Rehabbed REOs spend less time on market

Investors perform fix-up work that banks can't afford to do

By Steve Bergsman, Friday, April 22, 2011.

Inman News™

Most Realtors recommend sprucing up a home before putting it on the market, because a nicer-looking home sells quicker. The same theory permeates the foreclosed, or REO (bank-owned real estate), sector.

A recent study undertaken by a national field service company that works on REO properties not only confirmed what was at most an empirical belief among Realtors, but accentuated the difference between rehabbed and nonrehabbed properties.

Ironically, all this proof of purpose comes down at a time when the banks have not only slowed the rehab of REO properties, but also constrained the pipeline of REO properties for the open market.

Field Asset Services Inc., an Austin, Texas-based property preservation and REO asset management company, for two years now has surveyed foreclosed and REO properties comparing number of days on market (DOM) for remodeled properties versus those that are not remodeled.

In the company’s initial study two years ago, rehabbed properties spent 54.6 percent fewer days on market than unrehabbed properties. In its most recent study, published earlier this year, results showed a dramatic 68 percent reduction in DOM for properties that underwent rehabilitation.

For the present study, FAS tracked 17,252 properties across 13 states. The average DOM for the properties represented without rehabilitation was 222.8 days. This number dropped significantly for properties with rehabilitation to 69.8 days.

"When a home looks better, it sells faster," said Javier Zuluaga, director of sales and marketing for Home Repairs and Remodeling (HR&R) LLC in Tempe, Ariz. And the banks believed that to be true, too, because starting in 2008 they were paying HR&R about $7,000 to $12,000 to do basic rehabs on REO properties: clean, make ready the pool, replace the carpet, and replace or repair cabinets."

The banks still believe in rehab; nevertheless, that business has gone away.

"What happened was," Zuluaga explained, "the banks could not keep pace with the down-spiraling prices. So, sometime around 2009, the banks simply said, ‘We are not going to put all this money into it. We are just going to get the properties cleaned up and if it is missing cabinets, it is missing cabinets — that’s just the way it is.’ "

Zuluaga added, "When we rehabbed, homes did sell quicker, but it got to the point where the banks realized they were putting money into the homes but were not getting their price points back. The homes were selling but the banks just ran out of funds."

Field Asset Services has also seen its business decline.

"Business started to decline around last October and has not kicked back up," said Dale McPherson, president of FAS. "Our business is down about 25 percent."

That drop-off is attributed more to congestion at the banks rather than the expenses of rehab.

Mortgage servicers are having to redo their foreclosure compliance work sometimes three or four times in order to get a property into foreclosure.

"What has happened is the average foreclosure time frame has gone from seven months in 2008 to 18 months today," McPherson said. "The pipeline is bundled up. At some point, it has got to unravel — it has to!"

The REO market has definitely bifurcated between owner-occupant buyers and investors, and the two markets vary immensely.

About the only dependable financing for buyers who want to live in the property they are acquiring are those insured by the Federal Housing Administration, which is a division of the U.S. Department of Housing and Urban Development. To get an FHA loan, the prospective home has to meet minimum standards.

"To buy, you have to be able to finance through HUD because until recently there has been no other financing available, as there is very little conventional financing," said McPherson.

"In order to sell to a HUD buyer, you have to have a move-in property. It has to pass HUD’s appraisal standards. You can’t buy a property ‘as is.’ You can’t buy a property that doesn’t have working appliances, missing countertops or chipped paint."

On the other hand, investors prefer the beat-up home. They pay cash, try to close quickly and will take care of rehab themselves.

According to Zuluaga, "the investors are making the margins that the banks are not making now," which is good business for companies like HR&R.

"The private guys are hiring us; they are buying these homes at a very low price and hiring us to do the remodeling," Zuluaga said.

When a cash buyer steps in, he is going to expect the (mortgage) servicer to "take a haircut," McPherson said.

Then comes the remodeling. Investors are either going to fix the homes up and resell, or fix it up and lease. The key for investors is getting the proper valuation to ensure, at minimum, a least a dollar-for-dollar return on the investment.

Investors have to do a valuation on both repaired and as-is sales, because that’s how they determine their repair margin. For example, a home is worth $90,000 as is, but after repair could be sold for $100,000. The owner, bank or investor gets a repair bid, which comes in around $7,000. The margin of $3,000 is generally enough to go ahead with the repairs.

"I would contend," McPherson said, "based on our results, you are still going to sell the house faster — even if it is only a dollar-for-dollar return — if you fix it up. In a market such as Phoenix, where there is an immense amount of foreclosed homes, you might see five or six REO properties on the same street. If you want to compete, you need to have the best-looking house on the block."

Steve Bergsman is a freelance writer in Arizona and author of several books. His latest book, "After the Fall: Opportunities and Strategies for Real Estate Investing in the Coming Decade," has been ranked as a top-selling real estate investment book for the Amazon Kindle e-reader.

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A growing body of research shows that these so-called “strategic defaulters” defy the tell-tale characteristics of most people whose loans go bad. They pay their bills on time, rarely exceed their credit-card limits and hardly use retail credit cards, according to a study released Thursday.

And they plan ahead.

They know their credit scores will take a hit after they fall behind on their mortgages, so they tend to open new credit cards in advance of defaulting, according to Thursday’s study, conducted by FICO, the firm that created the nation’s most widely used credit scoring system.

“These are savvy people who organize themselves,” said Andrew Jennings, FICO’s chief analytics officer. “This is a planned activity, not an impulse activity.”

This relatively new type of behavior is the latest sign of just how profoundly the mortgage crisis has reshaped consumer attitudes toward their homes and their finances. It is largely driven by plunging home values, which have left nearly a quarter of the nation’s homeowners underwater, or owing more on their mortgages than their homes are worth.

So some do the math and walk.

A team of researchers estimated that 35  percent of defaults in September may have been strategic, up from 26 percent in March 2009. But they acknowledge in a report published last month that the numbers are tough to tease out because “strategic defaulters have all the incentive to disguise themselves as people who cannot afford to pay,” according to the report by researchers from the European University Institute, Northwestern University and the University of Chicago.

That’s because lenders have become more aggressive about trying to recoup money lost on foreclosures, and they’re chasing after borrowers who they suspect have skipped out on a loan they could have paid.

In many localities — including Virginia, Maryland and the District — lenders have the right to pursue those borrowers and collect the difference between what the property sold for in foreclosure and what the borrower owed on it, also called a deficiency.

A handful of states do not allow lenders to pursue deficiencies. But in states that do, the laws vary widely. Some states limit how long the banks have to file a claim or collect the debt. Others may calculate deficiencies based on the fair-market value of the house. For instance, if a home sells for $200,000 yet its fair market value is $250,000, the borrower who owes $240,000 on the mortgage would not have a deficiency.

Many borrowers may not be aware of these laws. Instead, their decision on whether to strategically default may be tied more to emotion than anything else, the team of university researchers concluded in last month’s study.

They found that people are less willing to strategically default if they think it’s immoral. They are more likely to do it if they are angry about their financial situation or mistrust the banks and want them to be better regulated. They are also more willing to proceed if they know someone who defaulted strategically.

A year ago, another report added to the body of data being gathered about these borrowers. Those who have high credit scores and new mortgages with relatively large balances are more likely to default than those who don’t, Morgan Stanley analyst Vishwanath Tirupattur wrote.

Morgan Stanley’s analysis is cited in the FICO study and meshes with FICO’s conclusions. FICO defined strategic defaulters as borrowers who are underwater on their loans and fell 90 days behind on their mortgage yet kept up with all their other debts — a departure from the traditional pattern of a typical struggling borrower.

But Sam Khater, a senior economist at the mortgage research firm CoreLogic, said it’s important to put the numbers in perspective when trying to figure out how big a challenge these borrowers pose for the lending industry and the housing market at large.

The more people who default, for any reason, the tougher it will be for the housing market to recover. Foreclosures sell at a steep discount and drag down the value of the properties around them. Clearing them off the market is key to a rebound.

But even though 11 million homeowners in this country are underwater, only 7 percent of them have defaulted, Khater said. If every one of those loans belonged to a strategic defaulter, an unlikely scenario, it’s still a relatively small number, Khater said.

Still, “strategic default starts to make sense for borrowers who are extremely underwater on their loans with little prospect for price recovery,” Khater said. “But the factors pushing underwater borrowers toward strategic default are beginning to fade in part because home prices are nearing the bottom.”

Some day, when I’m no longer cohabitating with three other people and a dog, I’ll live in a cozy, super-efficient tiny house. I’ve been in enough well-designed and perfectly built homes of less than 500 square feet to know that it’s surely the best way to live. If you’re on the fence about how much living space is enough, check out this great list compiled by Tinyhouselistings.com founder Steven Harrell on why smaller is better. (Tinyhouselistings.com is the web’s central place to buy, sell and rent houses that are less than 1,000 square feet. It’s worth checking out, whether you’re seriously hunting or just dreaming.)

1. Less initial cost. Tiny houses have traditional features such as kitchen, plumbing, roof and flooring that can make the price per square foot more expensive, but because overall size is so much smaller, the overall price is only a fraction of traditional homes.

2. Less energy consumption. Tiny houses require much less energy to heat and cool simply because they have much less interior air space. Refrigerators and hot water heaters, two big energy consumers, are typically smaller in a tiny house. And if you need to get a new boiler for your home there are some brilliant options online where you can easily arrange the installation of a new gas boiler at a time of your choosing so it’s all very easy and convenient.

3. Less water consumption and trash. If you have a small shower and small hot water heater, chances are your showers will be a lot shorter. If you have a small trash can, chances are you will generate less trash.

4. Less cost for repairs. The cost to replace a 2,000-square-foot roof will be a lot more than the cost of a 300-square-foot roof.

5. Less land to purchase and maintain. If you elect to buy a very small plot of land for your tiny house, you’ll spend less time cutting grass. If you buy a regular size lot, you’ll have more room your garden.

6. Less food. A small pantry means you’ll have a small amount of food in your house.

7. Less taxes. The savings can go toward investments, retirement, college for your children, vacations, or donations to tinyhouselistings.com.

8. Less insurance. Tiny houses cost much less to insure because they are less valuable. Many insurance companies consider tiny houses on wheels to be an RV.

9. Less interest paid. It’s no secret that over the course of a 30-year loan, you will pay more for interest than you will the house itself. Most tiny house owners elect to pay cash for their tiny house, or to pay it off quickly.

10. More disposable income. By owning and living in a tiny house, you are slashing your living expenses at every level.

11. More freedom. (OK, 11 reasons.) By living in a tiny house, you free up money by cutting expenses in a big way. You use fewer natural resources. You spend less time cleaning and maintaining your home. You trade square feet for freedom.

With this graph, Steven Harrell of Tinyhouselistings.com shows the difference in price between traditional and tiny houses. The purple bar shows the average price of a house, the interest paid and the total of both the house cost and the interest paid. The green bar shows the same for a tiny house.

Jay Shafer of Tumbleweed Tiny House Company sent me this shot to show that his beautiful, well-built homes can live anywhere. This one (my favorite design) is less than 100 square feet.