Disposition Strategies

For local governments, transferring properties to a responsible owner as quickly as possible is key to restoring the housing market. Doing so ensures that municipalities will not become long-term property owners and landlords of scattered foreclosed properties. The goal for any municipality is to limit the holding period and get properties back into the hands of responsible owners.

A Lesson on Property Management from NYC

All cities can learn from the mistakes New York City made in the 1970’s and 80’s, when the City became the reluctant and poor-performing landlord of 10,000 distressed, occupied multifamily buildings that were tax delinquent, and by the mid-1990s, was paying $220 million a year to manage and maintain them. This time around, NYC will subsidize the efforts of a nonprofit group to purchase, rehabilitate, and transfer properties to working families.

Disposition strategies should fully align with community planning goals for neighborhoods that have been crafted with broad resident input. Often when faced with a crisis, local governments overlook the importance of planning and rush to implementation without clear objectives. Neighborhood plans not only describe the neighborhood and its assets but also set out a vision for its future that can guide foreclosure recovery efforts. For instance, where a neighborhood plan calls for reducing density, demolition and the creation of green spaces will accord with the planning goals. In a neighborhood that is attempting to increase its single family properties and undo years of conversions into multiple units, an emphasis on rehabilitating foreclosed multiple unit properties and restoring them as single family may be a key objective. Each neighborhood is unique and requires a disposition strategy that accords with neighborhood planning goals as well as market realities.

Eight disposition strategies include:

The Rental Market: Strong By Comparison

Rents dropped – though slightly – in 54 of 79 metropolitan areas during the fourth quarter of 2008 according to an analysis by the research firm Reis Inc.

1. Sell property as affordable housing. The foreclosure crisis and downturn in the economy provide an unprecedented opportunity for governments and nonprofits to buy up foreclosed properties and to rehabilitate them and create affordable housing units for low- and moderate-income households. These affordable homes can be rented, sold, or kept in a community land trust so that the initial subsidy can provide affordable homes for generations. To create affordable housing with limited subsidy, all of the steps in this tool must be achieved efficiently, including the acquisition and rehabilitation of each property.

2. Rent property for short or long term. In today’s market, the highest and best use for many properties may be rental housing. Despite massive overbuilding during the real estate boom, and a flat sales market that has expanded the pool of rentals in some areas, rental housing is being lost every day to foreclosure. As a result, only a small surplus exists and there is a strong rental market in most areas of the country.

Foreclosed properties can be used to create two different types of rentals: short-term rentals designed to generate income while the property is on the market, keeping the foreclosed property occupied and less vulnerable to theft and vandalism; and traditional long- term rentals with multi-year leases. Short-term rents tend to be lower to encourage immediate occupancy and often are just enough to cover utilities, taxes and maintenance. In return for the low rent, tenants are informed that they will receive very limited warning before eviction. Opportunities may even be presented for “reoccupancy” of the property immediately by former owners under short-term leases. Short term rentals may not be legally permissible in rent control jurisdictions and those with strong tenant protections that prohibit the owner from selling the property quickly. Traditional long-term rentals are attractive where the sales market is not strong or where an inadequate amount of rental products exists.

Reno’s Rental Strategy

Reno, Nevada has as part of its foreclosure recovery plan a strategy to purchase foreclosed homes, re-mortgage them, and offer them for rental to households at or below 50 percent of AMI. By re-mortgaging the properties, the Reno Housing Authority can stretch the $5 million in Federal NSP money to buy other distressed properties.

Some cities have proposed that lenders and servicers consider short-term rental of REO homes to offset carrying costs and protect the properties. The challenge is that most banks do not want to become rental property managers and in states with strong tenant protections, are worried about the difficulty of removing a tenant, limiting their flexibility and ability to sell the property. Fannie Mae, however, is agreeing to keep approximately 4,000 tenants in its foreclosed rental properties. Beginning January 9, 2009, Fannie Mae began acting as an interim landlord.

3. Use a lease-purchase model to move people into homeownership. When a home is offered as a lease-purchase, the lessee typically makes monthly lease payments based upon the home sale price and the monthly operating costs. Payments go into an escrowed savings account that is used to pay the down payment the closing costs, or both, at the time of purchase. Home prices are fixed at the beginning of the lease, which can help stabilize neighborhood prices. The period of the lease varies greatly, as does the extent to which the participant is responsible for repairs and maintenance on the home during the program. Often, there is a requirement that lessees must attend homeownership education classes or counseling sessions to learn about important homeowner responsibilities.

A lease-purchase model offers many advantages to a community with a lack of qualified buyers and a surplus of available homes. Lease-purchase ensures that homes are occupied and protected from crime and vandalism and prepares households for homeownership by giving them time to repair their credit, raise a down payment, and learn about the responsibilities of homeownership. Lease-purchase programs tend to target households below 80 percent of median income threshold who are motivated to save for homeownership and do the work necessary to transform their lease into a deed. The disadvantage of the lease-purchase model is the significant administrative costs needed to acquire the property, coordinate the rehab work, provide education on household budgeting and credit repair, and manage and maintain the property until the household can assume the mortgage and other homeowner responsibilities.

Habitat Gets to Work on Foreclosed Properties

In Atlanta, the nonprofit Habitat for Humanity is adding acquisition and rehabilitation of foreclosed properties to its mission. Despite the fact that it is harder to attract volunteers to rehabilitate an existing property than build a new house, Habitat feels it can get more people in homes this way. Habitat affiliates across the country may be willing to delve into home renovations in communities receiving the federal grants, said Stephen Seidel, a field director for Habitat for Humanity International. Habitat will only work on homes that can be sold for between $90,000 and $140,000.

Self-Help, a nonprofit community development lender and real estate developer, has been offering lease-purchase locally in Charlotte, North Carolina, and is hoping to extend the program nationally. Self-Help received approval to deliver $200 million of its lease-purchase mortgages to Fannie Mae and will work with local nonprofit housing organizations that acquire and rehab vacant or foreclosed properties in neighborhoods throughout the nation. The nonprofits identify “tenant purchasers” – renters who are likely to be able to assume the mortgage on the property in one to five years – and provide credit and homeownership counseling and property management services during the rental period. Self-Help will offer some financing for acquisition and rehab. Once rehab of the property is complete, the nonprofit pays back the acquisition/rehab financing by taking out a lease-purchase mortgage on the property. This mortgage is originated by a bank partner and sold to Self-Help. Self-Help retains the credit risk and sells the mortgage to Fannie Mae. After the rental period, when the tenant-purchaser can qualify for the mortgage under standard underwriting criteria, the tenant-purchaser will assume this lease-purchase mortgage from the nonprofit. See a case study of Self-Help here.

4. Enlist nonprofits and CDC’s as partners: As a general rule, local governments will not have the capacity or desire to rehabilitate and manage foreclosed rental homes. While some governments will contract directly with for-profit contractors, brokers, and property managers to provide this capacity, many will sell the newly acquired properties to a nonprofit with the necessary expertise and resources and fund the nonprofit to complete this work. A nonprofit’s fitness for the job is determined based on its response to an RFP. Once the nonprofit demonstrates that it can handle the task and commits to selling or renting the properties to residents at specified income levels, selections are made. While some municipalities will partner with CDC’s to work in a single neighborhood, others, such as New York City, will hire a city-wide nonprofit to handle all the work.

The capacity of nonprofits to reclaim foreclosed vacant properties at scale varies significantly from city to city. Some cities, such as Cleveland or Philadelphia, who have tackled repair and rehabilitation of an older housing stock for decades, may have CDCs well equipped to fix up foreclosed homes. In other areas, CDCs have focused on new construction and have little experience improving older homes. In addition, many CDCs are so small that a city or county could easily give them more properties than they can handle effectively.

5. Land bank properties for future development. Land banks are a key tool where the supply of vacant properties exceeds demand. A land bank is a government-authorized public authority created to efficiently acquire, hold, manage and sometimes develop vacant and abandoned properties. A land bank authority can be created as a nonprofit or as part of a redevelopment authority or other government agency. A land bank is essentially a virtual entity — since it is not possible to shelve land as we can dollar bills. However, it acquires the property, clears title to the property, owns the property, and rehabilitates and markets the property. In some jurisdictions, the land bank is restricted to holding vacant land lacking homes or structures. This was the case in Cleveland, which prompted Cuyahoga County to create a new land bank with expanded powers to acquire, hold, and transfer buildings as well as vacant lots. Land banks usually will possess property management capacities and have clear public purpose responsibilities for the subsequent disposition of property, such as neighborhood stabilization or affordable housing. Land banks are responsible for maintaining the properties they own and it is not uncommon for the land bank to be responsible for hundreds of code violations as they direct their energies toward getting properties ready for market.

Varieties of Land Banks

The Fulton County/City of Atlanta Land Bank Authority operates like a literal bank, accepting land “deposits” from local governments and nonprofits that pay fees to the land bank to manage properties until they are “withdrawn” to be disposed of by the depositor for affordable housing or other public uses. Other land banks, like the Genesee County Land Bank in Michigan, serve as redevelopment bodies, accumulating property that they themselves aggregate and market for comprehensive reuse. The operation costs of a land bank are typically funded through property sales and interest and penalties assessed against delinquent property taxes, or through the fees and contributions of the entities depositing properties.

To create a land bank, the entity must be given legal authority. This may require a change in state or local laws if they currently do not allow for a land bank. When establishing a land bank, certain decisions should be made up front:

  • Will the land bank be a separate nonprofit entity or a part of municipal government?
  • What are the primary tools the land bank will use to acquire properties? Will it include condemnation?
  • How will the land bank be financed?
  • What is the land bank’s mandate with regard to holding properties long-term for assembly or selling individually where possible?
  • Who needs to approve clear, written policies and procedures for the land bank?
  • Who needs to approve an individual acquisition or an individual transfer?
  • How can the land bank streamline processes in order to deliver homes to buyers and land to developers on a fast, predictable basis?
  • Who are appropriate purchasers for land-banked properties?
  • What clear guidelines can be established for disposition of individual homes, agreements with contractors, and developer’s agreements for larger tracts of land?

6. Demolish non-viable properties. Preservation offers many advantages over demolition, including a much stronger potential to stabilize nearby property values. In fact, a study found that demolition may cause surrounding property values to fall by as much as $1,300, while rehabilitation tends to raise property values. However, demolition is an invaluable tool when a property is:

1. imminently dangerous;
2. obsolete and of a type for which there is little demand; or
3. needed for assembly of a developable site.

Other factors to consider in determining whether demolition is appropriate are location, historical significance, and the cost of rehabilitating the structure in relation to the market value of the property.

Demolition costs vary considerably among cities. Philadelphia, with its attached row homes, pays over $20,000 for the demolition of each house. Single-family detached housing that predominates in other cities is less expensive to demolish.

Where a city contracts for the demolition of a number of structures, instructions should be clear that dangerous and public nuisance properties should be removed first. Otherwise, contractors may choose to demolish the homes in the best condition with the nicest features first because they can recover the most money through salvage for those homes’ marble, mahogany, copper and stone. In the absence of a priority list, funding may run out before public nuisances are eliminated.

Vacant lots may be used as green space or side yards for adjacent properties or left empty and well-maintained until the residential building market is active again. The Pennsylvania Horticultural Society and the City of Philadelphia have developed a series of inexpensive vacant lot treatments, involving simple plantings and fencing, that discourage illegal dumping and make the lots a more attractive part of the neighborhood. For further information, see this report.

Demolition is a critical strategy being deployed in Cleveland, both by the city and by community development groups. The reason why demolition is the strategy of choice is the lack of market demand for older homes in Cleveland and the poor structural condition of many foreclosed homes. Many would require substantial subsidy dollars that could not be recovered at resale. City demolitions have been occurring at a rate of about 200 a year throughout the decade, but 1,000 homes were demolished in 2007 and 2008. The City is allocating three-fourths of its $25 million in NSP funds toward demolition. See the Case Study section.

Dayton, OH, plans to employ strategic demolition. In the past, the city's policy was to mothball vacant properties, hoping they would be worth restoring and reusing some day. But Director of Planning and Community Development John Gower now explains that "the region is stunningly overbuilt." The City is now increasing its strategic demolition and studying how zoning can encourage concentrating the population in areas with good housing stock.

7. Employ real estate agents and other professionals to sell foreclosed homes. Some cities are working directly with selected real estate agents or brokers to hasten sale of foreclosed properties. Approaches vary from taking prospective buyers on real estate tours, to establishing strong working relationships with selected real estate brokers.

  • Boston’s Department of Neighborhood Development is offering trolley tours of foreclosed homes located in targeted neighborhoods. Interested buyers first take a free home-buying course and a seminar on how to buy a foreclosed property, and then spend a day touring as many as 50 available homes.
  • The Center for New York City Neighborhoods, established in 2007, has created a mission-driven nonprofit broker (MDB) for short sales, which is the most common method in NYC by which foreclosed houses exchange hands. The Center aims to prevent short-sale properties from being purchased by speculators, and instead to facilitate their sale to working families who can be in-residence homeowners and members of a neighborhood. The Center expects to work with 90 families in its first year and handle 500 properties through its acquisition, rehab, and re-sale program.
  • In 2003, the City of Baltimore created a program called SCOPE (Selling City-Owned Property Efficiently), in which it partners with the Baltimore Economy and Efficiency Foundation and the Greater Baltimore Board of Realtors. The goals of SCOPE are to obtain the best prices for city-owned, vacant properties by exposing them to the broadest possible market, to handle the process efficiently, and to revitalize neighborhoods. Many of the properties sold by the SCOPE program are seriously deteriorated and need extensive rehabilitation. To sell them, the City contracts with experienced realtors, who list the properties on the MLS. When they receive offers, listing agents give the offers to the Baltimore City Real Estate Officer, and a City Committee selects the best offer. When a sale occurs, the City pays the broker $2,500, or 8 percent of the sales price, whichever is greater. Buyers are required to accept a property “as is,” and to prove that they can afford to rehabilitate the property in question within 18 months; to date, not all buyers have accomplished the renovations. Buyers also must agree to allow checks of court and housing inspection records to make sure they are not negligent landlords or property flippers. In SCOPE’s first two years, 98 properties had sold out of 174 listed, and the City was experiencing a net financial gain through the program. 

8. Offer homeowner buyer incentives or financing for purchases of foreclosed properties in targeted areas. Several cities are offering incentives to encourage qualified homeowner buyers to purchase, repair, and occupy foreclosed homes. HERA’s Neighborhood Stabilization Program specifies that grants can be used to “establish financing mechanisms for purchase and redevelopment of foreclosed upon homes and residential properties,” including “soft-seconds, loan loss reserves and shared-equity loans” (Sec.2301(c)(3)(A). The goal is to offer incentives for qualified homeowners to buy a foreclosed home, rather than to repeat the mistakes of the past and offer “too good to be true” deals to households that cannot sustain homeownership.

  • Providence, RI, introduced a loan program to encourage people to buy foreclosed homes. The city will make no-interest loans of up to $20,000 to help buyers make repairs to foreclosed homes that they purchase.
  • Baltimore is providing loans of up to $50,000 - depending on the scope of renovations - to pay for settlement costs, restoration work or to buy down the mortgage amount. The loan is in the form of a second mortgage, the balance of which would be forgiven if the buyer lives in the home for about 15 years. Baltimore’s requirements for buyers include good credit and a stated intention to live there. Eligibility is capped at about $78,000 annually for a two-income household and about $40,000 for a single wage earner. Housing counselors will help prospective buyers with home selection and renovation estimates.
  • Minneapolis is offering the Minneapolis Advantage Program, which aims to stabilize key neighborhoods by providing $10,000 in down payment and closing cost assistance to each buyer of a home that either has been foreclosed upon, or is in the same block as a foreclosed home. The $10,000 is offered as a zero-percent interest loan that is forgiven if the buyer occupies the home for five years. The program began in 2008 and has been renewed for 2009. Seventy-eight percent of the buyers to date were first-time homeowners.
  • Los Angeles has implemented a Walk in Program to ensure homeowners rather than speculators buy foreclosed properties in its priority target areas. The Program encourages realtors to show homes in fairly good condition to homebuyer households with incomes up to 120 percent of area median income (AMI) ($90,960 for a family of four), and provides those houses with a soft second mortgage underwritten by the city. See case study.
  • Minnesota is using contract for deed as a financing tool to help residents purchase homes. A contract for deed, also known as a "bond for deed," is used for homebuyers who can not obtain traditional financing. Under a contract for deed, a nonprofit organization buys the REO property and then finances its sale to a homeowner. The buyer agrees to pay the purchase price of the property in monthly installments. The buyer immediately takes possession of the property, often paying little or nothing down. The seller retains the legal title to the property until the contract is fulfilled. In a typical contract for deed, there are no formal applications, or high closing and settlement costs. Yet the contract for deed offers far greater risks and fewer protections for the buyer than traditional financing. If the buyer defaults on payments in a typical contract for deed, the seller may cancel the contract, resume possession of the property, and keep previous installments paid by the buyer as liquidated damages. The Greater Metropolitan Housing Corporation has sold two foreclosed homes using contract for deed in 2008 after they were full rehabilitated. The official launch of the Contract for Deed program was in January 2009. See the Case Study.

Nationwide, HUD is offering incentives to purchasers of HUD homes. The incentives vary by State. In Pennsylvania, Michigan, and Ohio, the maximum incentive program is operating, and it includes a provision that buyers need to offer only $100 as a down payment on a HUD home when the buyer uses FHA-insured financing. The program in these states also provides a sales allowance that can be used to cover closing costs, finance repairs, or pay down the mortgage amount, and broker bonuses for sales of homes that will be occupied by the new owners.