Beyond the Foreclosure Blame Game

Real estate investors are becoming a convenient scapegoat for many looking to assign blame for the recent surge in foreclosures and faltering real estate market.

In its National Delinquency Survey for the second quarter of 2007, the Mortgage Bankers Association identified a “disproportionately high share of investor loans, or loans to buyers who do not plan to live in the house” as one of the driving factors behind high delinquency and foreclosure rates in Nevada, Florida, Arizona and California.

“These investors are much more likely to default on their mortgages if they see the value of their investments falling due to falling home prices,” the association’s press release said.

“Therefore, the problems in these states will continue, and they will continue to drive national numbers, but they do not represent a national problem,” concluded MBA’s Chief Economist Doug Duncan in the release.

And from a recent Real Estate Insights newsletter published by the National Association of Realtors: “One factor that contributed to the housing slump was the exodus of speculators from the marketplace.”

While investors may make an easy target — they tend not to be viewed with the same empathy as homeowners who lose their homes to foreclosure — a survey of third-quarter 2007 foreclosure records from RealtyTrac demonstrates that the forces behind the recent spike in foreclosure activity are deeper and more widespread than a few rogue real estate investors.

Based on a comparison of owner mailing addresses to property addresses, the survey found that only 20 percent of all U.S. homes with default notices or foreclosure auction notices filed against them in the third quarter were non-owner occupied. That is actually lower than the percentage of total occupied U.S. housing units that are non-owner occupied, 33 percent, according to the U.S. Census Bureau’s 2006 American Community Survey.

This percentage was higher in some states with foreclosure rates that consistently rank among the nation’s 10 highest — 23 percent in Nevada, 24 percent in Arizona, 28 percent in Florida and 29 percent in Michigan. But this pattern was not consistent for all states with top 10 foreclosure rates. In California, for example, the survey found that just 14 percent of homes with foreclosure actions were non-owner occupied. And on the opposite end of the spectrum was New York, whose foreclosure rate ranked No. 29 among the states in the third quarter but where 31 percent of third-quarter properties in foreclosure were non-owner occupied. However, that high percentage is not too surprising, given that nearly 46 percent of all New York occupied housing units are non-owner occupied, according to the Census Bureau.

All of this demonstrates the percentage of foreclosures that are non-owner occupied —and presumably investor owned — is not disproportionate when compared to the percentages of non-owner occupied housing units in any given state. In fact, oftentimes the opposite is true.

Certainly many investors have fallen into foreclosure due to poor choices or bad luck on purchases — often based in part on the easy availability of credit and rapidly appreciating home prices in many areas. And while it makes sense that investors will be less inclined to avoid defaulting on their loans because they will not be left homeless by a foreclosure, the RealtyTrac survey demonstrates that many homeowners also made similar poor decisions based on the same easy credit and roaring real estate market aggressively promoted by many in the industry.

Pinpointing painful loans
The majority of the foreclosure filings in the third quarter — 68 percent — were on loans that originated in the previous two years. More than 40 percent were originated in 2006 alone. And adjustable rate mortgages made up the bulk of the loans in foreclosure. Although the type of financing was not available on all foreclosure records, of those that did have this information available, 86 percent were adjustable rate mortgages and 14 percent were fixed rate mortgages.

Furthermore, a substantial percentage of the third-quarter foreclosure filings appeared to be on subprime loans — based on the interest rates of those loans. For loans originated in 2005, 39 percent started with interest rates above 8 percent. That would comfortably fall under the umbrella of what would be considered a subprime loan given that the average interest rate for a 30-year fixed rate mortgage in 2005 was 5.87 percent, according to the Freddie Mac Primary Mortgage Market Survey. For loans originated in 2006, 38 percent had interest rates above 9 percent — compared to an average interest rate of 6.42 percent for the year, according to Freddie Mac.

While 38 or 39 percent may not seem like overwhelming numbers, they are significant when compared to the FDIC estimate that subprime loans at their peak in 2006 still accounted for just 20 percent of all loan originations.

So much of the pain in the housing market in terms of foreclosure is being caused by a select type of loans: adjustable rate mortgages — a disproportionate number that would be considered subprime — that originated in 2005 and 2006. Both investors and homeowners who utilized these types of loans are now falling into foreclosure. In fact, the percentage of foreclosure actions on owner-occupied homes are disproportionately high when compared to the percentage of total occupied U.S. housing units that are owner occupied.

Many investors that Foreclosure News Report has interviewed over the past year have decried the fact that the more convenient loan products that they have become accustomed to using over the past few years — often of the adjustable rate and stated income variety — are no longer available because those products were used irresponsibly by some (See Finding Financing for Foreclosure Deals, September 2007).  But tighter lending standards by lenders could be good news for legitimate investors who’ve kept their wits about them during the heady market of the last few years.

“If by ‘investors’ we mean people with cash and credit they’re still in the game,” said Peter G. Miller, syndicated columnist and author of the Common Sense Mortgage. “However, investor loans with little down and cheap rates are a vanishing breed. A lot of recent investors and would-be flippers are gone. Gone also is the demand they represented, meaning there’s less competition out there for those who can buy in today’s financial environment.”

While the free-market response from lenders may have gone overboard, Miller believes it is still good to help prevent the proliferation of loans that are highly susceptible to foreclosure. Eventually, lending standards will loosen up a little bit and provide plenty of financing options for investors.

“At this moment financing options are unsettled. Investor loans with 10 and 20 percent down remain available. Under the FHA program you can buy one to four units if you occupy one as your residence. You can then get owner-occupant financing — that’s a good deal for a lot of investors,” he said. “What we might begin to see are new forms of financial thinking. For instance, lenders might allow investors to buy properties by assuming delinquent loans, something that will amount to 100 percent financing in many cases with no foreclosure on the books for lenders and no taxes on imputed income for borrowers. We could also begin to see new forms of investor equity-sharing. For instance, lenders might approve deals where investors get equity in a distressed property in exchange for picking up some of the monthly cost, thus keeping the property out of foreclosure.

“Savvy investors are going to check the foreclosure market every day, cherry-pick the crop and look for the discounted properties most likely to generate solid rents and higher values,” he continued. “As always happens in times of trouble, some people are going to make a lot of money by going against the herd.”

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