As an investor, your intention is somewhat different than that of a property owner.  You probably own your own home (or are making payments towards that goal).  In making decisions about your home, you most likely consult with your Spouse or significant other.  However, when you act as an investor, you need to consider putting together your team.  That’s correct —teamS.  One team will consist of yourself and your Investment Advisors or consultants. The other team will consist of yourself and your Investment Partners.

First, if you are just starting out as a new investor, you should assemble a team of individuals with the professional expertise to provide you with competent advice on different aspects involved in real estate investments.  I previously mentioned you should consult with aFinancial Planner, someone who can provide an objective and professional perspective on your financial situation and goal, and advise you on how best to structure your financial plan.  You should also use the services of a Certified Public Accountant, commonly referred to as a CPA.  This individual can provide important advice as to the impacts of capital gains taxes, depreciation, deductible expenses, and other financially critical matters that will affect your decisions.  You will need Brokers, both for real estate transactions and to help you get financing for the acquisition phase, and whenever you seek to sell investment property.  The right Broker can be worth many times their commission if they help you get a better understanding of local economic conditions, know the neighborhoods, and even help you get financing.  You will also need a Property Manager, a very critical element in the success of your investment structure.  Property Managers help you find and screen tenants, help maintain your property, and keep the value of your investment intact.  Last, but not least, you need an Attorney.  Keep in mind that your family attorney may be great with wills and trusts, but may not have a background or training in land use or real estate issues.  Also, they may or may not be licensed to practice law in the same state where your investment property is located.   Together, the primary function of this Team of Advisors is to provide assistance to you in helping you achieve your investment goals, not theirs!  As you become more experienced in real estate investment issues, you will quickly become more selective in both who you have on your team, as well as to how you will use their services.

Second, you need to consider assembling a team of Investment Partners.  Many investors lack sufficient capital funds when they are starting out, and need to line up equity partners, lenders, and other investors in order to make their deals work.  This is probably where your Attorney can prove to be the most valuable — helping you determine how best to organize these individuals so that in the end, you achieve your goals.  For example, you will need to determine the correct form of entity to use when different people are involved:  will it be a partnership, corporation, Limited Liability Company (LLC), or a Tenancy in Common (TIC) arrangement?  Who will control the decision-making process?  How will expenses and profits be allocated?  What happens if one of the partners refuses to contribute their fair share of an emergency repair?  Is your system set up so you can add additional investment partners in the future?  Is the investment structures so that it can take advantage of tax deferral strategies, such as a “1031 Exchange?”  (Note:  if it is held in an LLC, it may not be possible for an individual member to use this common but effective tax-deferral method).

Last, but certainly not least, you must include your Spouse, if you are married.  Perhaps nothing is as catastrophic to an investment plan if the Spouse is left out of the loop, or not involved when they should be.  More important than providing legally-required signatures and consent, your Spouse often serves as your closest and most trusted investment advisor, someone who knows your goals better than anyone, and can provide a critical “reality check” when you might otherwise get carried away in the passion of “the deal.”

PAYMENT

At some point in every investment decision, there is a bottom line.  You will have to make payments (mortgage, insurance, taxes, fees), and in order to do so, you need to receive payments (rent, sale price).  The total amount of the first type must be covered by the second, or your investment goals will not be realized.

To purchase real estate for investment purposes, you need to get financing that is different than the type of financing that you need for “owner-occupied” property.  For the new investor, especially someone who just purchased their first home, it often comes as a surprise that financing for investment property may include very different terms and conditions than what they expected.  At the same time, you may have resources that were not available to you when purchasing your home.  For example, you may be able to use a Home Equity Line of Credit (or HELOC), or a loan from a relative, or even funds from a Self-directed IRA (”SDIRA”).  A qualified Mortgage Broker can provide you with options and opportunities.  However, in general, you should expect to have to come up with between 30 – 40% down payment, plus pay a slightly higher interest rate on any loan you may be able to secure.

A quick note about using SDIRA funds to purchase investment property:  It is perfectly legal to use your IRA funds to purchase investment property; in fact, it is uniquely suited to such transactions since regulations prohibit you from using SDIRA funds for any property that you would use (such as your home, your office building, or your vacation property).  However, in order for you to successfully use a SDIRA for investment purposes, you need to take steps to set up the account, roll over your exisiting 401(k) or other eligible Pension Plan fund, and work with a Plan Custodian, like Pensco Trust, that will allow you to use SDIRA funds held by them to invest in real estate.

To make the payments, you will need INCOME.  Of course, the ideal situation is an investment property that produces both positive cash flow (rental income is greater than mortgage payments, interest, insurance, property taxes, maintenance, emergency repairs, vacancies, and property management fees), and appreciates in value so that the net proceeds from the eventual sale of the property are more than any existing encumbrances on the property.  To ensure the highest probability that you will receive steady and sufficient rent, you will need to consider all of the factors (and more) mentioned under the Property section, above.  Just because you can get a great price on a property in the central valley of California or in a downtown area of Detroit does not mean you will be able to find qualified tenants willing to pay sufficient rent.  Again, you “gotta know the territory.”  And, you have to plan for contingencies … you will experience unexpected maintenance costs, emergency repairs, and periods of vacancy.  Plan accordingly.

PATIENCE

As the old prayer goes, “Lord grant me patience, but grant it NOW!”  The importance ofPatience, the 5th “P” in this article, is underscored by the need to dispel the myth of the “get rich quick” scheme.  Many individuals were, and some still are, successful doing “flips,” where they acquire title to property, do some quick repairs, then turn around and sell the property for a substantial profit.  Is this possible?  The answer is yes, but more and more it is exceedingly difficult.  One reason is that with the credit crunch, not many individuals are able to get financing, so the “flippers” are finding themselves holding onto property much longer than they planned.  Since they often used “hard money” loans or other types of “borrowed” funds, they often find themselves owning more and more of the anticipated profits from the planned “flip,” and often must drastically reduce the selling price or start renting it out.  The true “value” of a real estate investment is built over time, both from incremental rental increases and from appreciation in value over time.  The smart strategy is to be patient, build a solid investment portfolio, and let it grow in value over time.

Conclusion

The foregoing Five “P”s are intended as a short-hand checklist of the key elements to be considered as part of your overall investment strategy and to help you do your “Due Diligence.”  Of course, you cannot eliminate risk, and you cannot guarantee that you will never have legal issues.  But you reduce the probability of legal problems by taking the foregoing steps.