During the housing boom, mortgage lenders allowed anyone to buy a home or refinance one they already owned. We have seen the result of such liberal lending practices in the form of the largest foreclosure crisis in history. Many real estate investors take a careless approach in times like these; buy houses anywhere, confident that appreciation is just around the corner to make them instant millionaires. Before you go on a shopping spree, you’ll want to consider some sobering indicators of what the market is actually doing as of April 2010: One in 14 mortgages (3.5 million) is at least 90 days past due as homeowners have realized that banks are more willing to repossess their homes than to modify their loans. These homeowners are literally walking away from their homes and their mortgages, as two million of these foreclosed homes are more than 180 days past due. If you thought the housing market was on the brink of improvement, think again. The delinquency rate on mortgaged homes is 65% higher now than it was just a year ago.
These numbers are a telling reminder that prospective homeowners and active investors will need to hold out for several years before the market clears, sending prices back up. Today’s foreclosures will take years to work through the system and reach the market. Banks are overburdened with inventory and we have already seen evidence of banks “fixing prices” by intentionally withholding foreclosures from the market in an attempt to get the best price for home inventories. Current victims of foreclosures from the recent past will have bad credit; preventing them from buying a new home for several years. Their inability to buy, among several other factors such as high unemployment, tightening credit guidelines, and lower wages for working families, will continue to delay home value appreciation. Real estate prices are low and will remain so for several years; But this doesn’t mean that homeowners and investors should stay out of the real estate market entirely. It simply means they need to make calculated decisions when buying a home so that the next wave of appreciation will exponentially increase their wealth. One of those decisions is choosing where to buy a home.
Urban areas/city centers
Lifetime renters, many of whom receive government housing subsidies such as Section 8 or FIA, make up a large part of the inner-city population. It’s important to note that the subprime collapse began in big cities when massive amounts of liberal credit were extended to people who would normally be renters. Credit was also extended to investors who personally bought dozens of homes and walked away from them when the market began to unwind. We see evidence of the foreclosure crisis in the form of boarded up homes, high unemployment rates, and crime.
If your plan is to buy homes to remodel in inner-city areas, there are several obstacles standing in your way. For starters, the credit guidelines for potential buyers are almost impossible to beat right now. How can you flip a house if potential buyers can’t get a mortgage? Second, even if you have a qualified buyer available who wants to buy your home, the appraisal is likely to be much lower than expected, ruining your deal. Lenders will make any excuse not to lend in areas with a high “F-score,” which is lender terminology for the percentage of foreclosures in a given area. Another problem for urban investors is that qualified inner-city homebuyers are now migrating to the suburbs rather than staying in high-crime areas like downtown. This increases the amount of vacant housing in any given urban block; and unoccupied houses generate crime. An investor’s downtown redevelopment project may be broken down multiple times during the renovation process. Burglars love new hot water tanks, ovens, carpeting, and kitchen cabinets; I know from experience.
Even buying in urban areas or city centers right now for rental cash flow is an oxymoron. People come from all over the world to buy houses in cities like Detroit, Indianapolis and Cleveland for less than $2,000 knowing that these houses will flow easily; or so they think Where is a homeowner’s cash flow going to come from with unemployment that high? Also, houses that sell for the price of a mountain bike are often in horrible areas; the numbers look great on paper, but the reality is different. Investors who believe that government-subsidized tenants are the way to go should keep in mind that many of these potential tenants are moving out of inner cities for the safer suburbs. On the other hand, many permanent inner-city tenants live like nomadic animals, literally tearing up the owner’s home before moving on to their next unsuspecting victim. Good luck suing tenants like this for damages; many low-income inner-city renters are not collectible because they don’t work.
With years of appreciation away, stay away from inner cities unless you plan to wholesale homes to cash in on investors who don’t pay attention to the above risk factors. Being a go-between in inner cities without owning anything. Continually market to find desperate sellers and hungry buyers, then link the two for commissions you set by agreement. Banks hate inner-city loans right now, so seller financing reigns supreme over homes that owe nothing. Only practice seller financing if you have experience as a real estate investor or really understand the process with legal counsel on hand. Some investors buy houses very cheap and set seller financing terms of $500 down, with a mortgage payment of $500 per month, and the buyer does all the repairs. Conversely, savvy homeowners who have years of investment experience can survive through renters with subsidized housing vouchers and proven skills. New investors should stay away from owning anything within the inner cities at all costs until times improve.
outskirts
The foreclosure crisis will continue to play out in the suburbs as banks remain reluctant to modify homeowner loans. Frustrated homeowners simply walk away, knowing that their personal efforts to save their homes are futile. This spells “opportunity” for some savvy investors who are buying properties in county courthouses while the delinquent owners still live on them. Once an investor makes a purchase for a price well below what the owner owes to the bank, the investor contacts the owner and explains that he is the new owner of his house. Deadlines are met and monthly payments are established in these “lease-to-own” transactions. Over time, the homeowner can choose to buy back the home from the investor for prices up to 40% below previous outstanding loan balances. This strategy not only saves the house from the mortgagee, but also saves his credit. Investors who are practicing this strategy are forming partnerships, mutual funds, or already have lines of cash/credit to make these acquisitions.
Investors should be aware that banks are intentionally holding foreclosures out of the market, creating a false supply/demand curve. One of the nation’s top REO agents informed us that homes listed for just one day sometimes get more than 20 offers; while millions of other households sit on the books of various banks. A reputable insider explained that banks are expected to start selling these homes in August 2010, which will further drive down the value of suburban homes. This doesn’t mean avoiding shopping in the suburbs; it just means be very careful. Only settle for the best offer, in case a rush of foreclosed homes hits the market and drives prices down.
Although buyers will have to pay more for a house in the suburbs than in the center of the cities, finding good tenants is not a problem. Many suburban renters have been victims of foreclosures and are killing time until they can become buyers again. Others are renters in government-subsidized housing fleeing the city center. No matter the case, buy to hold in the suburbs appears to be safe; but with years of appreciation, owners will have to be patient and select only the best long-term tenants.
Young new home buyers are driving real estate, and they all want a good deal in the suburbs. If you can buy really low compared to other homes in the neighborhood, rehab the home to much higher standards than other listed homes, and price it better than other homes in the area, you can do just fine. A number of talented investors are furnishing homes and even launching items like televisions or, in some cases, new appliances to attract buyers. Even though the suburbs allow rehab changes as an exit strategy, many neighborhoods have sellers trying to short their homes. This creates price competition for investors looking to sell for a profit. Look at the numbers on every deal you make and be aware of what other sellers are trying to do in the areas you invest in.
