Can Turning Foreclosures into Rental Properties Save the Housing Market?

By Lois Beckett
ProPublica

Last week, the federal government put out a request for ideas on how to transform some of the roughly 250,000 government-owned foreclosed homes into rental properties.

The goal is to create more options in an increasingly expensive rental market, while dealing with the glut of foreclosed homes dragging down the housing market.

In the first six months of this year, more than 1 million properties had foreclosure filings against them. About 800,000 foreclosed properties are owned by banks, and roughly a third of those belong to the federal government through Fannie Mae and Freddie Mac and the Federal Housing Administration.

About 20 percent of those 800,000 properties are on the market, according to RealtyTrac, a foreclosure data service. Each month, 50,000 to 60,000 foreclosed properties are sold, according to RealtyTrac, but a slightly higher number are added to the market. In other words, sales aren’t making a dent in the total inventory of foreclosed homes, and in high-foreclosure-areas, empty houses are doing damage to neighborhood property values.

Meanwhile, according to a recent Harvard study, 10 million Americans are paying more than 50 percent of their income in rent.

The government is looking for win-win solutions for taxpayers, renters, investors and neighborhoods, but there’s plenty of skepticism about the foreclosure-to-rental concept.

Here’s our guide to some potential problems with the idea — and responses from an economist who supports the program.

Problem 1: If this is a good idea, why isn’t it being done already?

The government is looking to investors who might want to buy foreclosed homes in bulk and transform them into rental properties. But, as blogger Kevin Drum of Mother Jones asked, if the plan were profitable, wouldn’t investors be doing it already?

One answer: The government doesn’t make this process easy or cost-efficient for investors but is looking for ways to do so. Enabling bulk sales of government-owned, foreclosed homes, which is not currently standard practice, would be one incentive for investors. Providing bulk-price discounts would likely be another. The government’s call for ideas is an opportunity for investors to lay out exactly what incentives would make the foreclosure-to-rental plan attractive.

One real-estate investor from Phoenix told The Wall Street Journal that a crucial incentive for small businesses would be better access to loans that would allow them to take out multiple mortgages at the same time.

Problem 2: If investors benefit from the deal, taxpayers lose?

Government-owned properties are ultimately owned by taxpayers, so if the government gets a low price for homes in foreclosure-to-rental deals, taxpayers ultimately lose out.

Because foreclosed homes are selling steadily in one-off deals, real-estate executive Richard Smith called the foreclosure-to-rental plan “the stupidest idea I’ve ever heard in my life.”

“Foreclosed homes sold by government entities are already providing the taxpayer with a pretty lousy return,” economist Jared Bernstein, a former member of Obama’s economic team and a proponent of the foreclosure-to-rental idea, said in a phone interview. “Will that return get lousier? It probably will.”

But economists argue that the booming market in foreclosures is having a negative impact on the housing market in general.

The Wall Street Journal’s Nick Timiraos explained how this process works:

You agree to pay $200,000 for my house. You are making a 20% down payment and are approved for a $160,000 mortgage. But a vacant, shabbier house down the street just sold for $150,000 to an investor in a foreclosure. When an appraiser tells the bank how much my home is worth, they use that foreclosure as a “comparable” sale and tell the bank that my house is only worth $150,000. Now, to sell my house, I’ll either have to lower my price, or you’ll need to double your down payment.

Foreclosed homes “may be selling like hotcakes,” but “that’s contributing to lower prices, and that in itself is actually a non-trivial cost to taxpayers,” Bernstein argued. Because government agencies — and thus taxpayers — own a giant pool of mortgages, it’s in their interest to stabilize the housing market, rather than allowing home prices to spiral downward and releasing more and more foreclosed houses onto the market.

It’s a tradeoff, Bernstein said. “You’re selling a bunch of foreclosed properties for less than you otherwise would if you sold them as one-offs, but you’re ultimately reducing your credit risk with your outstanding properties.”

Problem 3: Can investors be trusted to maintain rental properties across the U.S.?

Even if the government finds investors willing to buy up big chunks of foreclosed properties to transform into rentals, or invest in a joint effort with the government to do so, there’s some concern that the process could lead to whole neighborhoods of shoddily maintained rental properties.

Richard Smith, the same real-estate executive who expressed skepticism about the value of renting rather than selling foreclosed homes, told The Wall Street Journal that investors in a bulk-rental plan would face the daunting expense of managing rental properties in many areas of the country.

“The hedge-fund approach to this is a pipe dream. It’s not going to happen,” he told the Journal. “The marketplace would much prefer that these go to small investors who manage them in their own backyard.”

Regarding the problem that “investors buying foreclosed properties in bulk make lousy landlords,” Bernstein wrote on his blog, “It’s a valid concern, but there’s a policy wrinkle in the FHFA/admin’s plan that should help: the proposal — the RFI noted above — should include requirements regarding property management and the Feds should reject proposals that aren’t convincing in that regard.”

The bottom line:

It’s true that the government doesn’t have a great track record in dealing with foreclosures. But Bernstein called it a “nothing-ventured-nothing-gained” situation.

“If it doesn’t work, it’s not going to hurt the budget. It just means that another idea didn’t work,” he said.

“At some level, the worst that can happen is this is another underwhelming government housing program.”

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