Understanding Key Foreclosure TermsThis tool assumes some prior knowledge of the foreclosure process and key terms. See this brief Foreclosure Glossary, which defines some of the most important terms used in this tool (such as “REO properties”). Foreclosures.com also provides an extended foreclosure glossary.
There is no one-size fits all plan for addressing foreclosures. This section describes 11 key steps that can be taken to develop an effective plan. It is important to note that there is no particular sequence, nor is it necessary to take all 11 actions. The critical action step is to do something NOW. The longer communities wait to take action on foreclosed properties, the harder it will take to revive neighborhoods.
How accurate are free national foreclosure databases?Private companies offer lists of REO (lender-owned) properties in communities across the country and include full addresses. Unfortunately, the data is not always accurate or comprehensive. Housing Link of Minnesota analyzed the accuracy of one national company, RealtyTrac. Comparing the number of foreclosed properties found on the RealtyTrac site compared to county sheriff’s sale data, they found that RealtyTrac listed fewer than 14,000 of the 20,000 foreclosures in the state in 2007 (see this presentation).
1. Understand the local foreclosure process. Knowing how the foreclosure process works in your community is essential for effective intervention. There are several steps that are taken before a bank or lender forecloses on a home including:
Foreclosure processes and procedures, including the timing of all of these stages vary considerably from place to place and are governed by state laws. The website www.foreclosurelaw.org provides information about foreclosure laws in every state.
2. Identify the number and locations of foreclosed properties. Local city or county records provide the best source of data on foreclosures (national companies track foreclosures, but their databases are not comprehensive – see text box, above right). Though foreclosure procedures vary, it is an almost universal requirement that to file for foreclosure, a lender or servicer must file with a court or a county agency, such as the sheriff’s office, and provide the street address of the property being foreclosed upon. Communities can keep this information in both list form and mapped using geographic information system (GIS) mapping software to provide a visual snapshot of foreclosure concentrations that can guide strategy. Universities and Metropolitan Planning Organizations typically have GIS mapping capabilities. Several sources for general maps of foreclosures across the country or in a particular county or region are available and some are listed in the Data and Maps section.
New laws might be needed to make foreclosure data readily available. Cities and states are passing vacant and foreclosed property registration ordinances to help track foreclosed properties and hold their owners responsible for their maintenance and upkeep. Georgia passed legislation in 2008 that requires the identity of the responsible owner to be included in the advertisement and in court records. Boston passed an ordinance requiring that vacant and foreclosing properties are registered and maintained, Milwaukee requires registration when an owner first goes into default. New Haven requires institutions foreclosing on local properties to register with the city and designate a local caretaker or face fines of up to $250 per day.
Needed Infrastructure: Online Property Information SystemsSome municipalities have developed online foreclosure databases to provide the public with accurate data. Gathering and assembling this data is no small task, but once created, a foreclosure database allows a community to identify how many foreclosed properties it has within its borders and track how that number changes over time. For example, Miami-Dade County’s Mortgage Foreclosure Online System provides statistics on the number of foreclosure filings every month, and also provides full addresses for foreclosed properties. See this report from the Lincoln Land Institute showcasing promising applications of land information systems, including early foreclosure assessment efforts in the Twin Cities and Cleveland.
3. Identify owners of foreclosed properties. Identifying the owner or servicer of a foreclosed property is a prerequisite to purchasing it. Unfortunately, as a result of the common practice of pooling mortgages and selling them to large institutional investors (pension funds, hedge funds, banks, etc.), identifying the owner or servicer can often be a complex and frustrating undertaking. Most REO properties are owned not by banks, but by trusts operating for the benefit of investors. The majority of subprime and “Alt-A” loans (loans with credit risks between prime and subprime) originated in recent years were securitized by non-agency sponsors (e.g., financial institutions other than Freddie Mac, Fannie Mae and Ginnie Mae). The trusts typically contract out the day-to-day management and disposition of REO properties to specialized servicers. As a result, the parties initiating most foreclosures in distressed neighborhoods are trustees or servicers representing the investors in the mortgage pool that contains the delinquent loan.
Giving Communities a First Look at REO PropertiesThe National Community Stabilization Trust is a consortium of national nonprofit housing and community development organizations including Enterprise Community Partners, the Housing Partnership Network, the Local Initiatives Support Corporation and NeighborWorks America. Currently being piloted in the Twin Cities (see Case Study), First Look gives local housing organizations a chance to view and acquire properties owned by Wells Fargo, CitiGroup, and Chase at below-market prices before they are offered on the general market.
To determine the identity of the lender or servicer who has control of the foreclosed property, a local government or nonprofit can:
Once the lender involved has been identified, to obtain appropriate contacts for a lender or servicer a local government or nonprofit can:
The Housing and Economic Recovery Act (HERA) of 2008 established a goal of 15 percent below market value for REO properties purchased by a city or nonprofit with Neighborhoods Stabilization funding.
4. Determine the market value of foreclosed properties before entering into negotiations. Having a clear understanding of a vacant property’s value is essential when deciding whether there is sufficient financing to buy and rehabilitate the property and for negotiating the purchase price. But valuation is challenging in the context of the housing market crisis. Continuing housing price decline, low demand from qualified buyers, and low sales rates of distressed property comparables have made traditional methods such as evaluating comparable properties less useful.
Sellers and buyers have different perspectives on valuation. Sellers have an obligation to investors and their key objective is to maximize value and minimize losses in a declining market. When weighing how quickly to sell foreclosed properties, sellers must consider the rapid depreciation of foreclosed homes and continuing holding costs, including insurance and property taxes. A buyers’ key objective is securing a fair price in a declining market so that they can fix up the property and get it back in the hands of a responsible owner.
One preferred method for determining the value of a property is called its “net realizable value” (NRV). The value of the property is determined by calculating the property’s market value minus the cost of disposition. The NRV is calculated by: 1) determining the estimated selling price in the ordinary course of business for a property; and 2) subtracting holding costs (insurance, real estate taxes and maintenance), administration (seller/servicer costs), rehabilitation required for code compliance and marketing, and the possible decline in value over the holding period.
The benefit of the NRV approach to sellers is that it takes into account both the market in which the seller purchases the property as well as the market in which it sells the property. Potential for further price decline, a lengthy holding period and the cost to rehabilitate the property are all considered in valuing the property. NRV provides buyers with a good negotiation tool, reflects market risks and program feasibility concerns and complies with requirements of HERA. See this paper for more information about NRV.
5. Assess the capacity of government agencies, authorities and nonprofits to reclaim foreclosed properties. Few cities or counties, and even fewer community development corporations and other nonprofits, can handle thousands, or even hundreds, of scattered-site vacant properties. Each stage of reclamation – acquisition, rehabilitation, maintenance, disposition, stewardship – requires specialized knowledge and might be accomplished by different entities. Many municipalities have never before needed to acquire properties for non-public use, whether to rehabilitate them or bank them. It is essential that every municipality or nonprofit be completely honest with itself about whether it has the expertise, resources and staff to carry out tasks needed to recover foreclosed properties.
The Cost of Rehabilitation“The rare home that we find in “move- in” condition is referred to real estate brokers who can sell it. We focus on the homes that need work,” said Stephanie Gruver at Greater Minneapolis Housing Corporation (GMHC). The goal is to find homes that can be rehabilitated with a relatively small subsidy, some of which may be able to be recovered at resale. GMHC’s average acquisition price on 45 recent rehabs was $63,000. Average development costs were $167,000. Average resale price was $135,000, leaving an average subsidy gap of $32,000. The properties were rehabilitated to comply with standards that assured the new owner will not have major repairs to deal with for the next seven years.
When the capacity is not there, cities or towns can sub-contract out some work, or create new entities. The city of Los Angeles, for example, created the Restore Neighborhoods nonprofit holding company, which contracts with teams of for-profit vendors to rehabilitate homes (see Case Study). Minneapolis and St. Paul are hiring subcontractors to acquire REO properties (see Case Study). In Ohio, Cuyahoga County launched a new nonprofit land bank to aggressively acquire vacant properties in April 2009. Nonprofits can similarly take advantage of private market contractors to do the work but still must have sufficient expertise on staff to provide appropriate oversight.
When looking at capacity, a city or county should ask whether there is sufficient knowledge of current property inventory, location and condition and sufficient staff expertise and time to inspect and value each property, negotiate for its purchase and determine the best property disposition method. The Neighborhood Stabilization Program requires local governments to gear up quickly. Many are gearing up by outsourcing the work to capable nonprofit or for-profit companies.
Understanding Neighborhood MarketsThe Reinvestment Fund (TRF), a nonprofit community development financial institution based in Philadelphia, has developed a “market valuation” approach to identify areas where reclaiming vacant foreclosed properties will have maximum impact. TRF uses extensive data points to identify areas where foreclosure-related vacancies are a potentially destabilizing force.
6. Calculate costs of restoring the property. Homes of borrowers in financial distress often fall into disrepair, requiring significant repairs and capital improvements (including painting, plumbing repairs, replacing appliances and carpeting, and repairing water damage). In addition, angry former owners or thieves looking for copper and any other materials may vandalize a property. Prior to purchase, an expert in housing rehabilitation should inspect each home, determine whether the property can be made safe and livable and, if so, estimate costs.
The majority of REO properties need some rehabilitation work. Where rehabilitation for a house will cost considerably more than existing subsidy dollars for each home, then demolition must be considered, particularly if the house has no special characteristics that would entice a buyer to purchase it as a fixer-upper. Prospective nonprofit or municipal buyers also must remember to check for liens on the property, because if the owner is unable to pay mortgage payments, there is a good chance that he or she has not paid tax, utility, or other bills, which create debts attached to the property that a new owner must pay.
7. Create priority areas to target efforts. If funds are scattered about rather than used strategically, some properties will be rehabilitated or demolished, but cities and towns are unlikely to see any sustained improvement in their neighborhoods or the city’s fiscal condition. Identifying priority areas is essential to achieving an impact, particularly when the number of foreclosures far exceeds available resources.
Choosing priority areas can be politically difficult. Every councilperson wants the city to address the foreclosure problem in their district. Every resident wants action taken in their neighborhood. As a result, it is essential to develop clear criteria for targeting efforts. The criteria must take into account the stability of the neighborhood market and the ability of foreclosure recovery efforts to have an impact. Decades of experience have shown us that governments and nonprofits have a greater impact in asset-rich, stable neighborhoods that are at risk from abandonment and vacancies than they have in low-asset neighborhoods with large concentrations of vacancy and foreclosure and low buyer interest.
If we can only acquire two homes in a two block area that has 15 homes, then we must have made no impact. We must target our efforts very strategically. The NSP money at most allows us to acquire 200 homes over 20, 000 vacant homes. - Deborah McCullough, Director,
Philadelphia Office of Housing and Community Development.
The municipality or nonprofit should calculate how many homes it can acquire and rehabilitate in a neighborhood, and then evaluate whether the number of homes that can be restored is sufficient to positively impact the neighborhood. The reason is simple. If a neighborhood with extensive vacancies is targeted and the city can afford to buy only a quarter of the foreclosed properties in the neighborhood, the remaining vacant homes will continue to drag down home values and will lower demand from buyers. Years ago, the philosophy was to throw a few seeds into a neighborhood and then to watch them grow as the private market did the rest. That approach did not work. The intervention made in any neighborhood must be substantial enough to change the market or it will have little impact. Also, different lenders and servicers control REO properties on a single block. When a nonprofit or municipal entity plans to target an area, it must assume that it will only be able to acquire some of the properties and this percentage of the properties must be sufficient to have an impact. In fact, the location of foreclosed properties owned by a lender or servicer who is willing to sell at a fair price may be a factor in the selection of targeted areas, since fixing up multiple properties in close proximity will have a greater impact.
Another strategy is to funnel foreclosure recovery efforts into neighborhoods where new residents will have access to assets such as transit, good schools or employment clusters. Other factors that can affect decisions on where to focus recovery efforts includes prioritizing neighborhoods that are scheduled to receive major public or private investments, or communities where schools, transit or other assets might be jeopardized by blighted or abandoned properties. If demolition is the city’s strategy of choice, the priority area may be very different than if rehabilitation is the city’s strategy of choice.
Neighborhoods devastated by foreclosures are at a tipping point… Getting these properties into the hands of community groups, instead of speculators, will go a long way toward stopping the downward spiral. - Mark McDermott,
Enterprise Community Partners, Columbia, Maryland
8. Discourage speculators. Speculators currently account for the majority of foreclosed property sales. The requirements for acquiring foreclosed properties give speculators an advantage since they are more likely to be able to round up quick cash, participate in a rapid 30-day closing process, and take properties in as-is condition without an inspection (see this article). Yet speculators have a poor record of maintaining their properties. Their primary interest is to “flip” the property, making, at most, some cosmetic repairs, and then re-selling it at a time when they can make a significant profit. Three key actions to discourage speculators from buying and leaving properties vacant or blighting a neighborhood are:
Green is a Smart Community InvestmentA study by New Ecology Inc. for its Green CDCs Initiative found that greener affordable housing projects on average cost 2.4 percent more to build but save purchasers an average of $12,637 in utility costs over the life of the home.
9. Define standards for rehabilitation that include energy conservation. The standard for rehabilitation adopted by a municipality, state or region determines the cost to repair foreclosed properties. Energy efficient rehabilitation provides an opportunity to reduce utility bills and the incidence of health problems such as asthma and other respiratory illnesses. Weatherizing homes, removing mold, and adding energy efficient appliances also creates good-paying jobs. The standard used by Minneapolis Neighborhood Housing Services is for a rehab to require no major repairs for a period of at least seven years after transfer. Other cities plan set as a goal cosmetic fixes, such as painting, in addition to requirements that the roof does not leak, the furnace works and the property is structurally viable. Cities should account for at least the potential of costly repairs when determining income-level requirements for owners.
10. Promote alternative models of housing tenure that incorporate protections to prevent a repetition of the present foreclosure crisis. Banking regulation and homebuyer education are not the only strategies to prevent a repeat of this crisis. Forms of housing tenure that incorporate stewardship and community ownership mechanisms protect residents from foreclosure. These include nonprofit-owned rental housing and shared equity homeownership models such as community land trusts, limited equity cooperatives, and deed-restricted units. Community land trust homes, for example, are six times less likely to go into foreclosure than non-land trust homes. See Stewardship Strategies in the next section for a description of these models.
11. Establish a detailed foreclosure recovery action plan. A good plan should include details such as objectives, timeframes, and budgets, and document all commercial activity in a target area, such as streetscape or façade improvements, redevelopment of brownfields, economic development efforts, and tourism projects. Questions to be answered in an action plan include: