Mike Bell’s Blog – Real Estate and Bank Owned Properties in Silicon Valley

A response to the recent WSJ Blog: Are Banks Holding a Shadow Inventory of Homes?

We don’t believe it.  Shadow Inventory, yes.  Banks holding back, not likely.  Basic market research, and our own experience as an REO brokerage tell us otherwise.

Let’s start with the series of foreclosure moratoriums between October ’08 and April ‘09.  First, major lenders and GSE’s stopped filing notices of default, then the federal government mandated it.  REO processing basically came to a halt for 6 months.  Standing inventory that was previously stagnant started to sell off quickly.  Agents used to complain about REO inventory; now we started complaining and speculating about the lack of it.  Multiple offers, buyer competition, number of listings down, number of sales up.  The market shifted for a moment and we all started theorizing: were these signs of a market recovery, were the banks holding back, etc.?

In April the wheel started to turn again as mortgage companies resumed foreclosure activity (see WSJ: Banks Ramp Up Foreclosures), hence the spike in notices of default.  The notices of trustee’s sale won’t follow for another 3-6 months.  We can’t compare these data in real time; we need to account for lag.

REO is a long process, and requires momentum.  You can’t grind to a halt and expect to restart at full speed.  It will take time to get the inventory to market: 5- 9 months to the trustee’s sale (foreclosure), another 2 to 12 months before the occupants vacate and the bank can take possession, and another month to trash out, clean up, etc.  A current notice of default might not become an REO listing for 18 months or more.  Inventory that was in process during the moratorium season is only now coming to market, and slowly.

One of our most reliable forecasting indicators is the amount of BPO activity, which mostly escapes attention.  Lenders order BPO to get a first glimpse of a property value and evaluate market strategy.  When BPO activity increases, REO activity increases.  Not coincidentally, our BPO activity was slow during the moratoriums, but has increased dramatically in the last 45 days.  We believe that there is a lot of REO inventory in process, and it will make it to market in due time.

In Silicon Valley, the current foreclosure cycle has been waxing and waning for over 24 months.  Our client lenders have been continuously adjusting, however slowly, to better accommodate the overwhelming volume of defaults.  They are increasing staff and focusing their resources on cutting loses through more efficient default servicing, and more successful loan mods and short sales.  In our opinion and from our perspective, deliberately holding back inventory so as to manipulate values would be counter-productive to cutting loses.

Lenders make loans.  They need to make a lot of loans to recover some of their enormous losses.  You can’t make loans on Shadow Inventory.

What Is The FED?, Part One.

When we think of “The Feds” we think of the federal government, like the guys who busted John Dillinger and Bonnie & Clyde.  So when we hear the term “the FED,” aka The Federal Reserve, it sounds like some government agency.  But that’s just a clever disguise.

The Federal Reserve Board is a private organization.  It’s like a private Central Bank that loans money to the federal government, then charge interest on it. The government borrows the principal; the American people pay the interest.  That’s why we pay income tax: interest payments on the federal debt, paid to the Federal Reserve.  It’s a trap that we can never escape.

But the government doesn’t repay the principal; they just borrow more.  Meanwhile, the interest keeps compounding, and the Federal Reserve Board can adjust the rate whenever they want, without notice.  Did we mention compound interest?

This deal is rigged, sort of like an interest-only, monthly adjustable, reverse amortized loan, built to fail.  The American economy is like a home loan in default.  The government is the landlord and the taxpayers are the tenants. The landlord owes more than the house is worth and is using the tenants’ rent to try to make the interest-only payments, but is falling behind.

Sound familiar?  If this was a home loan, it would trigger a notice of default, followed by a trustee’s sale and foreclosure.  The tenants would get locked out by the sheriff, quite to their surprise (just paid their rent) and would have no place to go.  The landlord would be nowhere to be found, having fled with the rent.

Is the government in foreclosure?  Maybe they’re asking the FED for a loan mod.  Maybe they’re just walking off with the rent.

OK, so let’s say you are a first-time home buyer and home prices have finally reached a place where you can afford to buy.  You’ve got some money for a down payment, and you’ve been pre-qualified for a home loan.  Maybe you’ve even made offers on short sales that seem to go nowhere, and you’re getting frustrated waiting for something to happen.  You’ve found a foreclosure that you like.  Sure it needs a little work, but it’s in your price range and you’re not afraid of a little sweat equity.  After all you’re pretty handy with a hammer and a paint brush.

Here’s the challenge: bank owned properties typically need repair, but the seller (bank) wants an a-is offer and will neither make the repairs or pay for them.  Meanwhile, your lender (also a bank, maybe also the seller) will likely require repairs before they will make the loan.  Seems kind of self-defeating, and it is by conventional methods.

You can’t afford the repairs because you’re using all your savings for the down payment.  So what do you do?

Build the repairs into your offer.  Ask your lender or Realtor for a list of typical items that the lender will require, then go and perform a thorough visual inspection of the property.  Estimate the amount you’ll need and add it into your offer price, then ask the seller to credit you for repairs.  You have to keep it reasonable, though, say within 3-5% of the offered price.  Most bank sellers will entertain this kind of offer, and it can even work for FHA and VA loans.

The point is to ask for these concessions up front.  Once you have presented your offer, it will be nearly impossible to ask for additional concessions.  The easier you make it for the seller, the more likely they are to agree.

There’s a lot of buzz about loan modification, a process where borrower and lender renegotiate the terms of a home loan so that the monthly payments are lowered.  Either the interest rate is reduced, or the repayment term is lengthened, or both.

The federal government, that is, both the administration and Congress, seem to think loan modifications are key to correcting the home loan mess.  We disagree.

In fact, our opinion is that in general, loan modification only adds to the problem.  We read recently where something like 3 out of 4 modified loans re-default within 6 months.  6 months!  What are the numbers after 12 months?  Basically, loan modifications are just extending bad debt further.  This is exaggerating the problem, not solving it.  Still, individual borrowers may get some short-term relief from a loan mod.

But be careful!  We’ve heard some horrible stories about people who still lost their home to foreclosure after paying lots of front money to “professionals” who offered to negotiate a loan mod.  They take your money, do nothing, and then they stop answering the phone.

Always interview more than one lender, ask a lot of questions, and don’t pay anything up front.

If you owe more than your house is worth and are having trouble keeping up with your payments, this is our first recommendation.

Very simply put, a Deed In Lieu of Foreclosure gives the property back to your lender, who forgives the debt, and you walk away mostly intact.  You suffer far less damage to your credit and the lender suffers fewer losses than with either a short sale or a foreclosure.

If the circumstances allow it, this is door #1.  Ask your lender about it, they should be very helpful in determining if this will work for you.  After all, they’re plenty motivated to cut their losses, which are already substantial.

REO means: Real Estate Owned.  Generally, this is a term commonly used in reference to bank-owned properties or properties that have been foreclosed.

More specifically, these are properties that revert to the lender after the borrower defaults on the loan.  The process is complex, but in the end the lender takes the property back and there is no longer a loan, hence Real Estate Owned.

When I first started in real estate, I thought that REO meant Real Estate Owed.  At least that’s what I heard, and it didn’t make any sense.  I couldn’t figure it out no matter how my broker explained it to me.   What a difference one little letter can make.  If only I owned everything I owe.

It’s almost certain in Silicon Valley.

Because of the overwhelming number of short sale offers, it can take months before the bank can review yours.  If there is a second lender, it could be another few months before you get a response.

Meanwhile, if the seller misses enough loan payments, the foreclosure process starts almost automatically, with a definite time-line.  It’s common that foreclosure will happen before the bank can respond to a short sale offer.

We’ve noticed that home values in some local areas have slipped lower than they were in 1997.  Chances are good that if you bought a home in the last 10 years, you owe more than your home is worth.

Before you try a short sale, ask your lender if they will consider a Deed In Lieu Of Foreclosure.  Just call customer service.  This is one of the least understood, yet best alternatives to foreclosure, and well worth the time to check it out.  You might not qualify, but if you do, it may save you from foreclosure.

Why are they so difficult?  Why do they take so long?

We get asked a lot of questions about short sales.  Short sales are usually challenging and frustrating for everybody, and have little chance of success.  Popular opinion is that banks seem to favor foreclosure instead of short sale.  It sure seems that way.

But that’s not it.  Foreclosure is far more costly to the lender than a short sale.  Banks want to approve short sales, but have been overwhelmed with offers, and simply don’t have enough qualified staff to process them.  It might be 90 days or more before an offer actually gets reviewed.  If there is a second loan or lien, then it’s practically impossible to get a short sale approved.

Banks aren’t being stubborn, or even stupid, as we’ve heard suggested.  They just can’t handle the volume.  This is the consistent feedback we get from within the default servicing industry.

If you are a buyer, ask your agent if the listing you’re interested in is a short sale.  You’re going to have more success and a lot less stress trying to buy something else, like a foreclosure.  Chances are that if you wait long enough, that short sale listing will become a foreclosure anyway, and it’ll probably be a bit cheaper.  We’ll blog about that later.

If you are a homeowner considering a short sale, a great alternative is a Deed In Lieu Of Foreclosure.  We’ll blog about that later, too.  In the meantime, you might want to google that term and ask your lender if they’ll consider it.  The circumstances have to be right, but it might save you both a lot of grief.