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 be aware of a few sobering indicators of what the market is really doing as of April 2010: One in 14 mortgages (3.5 million) is at least 90 days past due as Homeowners have found that banks are more willing to repossess their homes than 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 real estate market was on the verge 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 would-be homeowners and active investors will need to hang on for several years before the market clears, sending prices back up. Current foreclosures will take years to work through the system and reach the market. Banks are overloaded with inventory and we have already seen evidence of banks “pricing” by intentionally withholding foreclosures from the market in an attempt to get the best price for home inventories. Current victims of recent past foreclosures will have damaged credit; preventing them from buying a new house for several years. Their inability to buy, among several other factors like high unemployment, tightening credit guidelines, and lower wages for working families, will continue to slow home value appreciation. Real estate prices are low and will remain so for several years; But this does not mean that homeowners and investors should stay away from the real estate market entirely. It simply means that 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 the FIA, make up a large portion of the inner city population. It is important to note that the collapse of subprime mortgages began in the 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 as the market began to digest. 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 for remodeling in downtown areas, there are several obstacles that stand in your way. For starters, the credit guidelines for potential buyers are nearly impossible to beat right now. How can a house be flipped 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 will likely be much lower than expected, which will ruin your deal. Lenders will make up any excuse not to lend in areas with a high “F score,” which is lenders’ 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 instead of staying in high-crime areas like downtown. This increases the number of vacant dwellings in any given urban block; and vacant homes generate crime. An investor’s downtown rehab project may be broken up several times during the renovation process. Burglars love new hot water tanks, ovens, carpets and kitchen cabinets; I know from experience.
Even buying in urban areas or inner cities 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 the cash flow going to come from for a homeowner with such high unemployment? 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 forward should keep in mind that many of these potential tenants are leaving the inner cities for safer suburbs. On the other hand, many downtown permanent tenants live like nomadic animals, literally trashing the owner’s home before moving on to their next unsuspecting victim. Good luck suing renters like this for damages; many low-income inner-city renters are not collectible because they don’t work.
With years of appreciation far away, stay away from inner cities unless you plan to sell homes wholesale to cash in on investors who don’t pay attention to the above risk factors. To be an intermediary in the cities of the interior without owning anything. Continuously trade to find desperate sellers and hungry buyers, then link the two together for commissions you set by agreement. Banks hate lending in inner cities right now, so seller financing reigns supreme over houses that don’t owe anything. Only practice seller financing if you have experience as a real estate investor or truly understand the process with legal counsel on hand. Some investors buy houses on the cheap and set up seller financing terms of $500 down, with a mortgage payment of $500 per month, and the buyer does all the repairs. By contrast, savvy homeowners who have years of investment experience can survive through tenants with subsidized housing vouchers and proven skills. New investors should stay away from owning anything within inland cities at all costs until times improve.
outskirts
The foreclosure crisis will continue to unfold 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 wise investors who are buying properties in county courthouses while defaulting owners still live in them. Once an investor makes the purchase for a price well below what the owner owes the bank, the investor contacts the owner and explains that he is the new owner of his home. Deadlines are met and monthly payments are set on these “lease-to-own” transactions. Over time, the homeowner may choose to buy the home back from the investor for prices up to 40% below previous outstanding loan balances. This strategy not only saves the mortgagor’s house, it also saves their 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 back foreclosures from the market, creating a false supply/demand curve. One of the nation’s top REO agents told us that houses listed for just one day sometimes receive 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 houses in August 2010, further driving down the value of suburban homes. This doesn’t mean avoiding shopping in the suburbs; it just means being very careful. Just settle for the best deal, in case a flood 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 cities, finding good tenants is not a problem. Many suburban renters have been victims of foreclosure and are killing time until they can become buyers again. Others are renters of 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, landlords will have to be patient and select only the best long-term tenants.
Young new home buyers are driving real estate and everyone wants a good deal in the suburbs. If you can buy really cheap compared to other houses in the neighborhood, rehab the house to much higher standards than other houses listed, and price it better than other houses in the area, you can do well. A number of talented investors are putting together homes with furniture and even launching items like televisions or, in some cases, new appliances to entice buyers. Even though the suburbs allow rehabs as an exit strategy, many neighborhoods have sellers trying to sell their homes short. 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.