Foreword — Real Estate Owned
Federal Reserve Bank of San Francisco
The collapse of the housing market has devastated neighborhoods and balance
sheets alike. Millions of homeowners have defaulted on their mortgages and
holders of mortgage-backed securities (MBS) have suffered massive write-downs.
Banks and servicers have been increasingly called upon to renegotiate payment
terms and reduce mortgage principle to slow the tide of foreclosures and stabilize the housing
market. Despite such attempts to “work out” troubled mortgages, however, the foreclosure
rate continues to rise at a steady pace.
Lost in the current economic turmoil is a discussion of what happens to properties when
they have completed the foreclosure process and revert back to the primary mortgage lender. In some cases, foreclosed properties are auctioned off or converted to rental housing. In
others, they are razed or put into public use. In many cases, however, foreclosed properties
remain unoccupied and become a financial drain on their owners. Such properties are known
as real estate owned (REO).
Barclays Capital estimates that as of November 1, 2008, mortgage lenders and investors
held 871,000 REO properties–up from 414,000 a year earlier. That inventory is expected
to peak around 1.4 million in mid-2010. For communities that experienced rapid housing
appreciation, the REO fallout has been particularly acute. In this issue of the Community
Development Investment Review, Dan Immergluck provides city-level data that raises alarming
questions about the stability of communities overwhelmed by abandoned properties. Yet
from a community development standpoint, this large inventory of REOs offers an unprecedented
opportunity to increase the nation’s stock of affordable housing. Community organizations
and housing authorities across the country have been exploring ways to acquire
REO properties and make them available to low-income homeowners and renters.
Holding REO properties can be a significant ongoing expense. Taxes, insurance, and
repairs slowly erode owners’ equity in a down housing market. Concern over these costs has
led many lenders to sell their REO properties at significant discount; recouping, on average,
only 70 percent of the attached mortgage principal balance.
These discounted prices have allowed some community organizations and housing
authorities to purchase REO properties and put them back into effective use for low-income
homeowners and renters. To date, these purchases have been sporadic and uncoordinated,
mostly because of capacity and funding constraints.
Locating REO properties for potential purchase and rehabilitation can be a time-consuming
and costly process. Few community organizations are equipped to identify, bid on,
and acquire properties efficiently and cost-effectively. To assist these organizations many
advocates have proposed online platforms to catalogue REO properties in an easily searchable
format. Prabal Chakrabarti notes in this journal that such a database will soon be available
in New England, and others are expected to follow. These online tools will lower REO
acquisition costs and give smaller community organizations better access to REO properties.
Large nonprofits have also emerged to provide capacity-building support. In her article,
Mary Tingerthal discusses how the National Community Stabilization Trust (Stabilization
Trust) has supported community organizations operating in neighborhoods experiencing
a high incidence of foreclosure.
The Stabilization Trust has also advocated for increased neighborhood redevelopment
funding. According to Tingerthal, the Stabilization Trust successfully lobbied Congress
to set aside $3.92 billion of the $300 billion appropriated for the Housing and Economic
Recovery Act of 2008 to fund the Neighborhood Stabilization Program (NSP). The NSP will
directly support REO disposition through the Community Development Block Grant (CDBG)
program. Other sources of federal funding are available as well. For example, Anna Steiger
explores the use of the New Markets Tax Credit program as a vehicle to acquire REOs. As the
foreclosure crisis worsens, more federal and state programs will undoubtedly be tapped to
mitigate its effect on community stability.
In general, housing authorities and community organizations can reduce the national
inventory of REOs in three key ways:
Scattered Site Acquisition and Rehabilitation
REO properties are disproportionately concentrated in inner-city communities. Housing authorities and community organizations can acquire and rehabilitate
these properties to help address the national urban affordable housing shortage. In
their article profiling three federal asset-disposition programs, Ellen Seidman and
Andrew Jakabovics point out that this approach has been successful in the past. They
maintain that targeted REO acquisition and rehabilitation, if sufficiently informed
by previous attempts, could achieve two community development goals simultaneously:
returning abandoned homes to occupancy, and increasing the stock of affordable
housing in low-income communities.
Land Banking and Deed-Restricted Affordability
While an acquisition and rehabilitation strategy would result in a one-time increase in
available affordable housing units, those units will become unaffordable as housing
market appreciation resumes. One solution to this problem is “land banking”—limiting
a property’s resale value through deed restriction. Tina Brooks discusses this strategy in
this issue as she explores the possibility of making land banking a sanctioned municipal
activity in Massachusetts. As Brooks notes in her article, capping appreciation
allows land-banked properties to remain affordable for an extended period. Housing
authorities and nonprofits can adopt this approach with REOs and price discounts can
be passed directly to the homeowner. The flip side of this tactic is that homeowners
will be unable to capitalize on significant gains in the housing market.
Blight Remediation and Housing Stock Contraction
A foreclosed home can significantly affect the value of the properties surrounding
it. Some researchers have estimated that a foreclosed property can depress adjacent
home values by as much as 8.7 percent. Although this effect decreases over time and
distance, most homeowners would agree that living next to an unoccupied home is
undesirable for a number of reasons, not the least of which being crime and fire risk.
In cities that have suffered significant population decline, housing-stock contraction
may be the best long-term strategy for rehabilitating neighborhoods racked by foreclosures
and abandoned properties. This contraction might involve combining property
parcels or razing buildings and auctioning off the underlying land to prospective
mixed-use developers. In either case, blight is eliminated and local housing supply is
reduced (potentially increasing the value of the homes that remain).
These approaches, and others explored in this journal, are just a few of the ways that
REO properties can be used for public benefit. As foreclosures continue to mount and
house prices continue to decline, more homeowners will find themselves in a negative
equity position or unable to make their mortgage payments, or both. Already, one in five
American homeowners is underwater—owing more on their homes than they are worth—and
that number is expected to increase. This presents a community development challenge
on two fronts. First, there is an immediate need to put millions of recently foreclosed-upon
families into homes with affordable mortgage or rental terms. Second, the inventory of
REO properties must be reduced before it threatens to destabilize neighborhoods across
the country. For either of these goals to be met, Carolina Reid offers three lessons to the
community development field: more data are needed for targeted intervention, cross-sector
collaboration is critical, and complex sources of funding must be managed and leveraged to
achieve maximum impact. With billions of newly disbursed federal funds, the community
development industry should heed these lessons and develop a coherent national strategy to
put REO properties back into effective use.