During the housing boom, mortgage lenders were allowing just about anyone to buy a house or refinance their existing house. 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; buying houses anywhere, certain that appreciation is right around the corner to make them instant millionaires. Before you go on a buying binge, you’ll want to note some sobering indicators of what the market is actually doing as of April 2010: One in 14 mortgages (3.5 million) are at least 90 days delinquent as homeowners have realized that banks are more willing to reclaim their homes than modify their loans. These homeowners are literally walking away from their homes, and their mortgages, as two million of these mortgaged homes are over 180 days delinquent. If you thought that the real estate market was on the brink of improvement, think again. The delinquency rate of mortgaged homes is 65% greater now than just a year ago.
These numbers are a telling reminder that prospective homeowners and active investors will need to hold on for several years before the market cleanses itself, causing prices to rise again. Current foreclosures will take years to work through the system and hit the market. Banks are overloaded with inventory and we have already seen evidence of banks “price fixing” by intentionally withholding foreclosures from the marketplace in an attempt to rake in top dollar for home inventories. Current foreclosure victims of the recent past will have marred credit; keeping them from buying a new house for several years. Their inability to buy, among various other factors such as high unemployment, tightening of credit guidelines and lower wages to working families will continue to defer home value appreciation. Real estate prices are low and will continue to stay that way for several years; but this doesn’t mean homeowners and investors should stay away from the real estate market altogether. It just means that they need make calculated decisions when buying a home so that the coming wave appreciation will exponentially enhance their wealth. One such decision is picking where to buy a house.
Urban areas/inner cities
Lifelong renters, many of which receive government housing subsidies like Section 8 or FIA, make up a large portion of inner city populations. It’s important to note that the sub-prime meltdown began in large cities as mass amounts of liberal credit was given 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 itself. We see evidence of the foreclosure crisis in the form of boarded up homes, high unemployment rates and crime.
If your plan is to purchase homes to flip in inner city areas, there are several obstacles standing in your way. For starters, credit guidelines to potential buyers are next to impossible to overcome right now. How can you flip a house if potential buyers can’t get a mortgage? Secondly, even if you have a qualified buyer in hand who wants to buy your home, chances are the appraisal will come in much lower than expected, killing your deal. Lenders will make up any excuse to not lend in areas with a high “F-score”, which is lender terminology for the percentage of foreclosures in any given area. Another problem for urban investors is that qualified inner city home buyers are now migrating to the suburbs versus staying in high crime areas like inner cities. This increases the amount of vacant homes on any given urban block; and vacant homes breed crime. An investor’s inner city rehab project may very well be broken into multiple times during the renovation process. Thieves love new hot water tanks, furnaces, carpeting and kitchen cabinets; I know this from experience.
Even buying in urban areas or inner cities right now for rental cash flow is an oxymoron. People are coming from all over the world to buy houses in cities like Detroit, Indianapolis and Cleveland for under $2,000 knowing that these houses will easily cash flow; or so they think. Where is a landlord’s cash flow going to come from with unemployment so high? Also, houses that sell for the price of a mountain bike are usually in horrifying areas; the numbers look great on paper, but reality is different. Investors who believe government subsidized tenants are the way to go should note that many of these potential tenants are leaving inner cities for the safer suburbs. On the other hand, many permanent inner city renters live like nomadic animals and literally trash a landlord’s house before moving on to their next unsuspecting victim. Good luck suing tenants like this for damages; many low income inner city tenants aren’t collectible because they don’t work.
With appreciation years away, stay away from inner cities unless you plan to wholesale houses to cash investors who don’t pay attention to the above risk factors. Be a middleman in the inner cities without owning anything. Continually market to find desperate sellers and hungry buyers, then link the two together for commissions you set per deal. Banks hate lending in inner cities right now, therefore seller financing reigns supreme on homes with nothing owed. Only practice seller financing if you have experience as a real estate investor or you truly understand the process with legal counsel handy. Some investors are buying houses dirt cheap and setting seller financing terms of $500 down, with a $500 mortgage payment per month, and buyer makes all repairs. Contrarily, street-smart landlords who have years of investing experience can survive via tenants with subsidized housing vouchers and time tested skills. New investors should stay away from owning anything inside inner cities at all costs until times get better.
Suburbs
The foreclosure crisis will continue to unfold in the suburbs as banks continue to be reluctant to modify homeowner’s loans. Frustrated homeowners are simply walking away, knowing their personal efforts to save their houses are futile. This is spelling out “opportunity” for some wise investors who are buying properties at county courthouses while the delinquent homeowners are still living in them. Once an investor makes the purchase for a price far below what the homeowner owes the bank, the investor then contacts the homeowner and explains that he is the new owner of their home. Terms are reached and monthly payments are set in these “lease to own” transactions. In time, the homeowner can opt to purchase the house back from the investor for prices up to 40% below their former outstanding loan balances. This strategy not only saves the mortgagee’s home, but also saves their credit. Investors who are practicing this strategy are forming partnerships, money pools or already have cash/credit lines to make these acquisitions.
Investors need to be aware that banks are intentionally withholding foreclosures from the marketplace, creating a fake supply/demand curve. One of the nation’s top REO agents reported to us that homes listed for just a day sometimes receive more than 20 offers; while millions of other homes sit on various bank’s books. One reputable insider explained that banks are expected to start releasing these homes in August 2010, which will drive suburban home values down further. This doesn’t mean to avoid buying in the suburbs; it just means to be very careful. Only settle for the best deal, just in case a flood of foreclosed homes hits the market, driving prices lower.
Though buyers will have to pay more for a house in the suburbs versus the inner cities, finding good tenants is hardly a problem. Many suburban tenants are past foreclosure victims who are killing time until they can become buyers again. Others are government housing subsidized tenants escaping the inner city. No matter the case, buying to hold in suburbia seems to be safe; but with appreciation years away, landlords are going to have to be patient and select only the best long term tenants.
Young, new home buyers are fueling real estate and they all want a good deal in the suburbs. If you can purchase really low as compared to other homes in the neighborhood, rehab the home to standards much higher than other listed homes, and price them better than other homes in the area, you can do well. Several talented investors are staging homes with furniture and even throwing in items like TV’s, or in some cases new appliances to entice buyers. Even though the suburbs allow for rehab flips as an exit strategy, many neighborhoods have sellers trying to short sell their homes. This creates price competition for investors looking to sell for profit. Watch the numbers on every deal you do and be aware of what other sellers are trying to do in the areas you invest in.