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The potentially devastating pitfalls of turning REOs into rentals

A common misconception

First, let’s clear up a misconception.  Foreclosure is a process, usually involving a court of some kind; the process can vary depending on the state.  REO means Real Estate Owned; it is what a house becomes after a foreclosure, when a bank or government entity purchases a home back.  It actually comes from the term, OREO, meaning Other Real Estate Owned, meaning a non-performing asset on the banks books.  The two terms are not interchangeable, and do not mean the same thing.  With that being sorted out, let’s get down to business.

The government, as in the Treasury Dept, and the Federal Housing Finance Agency, has issued a Request for Information  on how to deal with all the REOs that Fannie, Freddie, and FHA have on their books.  There is a fairly big push coming from The Obama Administration, and Sen. Reed who wrote a letter to the FHFA director earlier this month, encouraging the government sponsored entities (GSEs) to start renting out their REOs.  They are asking for either outright purchases, in bulk, or possible joint ventures with the GSEs, to maybe even some other kind of partnership.  The public and other entities have until September 15th to comment.

Over 250,000 REOs between FHA, Fannie & Freddie

These are the ones that have actually completed the foreclosure process, some are currently listed, about 77,000, and some are pending, waiting to close, about 22,000, according to DSnews.  Shadow inventory, the ones in the pipeline, the homes that have received a NOD, the ones that are still going through the foreclosure process, in other words, are not mentioned.  Because of the way notes have been sold, and resold, there may not be way to determine how many are actually out there waiting down the line.  We really are looking a lot of houses potentially flooding the market, just from the GSEs.

It’s no secret that the GSEs have been losing money.  A lot of money.  Part of the push for converting REOs into rentals may be coming from the idea that non-performing assets could generate cash flow, if as above, some of these were done as a partnership with the GSEs.  We are talking about rentals en mass, here.  Not 3-10 at a pop, but entire geographical areas.  In theory, this should stabilize housing by not selling crappy REOs at a discount, it’ll also make rent more affordable in some areas, it could also create jobs since many will need rehabbed.

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Theories usually suck though.  We have to look no further than The Washington Post’s investigation into HUD’s HOME program.  What had transpired were many incomplete projects, lost money, money that didn’t get used, money that came from the government and was dedicated to these projects no less, and projects that were completed, but sitting vacant.  Some things were done correctly, yes, but not a lot compared to what was screwed up.  The potential for the same types of things going awry with a rental program is huge.  What is the Government going to do, make investors sign a piece of paper saying “I promise to be a good landlord, treat tenants right, rehab all the properties according to code, not be a jerk and defraud anyone?”  Uh-huh.  Sure.

Written By

Katie Cosner, occasionally known as Kathleen, or KT, is a Realtor® with Cutler Real Estate and is active in her local Board of Realtors® on the Equal Opportunity & Professional Development Committee. She has been floating around online for a number of years, and is on facebook as well as twitter. While Katie has a few hardcore beliefs, three in the Real Estate World to live and die by are; education, ethics, and the law - insert random quote from “A Few Good Men” here. Katie is also an avid Cleveland Indians fan, which really explains quite a bit of her… quirks.

57 Comments

57 Comments

  1. Sig

    August 12, 2011 at 7:42 am

    On the surface this "Theory" looks good. BUT. The journey between a good Government "Theory" and putting said "theory" into action always seems to be easier done if private industry does it. Look at the last time Government put "Theory" into action in the late 1980's and early 1990's via the infamous Resolution Trust fiasco. What a mess that turned out to be. It was a good 'theory" but very bad practice. Government needs to sell those homes to private companies who know how to rehab, and rent them. Government can help guarantee the financing and back the renters if they like but that should be the extent of Government involvement.

  2. Roberta Murphy

    August 12, 2011 at 9:35 am

    Another lovely example of government inserting it$elf into private lives and enterprise. For the sake of all, get those foreclosed homes onto the open market and allow them to be bought by both by both homebuyers and private investors. This lessens chance and opportunity for graft and fraud, and will directly benefit local contractors, suppliers and allow for pride of ownership in blighted neighborhoods.

    This is also a case of government competing against the private investor–and perhaps gaining a political/voting edge from those who benefit from government rentals.

    Do not trust this government grab!

    • Kathleen Cosner

      August 12, 2011 at 11:14 am

      Roberta, Bingo! Seriously, if you haven't, read the Washington Post piece. It's a totally in-depth look at what can happen when there's zero accountability.

  3. CJ Johnson

    August 12, 2011 at 9:47 am

    Who will pay for the property taxes, maintenance, collection of rent, insurance, etc? We will! Who will benefit when the rent is not paid? Evection attorneys! Who will pay to replace the stollen appliances, broken windows, and other damage tenants cause? You got it the taxpayers. Add to this all the neat new government jobs that will be created to administer this program. Can you say stupid idea?

    • Kathleen Cosner

      August 12, 2011 at 11:17 am

      CJ, excellent points, and probably ones no one is thinking about!

  4. Liz Benitez

    August 12, 2011 at 11:20 am

    Such a bad bad bad idea.

  5. ShortWoman

    August 12, 2011 at 11:31 am

    There are so many problems with the proposal that I don't even know where to start.

  6. Gena Riede

    August 12, 2011 at 1:39 pm

    Fannie, Freddie, Banks and the Government have no business in the business of rentals. The minute I heard this, my first thought was that of socialism and Russia. These properties should be sold and purchased by home buyers and investors.

    There is another caviat to this where Fannie has been soliciating a back door entry into MLS systems statewide on the premise that if they have access to the MLS Fannie will offer access to their "Help Desk" for short sales.

    This backdoor entrance into our MLS systems throughout the US and the prospect of them going into the rental business is NOT a good scenario for real estate.

    If Fannie is allowed full access into our MLS systems, where does this stop? Are the banks next. Any MLS that agrees to this in my opinion is opening up Pandora's Box and we are on the way to a much different real estate platform that scares me.

    • Kathleen Cosner

      August 12, 2011 at 3:24 pm

      Gena, Agree. Investors with credit & cash to do so, or owner occs should be the ones to purchase, not some crazy mass buy.

      Haven't heard of any MLS access thing in regards to Fannie. Is this a smaller MLS?

  7. Gena Riede

    August 12, 2011 at 4:49 pm

    Oh, no Fannie Mae wants access to ALL MLS system. They want each MLS to provide a Fannie Mae Help button on the current MLS system where they supposedly the Short Sale agent will have access to help. However, I see this as an opportunity for Fannie Mae to have access to all the listings and as we know, it won't stop there.

    The VP of Fannie Mae was interviewed on CDPE about a month ago where this was discussed and I called our MLS here in Sacramento who has NO INTENTION of providing access or a button for Fannie Mae. But, I have heard that there are states and areas who have done so.

    I see a lot of issues… and there not good ones!

    • Kathleen Cosner

      August 14, 2011 at 4:49 am

      That's about one of the craziest things I've heard of in a while! Wouldn't most MLSs have to re-write their rules in order for that to happen? Not sure they're set up for that kind of thing, a whole 3rd party access deal.

  8. Manhattan Beach Realtor

    August 14, 2011 at 12:59 pm

    What we're seeing is the initial phase of another bailout for GSE's; the feds need a good marketing pitch to the public of why they are going to transfer billions more. Stabilizing housing, making rent more affordable for low income, etc. it's all a nice way to dressing up the fact that billions, if not tens of billions, are soon to land into the accounts of GSE's.

    Consequences?

    Flooding rental market with "affordable" rentals will drive rental rates, and returns, down for landlords across the country. Worse, is that this will occur in severely distressed regions that need capital. Low ROI will drive much needed capital out of these areas.

  9. sfvrealestate

    August 15, 2011 at 12:37 pm

    I agree that this is a bad idea for the Feds to get involved. I can see a limited role for a limited amount of properties through some kind of local city government (perhaps partnered with individual investors) situation. It would be kind of like Section 8 is now.

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