Since the foreclosure meltdown began the basic policy for most lenders has been to keep foreclosed homes empty and available for resale as foreclosure listings. This strategy made sense when foreclosures were rare, discounts were small, and foreclosed homes could be sold with some speed.
The old days are plainly gone and now lenders are looking into the idea of renting distressed housing. Looking — but looking with caution because renting is not a cure-all for lender woes.
"In today's market lenders have an incentive to keep homes empty while investors have a reason to lease," said Daren Blomquist, vice president at RealtyTrac
. "The result is that investor activity is increasing at precisely the same time home values are stagnating. Investors are looking down the road and seeing both less ownership and a growing need for rental units."
Here's why banks are out, investors are in and why you should look at foreclosed homes and foreclosure listings. Foreclosed Homes: Bank of America Rentals
There's been a lot of publicity regarding Bank of America and its recent decision to rent distressed properties. However, when you read the actual announcement you can see why BofA described its plan as a "limited pilot test."
The program, said the bank: "will be conducted strictly on a solicitation basis; there will not be any opportunity for customers to volunteer or apply for consideration. Fewer than 1,000 customers will be invited to participate in the first phase of the pilot. Initial outreach has begun to preselected customers in test markets in Arizona, Nevada and New York, three states hit hard in the housing downturn."
New York? Hard hit by the housing downturn? Not quite. According to RealtyTrac's Foreclosure News Report
the Empire State ranked 45th for foreclosures in 2011. Foreclosure: Walk-Away Homeowners
The Bank of America announcement raises a big question: The lending system now holds some two million foreclosed properties. More are on the way. Rather than letting them sit idle why not rent them out?
The truth is that lender rentals are enormously risky. The worry is not just that the two million foreclosed homes lenders already own will lose more value, it's that foreclosure rentals could cause a large number of the 12 million homes
now underwater to quickly slide into foreclosure if lenders give the wrong signals.
So what would be a "wrong" signal?
Imagine that Mr. Smith has a $1,500 monthly mortgage and is about to lose his job. He contacts the lender and agrees to a deed in lieu of foreclosure if he can rent the property for $1,000 a month. At first this seems like a really good compromise. Smith and his family will have a place to stay, monthly costs will go down, and there will be no awful scenes of furniture being tossed on the front lawn.
Mr. Smith's deal also has some attractions for the bank. The lender gets title to the property without a big legal battle and it's receiving $1,000 a month. The property is occupied and there are few issues with maintenance or vandalism. The bank has not done badly considering that the alternative could be foreclosure and instant losses.
But it's not really the Mr. Smiths who concern the bank. It's the Wilson's.
Across the street live the Mr. and Mrs. Wilson. Like Mr. Smith, their home is underwater. Unlike the Smiths, the Wilsons have kept their jobs and can easily make their monthly payments. But why should they pay their mortgage? The Smiths have the same house on the same street so why should the Wilson's pay more?
"Forget mortgage payments," said Mr. Wilson. "We're already underwater, our purchase price will not be back for years and we can live for a lot less two blocks from here. Foreclose now and we'll live here payment-free for the next two years."
Many lenders worry — with great legitimacy — that by renting homes to foreclosed borrowers they will encourage walk-away thinking which will make all mortgage contracts more risky. The problem is not the two million homes which are now empty, it's the 12 million units which are distressed but not foreclosed could become strategic defaults
. Foreclosed Listings: Outside Investors
The National Association of Realtors says investment-home sales reached 1.23 million units in 2011. That's 27 percent of the entire market, up from 17 percent in 2010.
The fear of renting that concerns current lenders does not apply to investors. They're paying less for the property so their economics are different. A $1,000 monthly rental that's a sure loser for banks might be an easy winner for a new buyer of a foreclosure listing.
Imagine that a $200,000 home was financed with a $190,000 mortgage. The owner becomes unemployed and can no longer make payments. Walt Molony, a spokesman for the National Association of Realtors, tells us that "REO discounts are running 20 percent (relative to traditional homes in good condition), while short sale discounts are 15 percent."
Using the NAR estimates, our $200,000 home could be sold for $170,000 with a short sale and just $160,000 as a foreclosure listing, or REO, (real estate owned by a lender).
Such numbers may be too conservative, especially in major foreclosure centers. Last summer RealtyTrac reported
that "the average sales price for homes in foreclosure or bank owned was 32 percent below the average sales price of homes not in foreclosure."
That 32 percent is not a guarantee — foreclosure discounts may be higher in some areas, lower in others and nonexistent in strong markets, but it does reflect the idea that foreclosed homes are seen as damaged goods, wounded in terms of perception, condition and maybe both.
Meanwhile, while home values have declined more than 19 percent since 2007, the population continues to grow and vacancy levels are down. The result is that rental rates are rising — one national study shows a 3 percent increase in 2011.
There's little doubt that we will soon see more lenders offering rentals to distressed owners —but only in limited circumstances. The real action will be with investors, individuals who have plain incentives to buy, hold and lease foreclosed homes.
Peter G. Miller is syndicated in newspapers nationwide and operates the consumer real estate site, OurBroker.com.