Archive for October, 2010

An apocryphal story: there was once a law in Kansas that if two trains running on parallel tracks met at a railroad crossing, neither could move until the other was gone.

In light of the latest hiccup in the foreclosure crisis – the discovery that thousands of foreclosures may have been done in a slipshod manner (to put it kindly) — that’s an apt metaphor for the real estate industry right now. It’s not clear what has to happen to get real estate moving again. It could be stuck like a Kansas locomotive for quite a while.

Let’s start with Realtors. They list properties for sale. Clients call, get qualified. Realtors negotiate the contracts. But with anywhere from 40 to 60 percent of transactions involving some sort of foreclosure, the robo-signing crisis slows the process down. If banks actually start confirming that they own what they’ve foreclosed on, that’s going to take some time. Realtors who specialize in these homes won’t be getting as much inventory.

Let’s move onto title companies. They are a crucial component in the process, because without their confirming that the previous owner legitimately holds the title to the property, there can be no legitimate transfer of said title. Title companies have a vested interest in selling title insurance. And they don’t want to become party to their own version of the class action lawsuit that’s bound to hit the banks.

Lawyers aren’t normally part of the real estate cycle in this state, but they’re likely to show up too. Some owners or former owners are going to claim that their lender defrauded them. No one wants to buy a property that’s tied up in a lawsuit.

Of course, there are the lenders and the buyers. The lenders seem to be flummoxed into paralysis by this whole mess. They’ve instituted rules about lending that seem to eliminate a good portion of the potential buyers who, even though housing prices AND interest rates are down, can’t take advantage because their own income or net worth has been impacted.

The pace of transactions is stalling, and there’s no way of knowing how long the stall will last. The irony here is that real estate drives the economy. When people buy new houses, they buy new furniture. They hire exterminators. They hire landscapers. They hire painters. Without consumer demand, the economy isn’t coming back. If the economy isn’t coming back, companies aren’t going to hire more employees. And neither locomotive could get going again until the other was gone.

What’s the takeaway from all this? Real estate has changed from the way it was in the 20^th century. If you’re lucky enough to be sitting on some cash (perhaps you own Apple stock), and are thinking of investing in real estate, move with more prudence and caution than you’ve ever exhibited. Know the income potential of the property in the new context of the wider market. Know your tax implications. Know your exit strategy. Don’t get stuck at the railroad crossing waiting for someone else to make a move.

One of the most poignant scenes in American cinema takes place during the original Great Depression. In It’s A Wonderful Life, there’s a run on the Bailey Building & Loan, and Jimmy Stewart passionately explains to his panicky depositors that their money isn’t there: it’s in each other’s houses. “You’re loaning it to them,” he says, “and they’re paying it back as best they can.”

That’s the way things used to be, and I’m beginning to suspect that we might be returning to those days sooner than we think. In the old days, there weren’t lenders and mortgage brokers and title companies. You went to your local banker and borrowed money to buy a house; the house served as collateral for the loan.

Somewhere the system has gone horribly awry. It was bad enough when Wall Street started securitizing loans, knowing that more than 28% of them weren’t compliant with underwriting regulations. But when the other shoe dropped, and it turned out banks were foreclosing without being compliant with those regulations. You can’t sign 16,000 transfer documents (part of the foreclosure proceedings) and confirm that they’re all correct. What’s the rush?

Even worse, I fear that this latest so-called robo-signing scandal is just the tip of the iceberg. In fact, Bank of America has just suspended foreclosure proceedings in all 50 states, up from the original 23 where the process known as judicial foreclosure is the law. If it wasn’t bad enough with the investors and the lenders knee-deep in muck of their own making, now the lawyers are going to surge in with class-action lawsuits.

I’m frankly astonished that the highly regulated financial services industry can find so many new ways to screw up. And even though it is highly regulated, I’m also confident that the government will enact new regulations to keep this from happening again. Talk about a vicious circle. Wall Street oversteps the boundaries of sound investing and lending. The government enacts legislation. Wall Street complains that there’s too much regulation. No matter what happens, it seems to translate into higher costs and more delays for potential homeowners.

Nor is the future looking bright. It means that a foreclosure crisis, which was already beginning to move from bad loans to good loans held by people who are running out of financial resources, is going to be drawn out even longer by this delay. It could take two to three years to cycle foreclosures through the entire process. Don’t forget to factor in the issue that if the ownership of foreclosed houses is murky – because a bank didn’t foreclose properly – investors are going to be more hesitant to take a chance on buying them. And until foreclosed properties stop hitting the market and staying on the market, housing values aren’t going up. They may even get devalued.

One thing is for sure – what with increased regulation and litigation, even with interest rates at historic lows, it’ll be much harder to get a mortgage through traditional means in the coming years. Will that kill the drive for home ownership and real estate investing? If the financial services industry keeps dropping boulders in the pond, who knows what shore the waves will crash upon? Who knows when life might be wonderful again?

A couple of weeks ago, in a blog entry entitled The Battle Between Capitalism and Altruism,

I wrote about competing offers for properties in Chicago, Ill., and Hartsville, S.C. The battle referred to the fact that, in each case, one of the offers would have involved our getting paid off months or even years sooner than with the alternative offer.

In each case, however, the alternative offer was from exactly the kind of buyer DBNR has been targeting since its inception – people who are willing to work diligently to get themselves ownership of property.

As you may remember, in Chicago, one of the offers came from someone who was better at words than action. He regularly put me off with assurances that his own clients would come through with cash, but it never happened. When I gave him his final deadline, he never even bothered to call back. Sheila (not her real name) called me to find out what had happened even before I had a chance to call her. She signed her contract, got a money order, and sent both via overnight delivery.

That wasn’t quite the end of the story, though. When she took possession, she was astonished to find that the other party had been so confident in getting the property that he’d already had workmen inside. Sheila is not someone to be trifled with. She told him to get out and stay out. His response: he started making the same kind of all-cash offers to her. Sheila came back to me, asking about this guy. I told her, “If he hands you a certified check, take it. But if he could back up his words with cash, you wouldn’t be the owner today.”

In Hartsville, as you remember, I was talking to one prospect’s father, who was negotiating for his son, who lives outside the country. He had first lowered his offer and then, after finding out that there was another party interested in it, raised it again. When I called to determine the son’s level of interest, I never heard back.

The other prospect, Ronnie (not his real name), wanted to buy the property and park his trailer there. His ability to make his down payment, however, was predicated on his wife being approved for Social Security. There was a period of about ten days during which I wasn’t hearing anything from Ronnie, either, but I’ll be darned if he didn’t call me Saturday before last and say she had been approved and he was ready to send me a $500 nonrefundable deposit.

I told him he was still going to have to come up with the rest of the down payment – another $1,000 – but he was confident he could do that. I can still hear his Southern accent coming through the phone: “Ah don’t quite know how we’re going to make that happen, but we are.”

It may be longer before DBNR gets its money, but that’s okay with me. I like being part of a real-life Frank Capra movie where the little guy gets a piece of the American Dream by pluck and dedication. It makes me feel good.

One last thing about Ronnie – call it just one more indication of his confidence in his ability to get his dream property. He said to me, very politely, calling me Mr. Noble, “Do you mind if mah friends and Ah start cleaning off that lot for mah trailer?”

I told him I didn’t mind at all.