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Fed Outlines Potential REO Conversion Program

by Chicago Agent

The Federal Reserve recently sent to Washington a long-awaited discussion of an REO conversion program.

REO inventories, and the supposed plan on what to do with them, have attained a near-mythical status in recent months. Every month or so, we publish a story on recommendations from the National Association of Realtors, local attempts to incorporate non-profits in the process, and of course, the government’s admission that it has not the slightest idea on how to deal with its quarter of a million REOs.

Until now, that is. After subtle reminders that REOs remain on the government’s horizon, the Federal Reserve has finally come forth with a detailed analysis of housing that includes a passage addressing REOs and their possible conversion into rentals.

REOs, the Fed writes, pose three unique challenges to real estate investors, who have converted the properties into rentals only in small supplies, not the large amounts that are necessary for a housing recovery. Firstly, with how spread out many REO properties are, investors are having a difficult time establishing a fixed cost for their rentals. Secondly, the extreme discounts that investors demand for bulk sales of REOs are often too severe for property-holders to accept. And thirdly, banking regulations and financing obstacles often interfere with the process. Also complicating matter is the condition of the REOs. Though inexpensive, many of the properties are badly damaged and missing key components of a suitable, rentable property.

The Fed admits that because no precedent exists for an REO conversion program, “experimentation and analysis will be a crucial component of developing such a program,” though the agency does list in depth some of the determining factors for a program.

For instance, assuming that the government partners with third-party investors for the bulk sale of REOs, the government must work with lenders and create a new form of financing for such a venture. Though financing exists for multifamily and other large-scale developments, no options exist for single-family-home portfolios. Whether the government would provide debt financing or subsidies, even, remains to be seen.

Time is also of paramount consideration, considering that the longer an REO sits on the market, the more it – and the adjacent properties in the neighborhood – declines in value. Therefore, the REO program, the Fed writes, should minimize the amount of time an REO “lingers” until it is rented out. To quicken the process, the Fed suggests a couple interesting twist on the acquisition stage, one that would bypass the entire aforementioned process.

“Another possibility is to auction to investors the rights to acquire, in a given neighborhood, a future stream of properties that meet certain standards instead of auctioning the rights to current REO holdings,” the Fed writes. “A third possibility is to encourage deed-for-lease programs, which circumvent the REO process entirely by combining a deed-in-lieu of foreclosure – whereby the borrower returns the property to the lender – with a rent-back arrangement in which the borrower remains in the home and pays market rent to the lender.”

Two final factors, the Fed writes, must be considered after the REOs are finally sold – upkeep and re-salability. In terms of upkeep, it must be ensured that efficient, experienced property managers ultimately purchase the REO inventories, given the extremely negative impacts that poorly maintained, shadily-operated rental units can have on neighborhoods. Coincidentally, the Fed does mention the merits of incorporating local non-profits, an issue we mentioned earlier in this article.

And finally, re-salability will be the final goal of a conversion program, with the question being when the property will be re-sold as a single-family residence. Would the landlords be required to follow rent-to-own provisions? Should they wait a mandatory amount of time before listing the property? Or perhaps they should wait until the market sustains a healthy recovery?

With no official program yet announced, it’s all speculation and academics, but the Fed has at least gotten the ball rolling. The complete white paper can be read here.

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