September 2009

The “Shadow” knows.

Back in July, I mentioned the growing phenomenon of the so-called “shadow” inventory, which are the properties that by all rights should have been foreclosed on a long time ago, but where the banks are, for reasons of their own, not taking any action. The mainstream media has caught up, and there are two recent articles about shadow inventory that you should know about. One is in the Wall Street Journal (subscription required), the other is in The Atlantic Monthly, which helpfully quotes at length from the original Wall Street Journal article. As the Journal puts it,

“there were 217,000 loans in July where the borrower hadn’t made a payment in at least a year but the lender hadn’t begun the foreclosure process. In other words, 17% of home mortgages that are at least 12 months overdue aren’t in foreclosure, up from 8% a year earlier.”

What is the cause of shadow inventory? It does not appear to be exactly clear what is motivating the banks’ lack of action on these properties. There may be differing reasons: a lack of personnel qualified to process the foreclosures or loan renegotiation; an unwillingness to add a flood of foreclosures to a brutalized real estate market (which might trigger other foreclosures as homeowners’ equity evaporates); or, perhaps the most sinister reason of all — the banks are simply hiding their toxic assets. While it is one thing to have a nonperforming loan on your books, it is another thing entirely to have to write down the entire loss that a foreclosure will entail. Once this loss is realized, bank regulators may require a concomitant increase in reserves, at a time when cash is in short supply. The end result could be bank failure, and we’ve seen plenty of these already this year.

What does this mean for the real estate investor? One possibility is that the banks will be able to carry a lot of this inventory until the broader market recovers, then start selling it off in in an orderly process. The other possibility is that the housing crash might not be over until all of REO inventory is cleaned out, whether or not the bank acknowledges it as an REO. What will happen? Only the shadow knows.

Roadblock to FHA financing

First time home buyers (together with investors), are a major force behind the recent increase in sales in the San Fernando Valley. With FHA financing, first time home buyers can theoretically buy with as little as 3.5% down, and help themselves to the juicy government incentive/tax credit of up to $8,000 (at least, until Dec. 1, unless there is a change in the law in the meantime).

Not so fast. Unfortunately, because so many of the affordable properties are attracting multiple offers and bidding wars, many agents in Los Angeles feel that making an offer on an REO or a short sale with FHA financing is unfortunately pretty much guaranteed to end up in the dust bin. Sometimes the anti-FHA bias is even explicit, as the National Mortgage News noted, “[t]housands of properties listed for sale on various Multiple Listing Services around the country say simply: ‘No FHA’ under the description of acceptable financing, lenders and mortgage brokers say.”

So why is there such a discrimination against FHA financing? The answer is pretty simple. As Raffi Tal, the chief operating officer at IShortSale Inc. in Woodland Hills, Calif., was quoted in the same article, “[w]hen a property goes to REO, the lender is really discounting the price, and if the buyer has an FHA loan, it takes longer, so that’s why they’re discriminating,” he said. “The guidelines on FHA are tougher, and if they get multiple offers they don’t need FHA.”

One of the main concerns invoked by the industry is the perception that due to FHA stricter guidelines, escrow takes longer (60 days instead of 45 days) and might not even go through at the very end. Additionally, the “FHA” buyer often thought to lack sufficient closing costs.

FHA buyers are not the only ones feeling left out in the cold. Even our veterans who want to use VA financing (up to 100%) are in an even worse position bargaining against a cash buyer. Again, the perception is — rightly or wrongly — that a buyer with no/little skin in the game is more likely to flake out before closing.

The answer for one of my buyers, who was sick and tired of being outbid by conventional or all cash offers, was to buy through an auction, where the playing field was leveled somewhat. He ended up with the property he wanted, and only 3.5% down. (I know this because I represented him at the auction.) Not many people can say that these days.

First Time Homebuyers Going to Extremes Part Two: Getting Lucky at an REDC Auction

After months of looking for a property for my client, who was looking for a condo in the San Fernando Valley, we were both starting to lose hope in making the impending deadline for receiving federal first time homebuyer assistance.   When his purchase offers were not completely ignored by REO listing agents (despite the fact that he was offering well above asking price), they were rejected in favor of all cash offers.   We learned that his favorite property (which had been listed on the MLS) was put “on hold” by the listing agent, after he had already made an above-asking price offer on the property.   A little investigation revealed that the property was now due to be sold at an REDC auction in early August.  I had hoped that the bank would still consider our offer during the 3 weeks we had left till the auction; for some inscrutable reason, this didn’t happen, and the Bank never bothered to even respond to the offer.

So we went to the auction,  after having made sure we had done all the preliminary requirements posted on the auction website (pre-registration; pre-viewing the properties, etc.)  Arriving at 8 a.m. at the LA convention center to the sound of some blaring pop music, there was a carnival-like atmosphere, missing only popcorn and pompom girls.  We took our seats and waited.  Under the terms of this particular auction, some properties are cash only, but most can be financed. The properties are flashed on a big screen.  You need to have a good strategy for the property you want to bid on: once you get the bid, you are generally “stuck” with the property or you’ll lose your earnest deposit.

Before the auction started, there was a quick rehearsal of the bidding process: a fast-paced process with the auctioneer raising the bids as fast as he can.  Once the highest bid is reached, the auctioneer will either acknowledge that the bid is accepted, “closed”; or “subject to”.  “Closed” means that since the bid didn’t meet the (hidden) reserve price, it is rejected.  “Subject to” is a kind of limbo — it means that the bid will be submitted to the seller who has up to two weeks to accept, reject, or counter the bid.

When our property came on the screen, we were both feeling a bit nervous; but my client was able to ultimately win the bidding war!  Better yet, the deal was accepted on the spot (and was not “subject to.”)  We were then ushered into a back room where we had to pass the approval process, and were able to consult with three different lenders on site.  At that particular auction, REDC wants you to take the conventional loan route, since the properties are foreclosures and might not pass the FHA inspection.  Additionally, the escrow has to close in 45 days, and there is a penalty of $150 each day for missing the closing escrow date.  Once we got the green light from the banking tables, we were rushed to the escrow table where you pretty much sign and initial paperwork until your hand is aching!  Forget about any contingencies (e.g., loan, inspection, etc.) and you have to pay many costs that a seller would normally pay for in a non-auction context.  Further, you are committed — no matter what — so make sure you have done all the prep work well in advance.

In the end, my buyer had to go to extreme measures to secure a property — the advantage to him of the REDC auction was that the property went to the highest bidder, and the trump card normally enjoyed by cash buyers disappeared.

Finally, the question on everyone’s lips: did my client score a “deal” at the auction?  In purely financial terms, the answer is “no”.   With all of the competition, he was forced to pay pretty much the market price.   (On top of the bid price buyers are subject to an additional 5% or $2,500, whichever is highest and the buyer is on the hook for all inspection costs and pretty much all closing costs!)  However, my buyer was able to compete on par with every other bidder, saved himself months of frustration, and scored his absolute no. 1 favorite property.  All in all, it was a good deal for him, under the circumstances.  Now he can move forward and start thinking about what furniture to buy with his tax credit!

Do you need a Realtor® to purchase a property at a REDC auction?  If you can find someone willing to help you (the commissions are razor thin), you will likely be better off, as your Realtor® will be able to provide with some comparative market analysis for each property you have in mind, and can help you devise a strategy so that you don’t get lost in the somewhat confusing process.   (In addition, should you chose to use a Realtor®, you will be entitled to the C.A.R. H.A.F. Mortgage Protection Program).

Where Cash is King, First Time Homebuyers are Going To Extremes

In order to secure their first home in advance of the impending deadline for receiving federal first time homebuyer assistance, San Fernando Valley buyers are being forced to take extreme measures.  Why?   The vast majority of suitable (i.e., affordable) properties are bank owned and are receiving many, many offers.  Worse, a large number of these properties is ultimately being sold to all-cash offers from investors.   Few first time homebuyers can compete in the dog-eat-dog world of all cash offers.

I recently was helping a first time home buyer looking for an affordable condo in the San Fernando Valley.  My buyer had a FICO score over 750, steady employment, no loans (!), and downpayment money in the bank; he is technically the perfect candidate the Government had in mind when they allowed FHA loans for be written with as little as 3.5% down.
While the tax credit and FHA financing news is good, the reality on the ground is grim for first time homebuyers.  My buyer was stymied in his initial attempts to secure a property using FHA financing for several reasons:

- As noted, most of the REO properties he wrote an offer on ended up selling to cash buyers, or at least those with substantial down payments.
- The FHA guidelines are pretty strict when it comes to appraising the property.  The property has to be in decent shape, and, for instance, an illegally converted garage is a big “no-no”.
- Due to recently changed appraisal guidelines, appraisals are tending to be the conservative side, which means if you bid high (with multiple offers, you pretty much have to) and your offer is accepted (lucky you!), deals can fall by the wayside.

At the end of the day, my buyer had to go to an REDC auction.  More about that adventure in my next post.