In 1989, a savings and loan institution in Fort Worth, Tex. inherited a large portfolio of foreclosed properties as part of an FDIC-engineered takeover of insolvent lenders. As part of the workout, the Fort Worth S&L took title to a number of homes in low-income, foreclosure-plagued neighborhoods. The S&L had little financial stake in the homes, but because it had historically lent in the same neighborhoods, it had every interest in seeing the homes reoccupied. So it donated 40 of the homes to a community development corporation that was just starting up in a low-income eastside neighborhood.
Within a few years, the CDC renovated and reoccupied the 40 homes. Most of them were sold for about $30,000 — half of the median sale price in Fort Worth at that time. Homes on less desirable blocks were rented, with the resultant cash flow paying off loans used to repair the properties.
At the same time, several real-estate entrepreneurs targeted the neighborhood, bought scores of foreclosed homes for pennies on the dollar from stronger S&Ls and the newly created Resolution Trust Company (RTC). Using more or less the same business model as the nonprofit, these entrepreneurs put scores of vacant, boarded-up homes back on the market. As a result, a neighborhood decimated by foreclosures got back on its feet — not picture-perfect, but stabilized.
While today’s foreclosure crisis is significantly larger and more challenging than the previous one, those who aim to restore the hardest-hit neighborhoods can learn valuable lessons from this Fort Worth example.
First, the agony would have lasted for many more years — with much deeper scars in the affected neighborhoods — if the federal government had not provided bailout money through the FDIC and created the Resolution Trust Company (RTC). Together, they nudged, cajoled, and forced a large cast of characters to quickly dispose of their non-performing assets.
Second, as the vacant home inventory burgeoned, the RTC and other holders of foreclosed properties began to capitulate to fire sales, because they realized that too many homes were just sitting there empty, producing no revenue and dragging down property values.
Third, the fire sales put many of the hardest-to-sell homes in the hands of for-profit and nonprofit real-estate companies that were able to repair and reoccupy the homes — selling them if they could, and renting them if they had to.
In today’s foreclosure crisis, which is becoming more acute by the day, these three crucial ingredients — emergency government authority to dispose of the properties quickly, deep discounts, and redevelopment capacity — are just starting to fall into place, and none too soon. According to RealtyTrac, more than two million properties nationwide received a foreclosure filing through the third quarter of 2008, up more than 70 percent from the same period in 2007. In October, RealtyTrac predicted that close to one million homeowners would lose their homes to foreclosure in 2008 — an astounding two and a half times the numbers in 2007.
In 2008, according to the same market data firm, about 90,000 homes a month were being added to the inventory of bank-owned homes, bringing the total number of “real-estate owned” — or REOs — to at least 750,000. According to a report in September on MSNBC, the true number of REOs is probably much higher, since some are not formally listed for sale as lenders hold on to them hoping the market will improve. Rick Sharga, senior vice president at RealtyTrac, was quoted as saying that the market is so backed up that some repossessed homes take as much as 11 months to hit the market.
There are other signs of severe distress in the housing market. According to the National Association of Realtors, the annualized rate of existing home sales in August 2008 had dropped by one million since the peak of the housing boom at the end of 2004, while the inventory of unsold existing homes has nearly doubled to over four million. This has resulted in a 10-month supply of homes at present rates of sales, compared to a four-month supply at the end of 2004. According to an S&P Case-Shiller survey of 10 major cities, home prices had dropped 17.5 percent, year over year, as of the end of July. All of these dismal home-sales trends indicate that the build-up of REO inventory will get worse before it gets better.
New Federal Funding to Address REOs
In July, Congress appropriated $3.92 million for a new Neighborhood Stabilization Program (NSP) to be managed by the U.S. Department of Housing and Urban Development (HUD). Funds may be used to acquire, rehabilitate, demolish, or redevelop and then to sell, rent, or land-bank foreclosed, vacant, and abandoned properties, including multi-family housing. To ensure that homebuyers are prepared for homeownership and prequalified for home mortgages, homebuyer counseling is an eligible expense if provided in connection with the resale of properties. In addition, funds can be used for property maintenance and holding costs under certain circumstances. NSP funds cannot be used to fund foreclosure prevention, but Congress has increased foreclosure counseling funds provided in other HUD programs.
In an unexpected turn of events during November, HUD began to advise that NSP funds could be used to purchase and redevelop virtually any vacant property in a designated target area. As examples, HUD has mentioned vacant public housing and nonresidential buildings such as vacant firehouses. It is unlikely that congressional sponsors of the law envisioned this liberal use of NSP funds, but HUD’s advice conforms to a literal reading of the law. Since grantees are free to implement just one facet of NSP, this interpretation means that a grantee has the right to use NSP to fund what would be, in effect, urban renewal programs in foreclosure-impacted neighborhoods without ever buying, repairing, and selling a foreclosed home. It remains to be seen if any community will do so.
In September, HUD awarded NSP allocations to all 50 states, Puerto Rico, and more than 250 cities and counties. The allocations were based on the number and percentage of foreclosed homes, subprime loans, and defaulted loans. Eighteen states and Puerto Rico received the minimum allocation of $19.6 million, while the highest allocation, $145 million, was given to the State of California. States may spend these funds directly or allocate some or all funds to cities, counties, and Indian tribes. Many heavily impacted cities and counties received large allocations as well. For example, while the state of Florida received $91 million, 47 cities and counties in Florida received separate allocations, including a whopping $62 million for Miami-Dade County.
NSP was approved by Congress in the form of Community Development Block Grants (CDBG), but the program has a number of alternative requirements, including some that provide more flexibility and some that are more restrictive. Only 10 percent of the funds can be used for planning and grant administration — less than under the regular CDBG program. But, as with CDBG, program delivery costs can be funded in addition to administrative costs — meaning that costs of personnel or contracted services can be funded as part of the cost to carry out eligible activities. In addition, developer fees are allowable expenses if related to NSP-assisted rehabilitation or construction activities. Unlike the regular CDBG program, states may operate NSP funds directly and/or award funds to local jurisdictions, including local jurisdictions with their own allocations and Indian tribes.
As this issue of Shelterforce was going to press, states and local governments with allocations were required to submit budgets and action plans describing their proposed activities, target areas, expected outcomes, and other details. By the end of December, HUD expected to have reviewed all the plans and approved those that conform to NSP. If a plan is disapproved, it must be resubmitted.
NSP offers a very significant amount of funding — more than twice the annual, national budget for the HOME program — and Congress hard-wired a sense of urgency into the program. All funds must be obligated (meaning at least under contract) within 18 months of the NSP award from HUD, and the amount of the original allocation must be spent within four years. Some NSP program income can continue to be used for similar activities in perpetuity while other program income can be kept by the grantees after five years only at HUD’s discretion.
Because of the apparent flexibility and magnitude of the NSP funds, a few keenly interested developers and nonprofits began offering ideas to congressional staff members as well as local and state governments while the bill was still being debated in Congress. When HUD issued the NSP program rules on Sept. 29, those discussions began to accelerate rapidly. Given the tight application and spending deadlines, nonprofits and companies that want to get involved in the implementation of NSP should be reaching out now, if they haven’t already, to the appropriate NSP grantee agencies in their state. Would-be implementers might be told to wait until the formal requests for proposals are released, but that shouldn’t keep them for asking for information about the draft NSP action plans and more detailed program plans of their city, county, or state government and providing constructive input.
Likewise, neighborhood advocates should do their best to keep track of the rapidly developing NSP program plans, to help assure that the resources go to the areas of most need and are otherwise used wisely. Because of the short window for applications, many state and local governments drafted their action plans in broad-brush strokes, to preserve flexibility for future implementation options. While HUD promises to approve action plans in January and February, state and local governments will be drafting detailed program plans and requests for proposals both before and after that time. Because this is an all-new federal housing program dealing with difficult market conditions, HUD staffers expect to receive many requests for amendments of action plans.
Finding the Implementation Capacity
The coalition of housing advocates who advocated for NSP in Congress have estimated that 80,000 foreclosed homes could eventually be returned to productive use. Recognizing that some markets may not turn around quickly, NSP provides funding for so-called “land-banking” — meaning, in reality, a lot more than banking land. Program implementers can buy and maintain foreclosed and abandoned homes, demolish seriously blighted homes, and hold properties for redevelopment as long as 10 years. NSP funds may also be used to redevelop properties for various uses, including parks and other non-residential purposes. Governmental entities may even use NSP funds to maintain foreclosed and abandoned properties owned by others, so long as they charge the property owners or place liens on the properties for board-ups, junk removal, weed clearing, and other maintenance needed to stabilize the properties and neighborhoods.
Many cities and counties have code-enforcement and property-disposition departments that are capable of implementing these maintenance and buy-hold strategies. But it will be more difficult for local and state government grantees to find and expand the redevelopment capacity for scattered-site properties, particularly in the most distressed neighborhoods where NSP should be focusing.
The primary development activity envisioned by NSP — acquisition, repair, and resale of individual homes in various states of repair and typically in less desirable locations — is recognized by community development experts as being of very high value to distressed neighborhoods, but compared to new construction and multi-family rehabilitation, it is also recognized as labor-intensive and less predictable in terms of costs and marketability of the restored homes. There are no precise national figures available on the scale of this single-family acquisition, rehab, and resale activity. Several experts gave estimates to this writer, all of them under 5,000 homes per year.
At the same time, there are signs of a much larger gray market of small-scale entrepreneurs buying and flipping homes, or operating them as single-family rentals. To fund acquisition costs, most of them rely on secured real-estate loans, at commercial rates of interest at least a percentage point higher than conventional home mortgage rates. Many scrape together their working capital for down payments, construction and holding costs from credit cards, home equity loans, family loans, and other non-conventional sources. While no reliable data exist for purchases of distressed single-family homes by investors, the annual numbers are likely in the high tens of thousands, if not low hundreds of thousands, per year. But in recent months, this activity has likely declined as a result of the severe tightening of mortgage lending that began last summer.
To find the capacity to implement acquisition-rehabilitation programs, local and state governments will likely turn first not to these entrepreneurs but to specialized nonprofit and for-profit developers of subsidized affordable housing. However, because a limited number of these organizations are equipped to run acquisition-rehab programs, some NSP grantees may also seize the wide-open opportunity to finance capable and effective entrepreneurs who are scooping up foreclosed properties. The goal would be to harness the best talent to focus on the homes needing rehabilitation in the most distressed areas, using NSP subsidies as the incentive. But this is no easy proposition. It will be hard to sort out honest real-estate operators who can help rebuild communities from hard-nosed slumlords and na“ive investors who have bought a few homes and take much of their advice from TV shows like “Flip This House.”
Many of the more experienced and able entrepreneurs operate their businesses on a shoestring from their kitchen tables and pickup trucks, and have strong allergies to government red tape. Successfully engaging them in NSP may require creating some new forms of acquisition-rehab loan programs as incentives to buy and restore homes — ideally tightly targeted to the most difficult-to-address homes. The best use of NSP funds is not the isolated foreclosed homes in strong neighborhoods that need little or no repair work, since homebuyers and short-term investors can take care of those with no government subsidies.
In creating such programs, states and local municipalities should consider requiring matching private loans in order to screen out the operators with low capacity and stretch the federal dollars further. In addition, a heavy dose of technical assistance will be required to help these entrepreneurs develop workable project pro-formas, get matching bank financing, and deal with federal compliance issues.
A Coordinated, Multi-Pronged Approach to Implementation
Whether acquisition-rehab programs are run by nonprofit or for-profit businesses, it will be essential to link them up with counseling and training programs that can generate a stream of bankable buyers who meet NSP income criteria. Likewise, cities and states could fund soft-second mortgage programs as an incentive for homebuyers to take the risk of buying a foreclosed home in a highly affected neighborhood. NSP gives grantees the latitude to offer second mortgages that have no monthly payments and are due only on resale of the property.
Although bobbing and weaving is not a popular concept in government agencies, local and state governments implementing NSP would be well advised to consider their NSP programs as ongoing experiments, in which they learn from doing and adjust accordingly. For example, if $25,000 second mortgages aren’t incentive enough to sell houses in a certain neighborhood, the subsidy might be raised to $40,000. The FDIC-RTC successes in the S&L workouts resulted, in large measure, from their structural flexibility to adapt to different markets and to doggedly pursue a single-minded goal of clearing out REO portfolios.
Certainly some, but not enough, nonprofits are capable of running an entire program of acquisition, rehab, counseling, and resale with second mortgages. While many of the several hundred NeighborWorks affiliates have this expertise, they would be the first to say that nonprofits can’t implement the entire NSP program nationally. Likewise, some government agencies with relatively small NSP allocations may have the capacity to run vertically integrated NSP programs with their own personnel. In contrast, cities and states with bigger allocations and bigger foreclosure problems will need to stitch together an implementation apparatus with multiple administrators. For example, one subrecipient or contractor could manage an acquisition/construction financing loan fund for nonprofits and entrepreneurs, multiple contractors could provide housing counseling programs to generate buyers for the developers, and yet another subrecipient could run a soft-second mortgage program for the homebuyers.
Tapping Into Regional and National Financing Capacity
Given the need to rapidly implement NSP programs, there is too little time to be reinventing wheels, or to be inventing some new, critically needed program component in hundreds of localities. To help accelerate the process, four major national community development organizations have come together to form the National Community Stabilization Trust (NCST), with the goal of providing capital and workable program models to state and local government and nonprofit implementers of NSP. The NCST members are Enterprise Community Partners, Housing Partnership Network, Local Initiatives Support Corporation, and NeighborWorks.
One of NCST’s first orders of business was to find ways to pool private capital with the $3.92-billion federal appropriation, so that more homes can be rescued. Toward that end, NCST’s team of financial and affordable-housing experts is building models of leveraged loan funds that might be operated by states, local governments, subrecipients, or NCST itself. In tandem, the same team is working with major lending institutions to develop standard templates — which have been sorely lacking — for transferring large portfolios of REO properties from servicers and investors to local NSP implementers, at prices low enough to make repairs and resale feasible. Developers can increase their volumes through economies of scale and lower acquisition costs. Lenders and investors benefit by unloading larger numbers of foreclosed homes and avoiding the costs of holding, marketing, and selling the homes. Most important, communities benefit from having a high-volume approach to reoccupying foreclosed homes.
As illustrated by the Fort Worth example described above, bulk transfers were crucial to the speedy redevelopment and reoccupancy of REO homes after the S&L debacle. Yet the situation two decades ago, while dire, was far simpler to solve. FDIC either shut down or arranged purchases of insolvent S&Ls. The value of loan assets and REOs was either written down during the transfer, or the RTC took over the troubled assets and had broad authority to sell them at whatever discount was required to attract a buyer.
However, in our current and still-growing subprime lending crisis, no regulator like the FDIC has the authority — at least not as of this writing — to force such a solution. The most troubled assets two decades ago were loans and REO properties still owned by the S&Ls. But in recent years, as many as two-thirds of home loans were bundled into pools. The ownership of each mortgage pool was then sliced and diced into new-fangled investments — some almost unfathomable even to experts — and sold to banks and other investors worldwide. After too many homeowners stopped paying their loans, trillions of dollars of these exotic investments became nontradable, bringing the world financial system to its knees.
The foreclosure crisis is exacerbated by the fact that these troubled mortgage pools reside in so-called “brain dead” entities that exist only to pass gains, losses, and tax obligations to investors. Loan servicing companies were hired to manage the loans, but in far too many cases, they don’t have the authority to substantially modify loans to keep homeowners out of foreclosure, or to cut the prices of foreclosed homes deep enough so that the homes can quickly be sold and reoccupied. The NCST coalition is working hard to solve this problem through new legislation that grants more authority to loan servicers.
Another challenge for NSP programs is to come up with permanent financing for homebuyers that is attractive and flexible enough to work in troubled housing markets during this, the worst credit crunch since the Great Depression. Self-Help, a nonprofit lender and buyer of loans based in Durham, N.C., recently offered a new loan product aimed specifically at helping nonprofits purchase and redevelop REOs. As with the federal NSP funding, the loans can be used to buy, repair, rent, or sell REOs to homebuyers. A special and highly attractive feature of this loan product is that the loans to nonprofits can be transferred to homebuyers later, assuring a source of permanent financing and allowing for lease-purchase arrangements.
This new Self-Help loan product was made possible by a modification to its pre-existing secondary market program, which is predicated on Fannie Mae’s commitment to buy the loans and a $50 million grant from the Ford Foundation to provide a loan loss reserve. Self-Help is active not only in North Carolina, but the D.C. metropolitan area, California, and other states.
Self-Help’s product — or others like it — is well suited to be used in tandem with second mortgages funded by the new NSP program. To receive any NSP funds, state and local governments must agree that 25 percent of the occupants of NSP-assisted homes have very low incomes, meaning below 50 percent of area median income. Even if REO homes are substantially discounted, very-low-income homebuyers or renters will not be able to afford them unless subsidies are available to reduce the cost. As already described, a soft-second mortgage using NSP funding — whether to a homebuyer or operator of affordable rental homes — is a simple and proven mechanism to provide these subsidies.
Clearly, the foreclosure tsunami sweeping over large parts of the nation does not lend itself to a simple, silver-bullet solution such as the RTC’s swift actions in the nation’s last foreclosure crisis. Today, the problems created by foreclosures are far more diverse, with many more structural and market barriers to quickly acquiring and recycling the homes. In addition, solutions must be tailored to widely varying market conditions. The best mix of public-sector interventions for inner-city neighborhoods in Cleveland, Ohio will look very different from the right set for Santa Rosa, Calif. Many inner-city programs will undoubtedly include major budgets for rehabilitation, demolition, land-banking, and transitional rental housing. Suburban programs in areas with stronger local economies will likely focus exclusively on acquiring REOs that require only light repairs for quick resale.
REO rescue programs are already underway. Some cities, like Cleveland, have been dealing with the problem of vacant and abandoned housing for decades and will be able to use the additional funding to quickly expand these efforts. A few states — California, Massachusetts, and New York — already have pilot REO stabilization programs operating, using their own resources. Arizona has just made funding available to help local governments plan and apply for NSP funds.
The NSP program is not a panacea for the continuing national build-up of vacant and foreclosed homes, but at least it is an important step forward — a tangible federal commitment to begin reversing a destruction of home values that continues to undermine neighborhoods, cities, and — no small thing — the global economic system.