The Federal Reserve's plans for your Future Ben Bernanke's , the chairman of the Federal Reserve most recent letter addressed to our government policy makers can be found on my website longfininvestment.com under the blog section. This is a report stating the current status of the economy, forecasting the next 2 years and moreover what policy and roles lending institutions and government should implement this coming year. Some of the content is common knowledge, but the report addresses the bank's greatest liability Dead Weight. Dead Weight can be defined as properties that are vacant, non-income producing and a detriment to the local community. From a balance sheet perspective Dead Weight is the NOE without any foreseeable income. You might want to call in capital appreciation liabilities without any near term income potential. Here are some of the facts of what the Federal Reserve has planned for your future.
We all know that the overall status of the real estate market is weak, real estate values have dropped 33% since 2006 peak, which translates to $7 Trillion in lost household wealth. A quarter of the 2 million vacant homes sold in 4Q2011 were REO. 12 million homeowners are currently underwater on their mortgages; this ratio is 1:5. In some places such as Arizona, Nevada and Florida all capital appreciation secondary markets ½ of the homes are underwater. Many people that put 20% down are also underwater as well. The problems that have created this mess are first, excess supply of vacant homes that outpace demand. The second is long term downshift in the supply of lending and the third is inefficient foreclosure process on homeowner, lenders and communities.
The report goes on to state that rental markets are strengthening and that the conversion of properties from owner occupied to income producing rentals is the first solution to the excess supply.
Lending is a very difficult proposition right now. Many buyers with good credit cannot get loans and most properties are not being appraised accurately. This affects both new buyers as well as people looking to refinance. Less than half of the lending institutions are offering loans to FICO scores less than 620 on 10% down. Something to consider is that they might be offering these products but it certainly doesn't mean that it will fund so the actual number of closed loans is going to be much smaller. This of course leads to a much smaller pool of residential buyers.
Foreclosures are inflicting damage to many people and this affects the community. They are costly and the current system in place is not adequately efficient to deal with the larger numbers of foreclosed properties. This Dead Weight loss does not help anyone. Dead weight hurts home owners, lenders and neighborhoods. To make matters worse current policy has set up greater support for foreclosing properties instead of modifying the notes. Can you believe that they actually state this? I am impressed that they are straight forward to tell the truth here!
One solution that the Federal Reserve is suggesting is loan modification, but who is going to pay for this? The American tax payer again, if this is the case of debt financing debt then the only people that really benefit is the people that create the money from nothing. So the report goes on to state that GSE's or also known as Government Sponsored Enterprises such as Fannie Mae and Freddie Mac should play a role in implementing this policy. The Federal Reserve is suggesting that the tax payer should take a "short term" tax increase to lead to a quicker economic recovery. Likewise, homeowners, lenders, guarantors, investors and tax payers will all suffer economic loss regardless of the policies that are implemented. There might be some fairness issues as well since people that put money down on their loans and are paying on time might not be able to benefit from a loan modification.
Another solution that the report mentions is to convert existing owner occupied houses into rental properties. There seem to be recent strengthening in this section of the economy. Multifamily vacancy is on the decline across all metropolitan markets since the 2009 peak. Most of this conversion is happening with small investors on a limited scale. This is due in part because bank's desire for higher price for their REO inventory and that many investors are lacking the lending. Again the GSE's would be playing a key role in rental conversion, since they hold 50% of the existing REO inventory. The highest number of properties for sale right now is in Atlanta at 5000 units. The next largest are in the metro areas around Chicago, Detroit, Phoenix, California- Riverside and Los Angeles all have 2000-3000 units. But the report goes to state that not all of these properties are suitable for rental. Many are in economically unfavorable areas where there is little job growth, low demand and poor value. One half of the homes in Detroit and Cleveland are priced less than $20,000. For these low value properties it is unsuitable for either owner occupied or rental, this is the reports finding not mine! But for the rest of the country, more than ½ of the available rentals can produce at least an 8 cap rate, which in their definition makes this a desirable rental. A word of caution to all the fix and flippers looking for owner occupied buyers, there are 4x more pre foreclosure properties available than the current inventory. Rental properties is the solution, the banks can do this as well as investors and also joint partnerships.
This report also gives the blessings of several techniques that investors have been using for some time. And it is interesting at best that the Federal Reserve is suggesting to government and banks to create policies that support both lease options and deed for lease programs. Likewise with the increased demand short sales should be on the rise. The banks motivation is purely based upon decreasing Dead Weight and the associated costs, rental properties are the answer.