Bank foreclosures were contributing copious amounts of must-sell inventory to the housing market. So

The housing markets are abuzz about the REO-to-rental hedge funds buying up properties. The major players in private equity have committed or spent nearly $3.5 billion dollars to buy single-family homes, rent them out, and hold them for appreciation until the housing bubble reflates and they can get out at near-peak pricing. It s a good business model. I operate the same on a small scale myself. What makes the investment really attractive is the combined weight of the federal reserve and government policy working diligently to reflate the housing bubble red carpet inn davenport to ensure these REO-to-rental funds make great returns. It may look like crony capitalism on behalf of these funds, red carpet inn davenport but it s not. It s worse than that. It s crony capitalism on behalf of the major banks because the banks are operating the largest REO-to-rental business model of them all.
Bank foreclosures were contributing copious amounts of must-sell red carpet inn davenport inventory to the housing market. So much so that prices crashed, and the carnage attracted attention of private equity funds. If the banks had continued foreclosing and taking what they could get at auction, the private equity funds would have bought red carpet inn davenport all their distressed assets, and once the supply of distressed properties ran out, the hedge funds would profit from rising prices as the market rebalanced red carpet inn davenport itself. Somewhere red carpet inn davenport along the way banks realized that their foreclosure activities were killing themselves with losses and benefiting the more patient money of private equity who was loading up for the rebound. The banks reasoned, why not stop foreclosing and ride the equity wave ourselves? Good reasoning .
I reported recently that  banks are still exposed to $1 trillion in unsecured red carpet inn davenport mortgage debt . That s just their exposed mortgage amounts. All told, the banks hold about $3.5 trillion in residential red carpet inn davenport mortgage debt . That s a thousand times more than the combined total of all the private equity red carpet inn davenport put into REO-to-rental funds by private red carpet inn davenport equity. By far the major commercial banks are the largest players in the REO-to-rental red carpet inn davenport space .
How can I say that? They re not actually holding that much REO. However, the way they are treating borrowers red carpet inn davenport and playing the real estate market is very much like the REO-to-rental funds. So much so, that there is very little to distinguish the two.
Ordinarily the distinction between debt and equity is very clear. Equity participates in the changing value of the asset whereas debt does not. If an issuer of debt, like a bank, provides a loan to buy an asset, like a house, the owner typically contributes equity in the form of a down payment, and the owner reaps the benefits or endures the pain of the rise and fall of asset values.
The issuer of debt doesn t generally care much about the fluctuations in asset value because they don t benefit from the increases, and they aren t hurt by the decreases. Ordinarily, red carpet inn davenport lenders will analyze historic volatility in asset prices and force the buyer to put down enough equity red carpet inn davenport to give the lender a cushion in the event asset prices fall. Only assets red carpet inn davenport with a long history of stable values can be leveraged with very small equity requirements. That s one reason lenders erroneously felt safe with low down payment red carpet inn davenport loans during the bubble.
As lenders red carpet inn davenport found out painfully, if they eliminate all equity requirements and qualification barriers, they inflate values and introduce volatility to what was previously a stable market. Now that lenders know prices can crash, they should demand higher equity requirements in the form of large down payments to offset their risk. If they don t, they will inflate another bubble and get burned red carpet inn davenport again next time.
This distinction red carpet inn davenport is important because in today s housing market, the clear distinction between equity and debt does not exist. Since the banks have borrowers who are $1 trillion underwater, the banks don t recover their equity in the event of a foreclosure or a short sale. However, as prices go up, they recover more. In effect, holders of debt on underwater homes are equity participants. This makes the banks just like the hedge funds who benefit from house price appreciation.
According to Zillow about 30% of mortgage borrowers are underwater. If you factor in sales commissions and transaction costs, the number is closer to 50%. These people are no better off than renters. They have no equity, and they must pay whatever the bank tells them too up to the original contract amount, or they face foreclosure, trashed credit, and the loss of hope of future equity. In many ways they are worse off than renters who may leave their properties for job opportunities or personal reasons at the end of their lease term without lasting financial implications. Loanowners are trapped, and they don t have much leverage to negotiate to improve their financial circumstances.
Further, Both commercial banks and REO-to-rental funds can evict occupants for non-payment. If a renter red carpet inn davenport doesn t pay, there is a well-defined legal process for eviction. If a loanowner doesn t pay, there is also a well-defined legal process known as foreclosure. Both eviction and foreclosure are remedies red carpet inn davenport for removing occupants from properties if they quit paying. Ordinarily, the bank would foreclose if the borrower quit paying. However, with so many so far underwater, the foreclosure red carpet inn davenport is too costly for the bank, and political pressure from the masses makes foreclosure a public relations problem as well. In response banks started amending mortgage terms to avoid foreclosure.
The negotiation of terms for loan modifications is unique. Never have so many been in such circumstances, and there is no precedent for this activity. The lender has far more power than a landlord because the eviction of a loanowner (also known as a foreclosure) trashes the credit score of the borrower. This gives lenders the ability to demand payments for renting money that exceed the fair-market rent on the property — and loanowners will pay it.
For example, let's say a loanowner is facing a $3,500 payment on a property that rents for $2,000 — a common occurrence in the aftermath of the housing bubble. The borrower could simply strategically default and squat until the lender forecloses then go rent a similar property for $2,000 per month. Many do. However, after examining the borrower's finances, the bank may offer a loan modification that reduces the payment to $2,500 interest-only on a temporary basis if the borrower starts paying again. Since the bank makes up the formula anyway, they can spit out whatever number they think they can get the borrower to pay. Since the borrower has credit consequences to walking away in favor of rental, and since the borrower has hope of future equity, many borrowers will pay the extra money to stay in the house.
If you look at it from the bank s perspective, they are in a much better position to obtain maximum cashflow red carpet inn davenport value from the properties. Once purchased by a REO-to-rental fund, the property will be rented for fair market value. The banks can do better than that. Also, the REO-to-rental owners are acknowledged landlords expected to pay for maintenance red carpet inn davenport and repairs. With loanowners, they are the acknowledged owners expected to cover the expenses of ownership. red carpet inn davenport The banks run the REO-to-rental business model better than the private equity pros do because they can get better-than-market rent for revenue, and they can avoid most of the expenses.
The major commercial banks realized the REO-to-rental business model was a good one. They also realized that this same business model made money at their expense, so they figured out a way to turn this to their advantage. The banks released enough homes to get the big private equity players in the market, then they shut off the flow of properties and let the buying activity of the REO-to-rental funds cause the housing market to bottom and start moving higher. If it would have been conceived in advance, it would be a clever strategy. Realistically, it was a happenstance that lenders blundered into . However, now that these conditions exist, lenders are keen to keep REOs and short sales off the market to force prices higher so they can benefit from appreciation. More properties will come on the market as prices rise, but the formerly Must-sell shadow inventory has morphed into can't-sell cloud inventory . Banks succeeded in manipulating the market to their advantage. You poor saps waiting to buy the banks screwed you.
The former owner of today s featured property red carpet inn davenport more than doubled her mortgage and in the process, she spent herself out of house and home. She only paid $235,000 for this property, and she put $48,000 down. Unfortunately, she got caught up in the Ponzi borrowing, and she ended up with a $365,000 first mortgage and a $30,000 HELOC by the time she imploded. Still, she left money on the table. She didn t max out her borrowing red carpet inn davenport to 100% of value at the peak. She quit paying red carpet inn davenport in early 2010 and squatted for two years, and the bank took the property back for $389,097. They waited a year to bring the property to market, and the appreciation over the last year is going to put an extra $100,000 on their balance red carpet inn davenport sheet. I guess it paid for them to wait. Hopefully, we ll see more of these come to market as the banks start clearing out their inventory.
Wouldn't you be embarrassed to overpay by $100,000? Only fools buy houses without knowing neighborhood values. Don't be a fool. Don't suffer the pain of an underwater mortgage. The surest way to lose your house is to overpay for it. Our reports identify overvalued and undervalued neighborhoods. Use it to broaden or narrow your search area. Savvy buyers red carpet inn davenport work with us to find bargains. We've saved thousands from financial ruin. Let us save you too. If you want peace of mind while shopping for your next home, sign up for our monthly market newsletter.
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