Washington, DC, Delinquencies and Shadow Inventory

The Mortgage Banker’s Association reported that the seasonally adjusted delinquency rate for mortgage loans on one-to-four-unit residential properties fell to 7.99% in the third quarter of 2011, the lowest level recorded since the fourth quarter of 2008. While any decrease is good news, don’t get too excited just yet– it’s a decrease of just 45 basis points.

The delinquency rate is an important one to follow because it’s one of the best leading indicators we have for predicting ‘shadow inventory.’  Shadow inventory is the elusive backlog of future foreclosures–that is, homeowners who are inevitably headed towards foreclosure but the paperwork is still going through so the bank has yet to take possession of the house and/or list it for sale.  Foreclosure processes vary widely state to state, and it’s notoriously difficult to predict when a property will actually hit the market.  Buyers and market bears are always shouting about the huge backlog of inventory coming down the road, dooming recovery progress in the shaky housing markets.  Yet here in the DC area we have been waiting years for this alleged ‘tidal wave.’

I wouldn’t hold your breath.  First, these delinquency stats have been relatively stable for years, and we haven’t seen the big bump in foreclosures yet in our area–the fact is that our local market (particularly close in Northern Virginia and DC) has remained strong enough to absorb foreclosures and short sales as they come to market.  Second, remember that banks control the inventory they take possession of, and they are well aware of the laws of supply and demand.  If a bank is trying to recoup as much value as possible, why would they flood the market with inventory, thereby depressing prices?  The carrying cost of a property for a bank is minimal–after all, they don’t pay themselves a mortgage–so the only real incentive for them to get properties off the books is regulatory requirements that affect the amount they have to hold in reserves.  So it’s a big of a juggling act for banks.

Delinquencies, of course, are tied to unemployment rates: no job = can’t pay the mortgage = delinquency.  DC’s strong job market is another reason we don’t see the avalanche here that other parts of the country might experience.  But stay tuned…the lack of a budget deal from the super committee could mean serious cuts in government spending in our local market.

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Buyers May Not WANT Condo Docs for Short Sales & Foreclosures

I was quoted in the Washington Post yesterday for my recommended strategy of NOT asking for condo docs on a foreclosure or short sale.

In the original article here, the author discusses the fact that:

Virginia law requires sellers or their real estate agents to get a presale financial disclosure packet from the association and give it to buyers. Buyers have three days to review the financial disclosures and rules governing life in the association and can back out of the deal if they don’t like what they see. In Maryland, buyers have seven days in which to review the documents and cancel the purchase. In the District, buyers are allowed three business days.

The challenge with short sales and foreclosures is that the sellers either can’t or won’t provide these documents (which come with a charge of several hundred dollars.) This leaves buyers in a tough spot — they don’t know whether there are any problems with the Association’s finances, for example, because they never received the packet. Sometimes buyers can pay for the pack themselves, but often Associations won’t give them to anyone but a current owner.

BUT, there’s an upside to this frustrating situation: Buyers who never receive the packet retain their right to back out at any time up until, and for 3 to 7 days after receiving them (depending on jurisdiction). See my quote here:

Katie Wethman, a real estate agent in McLean, pointed out a way to game the system. “It can be a strategic choice not to ask for the documents,” she wrote. “Buyers retain a right of rescission up until, and for three to seven days after, the receipt of the documents. If the buyer is concerned about timing, financing, finding a better deal, or just getting cold feet, they may wish to delay receipt of those documents as long as possible. They may forgo them altogether in an attempt to keep their right to walk away right up until settlement.”

So talk to your agent about your situation and whether it makes sense to try to obtain the documents or not…you may come to regret having asked for them.

Scared about taking on a short sale or foreclosure home because of the rehab work involved? Consider purchasing one using an FHA 203(k) loan, described in my blog post here.

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Finding an Investment Property in Northern Virginia

As prices plummet, some solid investment opportunities are starting to emerge…but how do you identify good investment properties?

Step 1: Identify some target neighborhoods.

– The first thing to do is to consider long term (e.g., 10 years) appreciation potential. Think about area employment (and more importantly where those employers are—commuting time is a big factor). Also think about long term demographic shifts like BRAC, as well as infrastructure projects like new metro stations or light rail lines.
– Consider the neighborhood. Ideally you want to find the lone problem house in a great neighborhood, but that’s easier said than done. Also consider neighborhoods that previously had been more desirable in terms of age, location, and home condition, but perhaps were hit hard by this recent wave of foreclosures.
– Consider the price range – While you hope to ultimately find a property that will be cash flow positive, you nonetheless have to front the money to buy it, and getting a loan these days isn’t easy, especially for investors. Financing remains a problem, and lenders require investors to put 30% down, plus closing costs of about 3%. Interest rates run about a percentage point higher than owner occupied properties. Figure out how much cash you’re willing to put into the property, what you can qualify for in a mortgage, and back into a price range from there.
– Look at rents the neighborhood can command. Once you identify a few target neighborhoods, begin collecting rent data. The best place to collect rent data is on Craigs List in addition to the MLS. This is because many landlords conduct the process themselves and so the listings are never in the MLS. You also can’t be sure how aggressive a listing agent was in procuring a renter, which may skew the price. If they put it into the MLS but then never on Craigs List (by far the more popular site for finding renters), then it’s likely the rents there are lower than what the market actually commands. Unfortunately there’s no easy way to gather historical Craigs List data – you just need to keep watching and see which rentals seem to go quickly. Consider calling some of the landlords to ask whether they’ve had a lot of responses.

Step 2: Identify some target properties

Short Sales & Foreclosures are a great opportunity because you can be patient. (See my post on the challenges of timing a foreclosure transaction here and the frustrations of shorts sales that never close here.) While an owner occupant doesn’t have the luxury of time and can get frustrated with all the problems of these transactions, investors can go with the flow since their timing is more flexible. And that flexibility pays off by getting properties for less money.
– Consider the home’s condition and your level of expertise in doing or managing renovations. Many of the short sales and foreclosures on the market today come at bargain prices, but require everything from heavy cosmetic work to kitchen and bath remodels to mold remediation. Very few properties in the attractive price ranges are move-in ready, but there’s a lot of upside for people not afraid of elbow grease and with the right handyman connections.
Be patient. You may need to wait for the right house at the right price. Set up an alert so that you can be ready to jump on a property that meets your investment needs as soon as it comes on the market—you can be sure other investors are circling and waiting for the right opportunity as well!

I’ve seen some inside the beltway single family homes below $400K and townhouses in under $300 in areas that I feel have great long term potential given our area’s strong job market and expected government growth (see this post on the best place to live in a recession here, and article on the bailout being a boon to our local economy here.)

In another post I’ll cover how to look at cash flows for an investment property.

I’m working with several investors and have already previewed many homes that fit the criteria above. Call or email me to set up an appointment to discuss investing opportunities!

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Short Sales: Are They Worth a Buyer’s Time?

Yes. No. Maybe. If you’re looking for an absolute, don’t bother reading this post. I’ll go out on a limb and say usually it’s a waste of a buyer’s time—the odds are certainly against it.

What is a short sale? It’s a sale where the debt owed combined with the costs associated with the sale exceed the property’s market value. Creditor(s) MAY be willing to agree to allow the property to be sold for less than the loan amount.

You can recognize these listings by key phrases in the comments section such as “short sale” or “third party approval required” or “lender approval required.”

As a seller, how do I go about a short sale?
Every bank is different. At a minimum, you will need to establish that you are financially incapable of paying the loan(s). You must submit W-2s, bank statements, tax returns, a “hardship letter” stating the reason the credit should consider granting a short sale, and other financial statements outlining your assets and liabilities. The hardship letter is particularly important. Stating that your house isn’t worth what you paid for it is NOT a hardship. You must establish why you are no longer able to afford the payments.

As a buyer, I keep hearing that Short Sales don’t close. Why not? Can I do anything about it?
Some close, but it’s true that most do not. A quick search of the local listings showed 282 active short sales. In the past 90 days, only 35 closed. That’s a very poor hit rate. Short sales are typically priced at or just below current market value, and that’s reflected in the close price of those 35 homes—average closed price was $367K versus an average list price of $373K—98% of asking!

The overwhelming majority of short sales don’t sell and/or close because of one of these reasons:
(1) They aren’t priced competitively so don’t get any offers. On the flip side, sometimes they are priced at a low price that the bank will never accept!
(2) The sellers have not met the lender’s requirements to approve a short sale (e.g., have not submitted a hardship letter or otherwise proven that they can no longer afford the payments
(3) A secondary or tertiary lien holder has not approved the sale (if the first lienholder isn’t getting paid in full, the guys behind him are making nothing, and so have zero incentive to sign off on a deal). Often in this situation they will ask for a personal Promissory Note from the seller. If the seller refuses, it will scuttle the entire deal.
(4) The lender has received all of the paperwork but is “stringing along” the seller to collect a few more payments
(5) The lender has received all of the paperwork but is planning on foreclosing and collecting the mortgage insurance.

Buyers have no control over any of these reasons. Sellers have limited control over some. But it only takes one of these to prevent a short sale, so the odds are against it. In particular, if the bank is bound and determined not to approve a short sale (reasons 4 and 5), then no one can make them. If a seller is determined that they do not want to attempt to repay any of their debts (reason 3) then it’s not going to happen. Reasons 1 and 2 have a much better chance of closing. But why would a homeowner and agent list a home when it’s either overpriced or when the paperwork isn’t in? Lots of reasons: naiveté, ignorance of or inexperience with the process, denial. Why would an agent waste their time with a listing that won’t sell? In most cases, there’s no real ‘cost’ to them. Agents decide individually how they want to market properties and how much they’ll spend doing so. So they choose to spend nothing, and infact, they still get some free advertising via the yard sign and mere existence of the listing.

How can buyers identify a short sale that is more likely to close? Agents can put basically anything they want in the comments, but a few key phrases give you slightly better odds:

  • Bank already approved price of $x/Short sale already approved
  • Only one lien
  • No waiting/bank ready to close/can be closed immediately
  • Paperwork already submitted
  • Quick Response/Turnaround in x hours/days/weeks

And of couse, you should have your buyer agent contact the listing agent to see what the status of the paperwork is. If the agent doesn’t know or doesn’t return the call, it’s likely to be a waste of your time as a buyer.

Buyers, remember that, just like with foreclosures, timing is a big issue and so taking your chances with a short sale isn’t for everyone. With every passing week, banks are getting more efficient at processing these, so we might see more short sales and foreclosures closing. There’s also speculation that banks have too much real estate owned (REO) on their balance sheets, which impacts their regulatory capital requirements; so they may very soon be more amenable to short sales in the months to come.

Read More: Foreclosure Risk Series

Read More: Understanding the Difference Between Short Sales, Foreclosure Auctions, and Bank Owned Properties (aka REO)

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Housing Bill: Senate Amendments Create Buying Incentives

The senate started piling on amendments to a proposed housing bill that, if passed, would add some interesting incentives to buy. Of particular note is a proposed $7000 tax credit (not a deduction–a credit!) to anyone buying a foreclosed home (see my post: “I want to buy a foreclosure.”) A credit that size would indeed compensate for some of the risks involved in buying a bank owned property (see beginning of series here.)

For people in a 30ish% marginal percent tax bracket, a $7000 credit is equivalent to about $23,000 of income tax-free–that is 23,333* 30% tax rate = $7000 in your pocket!

Not interested in a foreclosure? That’s okay–Senator Ben Cardin wants to give a temporary $7000 credit to all first time home buyers--similar to the measure that has spurred a lot of first time buyers in DC for years–as well. (TBD on whether first time buyers who purchase a foreclosure get $14,000.)

We’ll have to keep an eye on this to see if it passes through as-is, but if I were on the fence about buying, $7000 is a nice chunk of change for the government to chip in.

Update 04/08/08: The House plan is proposing an $8000 first time buyer credit, and is good for the next 12 months. The credit would need to be repaid after 15 years. Stay tuned — this is destined for committee before being passed. So far, this is just a bill, not a law...remember the classic ditty: I’m just a bill…

Read more: Figure out your marginal tax rate, that is, the tax paid on the last dollar earned.

Read more: Risk of buying a foreclosure series starts here.

Read more: Tax Tips for Homebuyers

Read more: Local Classes for First Time Homebuyers

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Foreclosure Risks: Financing Complications

Buying a bank owned property creates a multitude of financing risks—not because a buyer may have any particular problems with their credit or loan otherwise, but simply because the transaction is complicated and timing is difficult to control (read previous post on timing difficulties in buying a foreclosure here.)

It’s critical that buyers protect themselves with appropriate financing contingencies (and make sure that the protections you want are not negated by those pesky bank addenda – read post here.) Buyers take on enough risks in buying a foreclosure—don’t expose yourself to unnecessary interest rate risk as well. Let’s take an example. You make an offer on April 1 (no, there’s no hidden message there just because I’m using April Fool’s Day as my example) when rates are at 5.875%. The bank takes four weeks to get back to you, at which time rates have jumped to 6.25%, or even worse, the 10% down program you were planning to use is no longer available and now you need 15%, which you may not have. Sure, you can still back out of the contract (the upside of having to sign off on the bank addenda mentioned earlier), but obviously the situation is far from ideal. Let’s take a riskier situation: the contract is ratified and the buyer has signed off on the bank addenda. The buyer locks into a rate for 30 days, and settlement is scheduled for day 27. But the week before settlement the bank has a problem with the deed, and needs to delay settlement for a few days/weeks. So much for that rate lock—now your financing is floating with the market, and you take on all that interest rate risk.

Another pitfall to look out for is inconsistencies between your type of financing and the property condition. FHA is a great example; FHA loans require that repairs for issues that “rise above the level of cosmetic defects, minor defects, or normal wear and tear.” In a “normal” sale, the seller has to pay for those repairs. But, as we’ve discussed before in the property condition post, the bank is not about to take their time to hire plumbers and electricians to come in and fix those items—the sale is “as is.” The bank won’t pay. You don’t own the property so even if you wanted to repair it yourself, you’d have some hoops to jump through. So the property needs repairs, the bank won’t do them, and so FHA won’t fund your loan. (There may be some creative ways to still make this happen, but I can’t give all the secrets away here, can I?)

So to wrap up, don’t underestimate the financing risks you take on in buying a bank owned property. It’s not a bargain unless you’re adequately compensated for that risk, in the form of a lower-than-market price.

Read more: Foreclosure Risks: Unpredictable Transaction Timing

Read more: Foreclosure Risks: Bank Addenda

Read more: Foreclosure Risks: Property Condition and Inspections

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Foreclosure Risks: Property Condition & Inspections

One of the most common scenarios in a bank owned (or REO) sale is that the property is “as is.” But most people don’t understand exactly what this means, or how to protect themselves from buying a home that may need tens of thousands in repairs.

Let’s back up a moment, and put “as is” in the context of a “regular” (i.e., non-REO) sale. “As Is” is a commonly misused term. We first must understand the home inspection process and one particular paragraph in the regional sales contract – the Property Condition paragraph, also known as paragraph 7 (because it’s literally paragraph #7 in the contract…sometimes we agents aren’t all that creative.) Paragraph 7 indicates that the systems of the house, including plumbing, electrical, and appliances, must be in “normal working order.” Unless the parties agree to strike through this paragraph, that means the seller must ensure all of those systems work at the time of settlement.

Beyond that, buyers may wish to also get a home inspection (highly recommended). If the home inspector notes items related to plumbing, electrical, or appliances that are not in “normal working order” then the homeowner must fix these—they’ve already agreed to based on paragraph 7. Any OTHER items the home inspector may find—e.g., foundation problems, roof problems, window/door problems, etc.—are negotiable.

Sometimes a listing will be marked “as is” but technically, unless they’ve crossed through paragraph 7, or unless an addendum supersedes paragraph 7 (see Bank Addenda post here.), then the seller is still obligated to fix those systems of the house indicated in that paragraph. They’re simply telegraphing to potential buyers that they will not repair or provide a credit for any additional items.

In a foreclosure, banks always say “as is”, and most Bank Addenda trump any inspections that you may think you’ve negotiated. The last thing a bank needs is the back and forth negotiating to give a buyer a small credit for some electrical problem—they’re way too busy and have tons more foreclosures to get off their books. Most banks though, do not have a problem with you having a home inspection; they just want a “go or no go” decision immediately following. You either take it as it is with the inspection findings, or void the contract. Tip: Even when a bank allows you to do an inspection, make SURE it includes a “right to void” based on the results!

You should always try to get an inspection so you know what you’re getting into with an REO property. It’s a sad fact that many frustrated borrowers take out that frustration on the property on their way out the door. (Read a WSJ posting discussing that approximately half of all bank-owned properties have “substantial” damage inflicted by angry homeowners prior to vacating. ) Often the repairs are simply cosmetic—a good scrubbing, some patched drywall, missing cabinets or appliances, or a fresh coat of paint—and those are good opportunities for a quick bargain. But structural and mechanical issues can easily run into the tens of thousands of dollars. And once settlement occurs, you have no claim against the seller, even if there was a problem that wasn’t disclosed to you (unlike other transactions). So remember that taking on that additional risk requires an additional reward, in the form of a very discounted price; otherwise that bank owned property isn’t such a good deal after all.

Read about some other risks of foreclosures here:
Foreclosure Risks: Title Defects
Foreclosure Risks: Bank Addenda
Foreclosure Risks: Unpredictable Transaction Timing
Foreclosure Risks: Financing Complications

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