How to Fix Housing, Employment and The Economy (Part 2)

So if the Government is the only organization large enough to lead and create the incentives that drive housing forward, the banks must become the oil that keeps the system humming.  Just like the first part I am not talking about or even looking for handouts. 

In fact if a few banks take the lead by following the ideas below they will be the most profitable and likely take out their weaker competition.

I freely admit that the banks are in a very tight spot as many of them are in real trouble and if we truly had to value assets at today’s prices many of them would be insolvent.  

We can’t have that and thus we need to be conscious of past mistakes while implementing new programs that foster sales and price stabilization.  Remember if we can first put a floor under housing and then turn housing prices around all of our balance sheets will be stronger (especially banks).  Okay so let’s discuss a couple of items that banks could or should do.

The first and most important yet painful thing the banks need to do is focus on clearing the system.  People that decide not to pay their mortgage because of life events or strategic default need to lose their house and lose it fast!!!

We need to stop seeing articles where people are bragging about not paying their mortgage for 18 Months, 24 Months, 5 years, etc.  That just sends the wrong message and drags prices lower and lower as more people decide lets test the system and see how long we can go without paying our mortgage.  

I guarantee you if we start getting people out in less than 6 months fear will come back into play and people will once again strive to pay the mortgage first.  Today many people pay it last after car payments and credit cards.  People used to pay the mortgage first and we need to get back to that if we are going to turn this puppy around.

It sounds terrible but both parties agreed to contract and if you don’t pay the bank gets the asset and they should take it quickly so we can shake out all the weak hands and start healing the system.  

If we keep on the same path we are on today we will see no noticeable improvements for at least a decade which is just too long for this great country.

Something else the banks really should consider is financing some of their own REO inventory.  I can tell you as a cash buyer I would gladly pay more for a property if I could get a 30 year loan with 25% down.  I haven’t run specific numbers but I can tell you this much.  I just bought a property last week for 38K cash that I would have easily paid 60K for if the bank had agreed to finance the purchase with 30 year fixed money!!!

Think about that for a minute.  I would have paid almost 40% MORE for the property if the bank agreed to finance the deal with 25% down and 30 year fixed at say 5.5%.  The property was fairly clean and needed about 4K in make ready costs so not a total trash job.  I would have even agreed to put the 4K in escrow if the bank asked.  I will say it again the banks NEED to start financing some of their inventory to maximize prices paid!!!!  Else properties go to cheap cash buyers like me which is not good for the system.

As an investor I need to manage my yield and thus under the current cash only world I have to pay ridiculously low prices to insure a return on my private investors capital.  But again if the banks reviewed their inventory and selected say 30% of the clean properties I guarantee you they would get better prices.  As you know better prices puts a floor under housing and may even increase the value of housing thus reducing future risks of default.

This simple act could be the catalyst for a positive feedback cycle instead of the current negative feedback cycle.

Something else banks need to consider is identifying programs that would enable them to extend credit profitably on cheap rental properties.  I understand that a 30K loan on a cheap rental house is not very exciting especially with 30 year money.  But maybe banks can get a little creative and dare I say it create a special program for rental housing under 50K.  Maybe they demand 25% down, escrow repair money, charge 7.5% and do a fully amortized 10 year loan.

The key for good real estate investors is leverage and bank lending is the key to cheap fix rate lending.   The banks that understand the power they have and the flexibility they have to demand darn near anything to finance cheap rentals will again increase demand, prices and make everyone more profitable.  

The first banks that figure this out will be way ahead of the competition as they will see a large spike in demand which will require more hiring and allow them to earn nice rates of return on their deposits.  I am just an investor and I know I would gladly line up for lending on cheap rentals.  

Today all I hear is no thanks you have too many properties or the loan amount is too small which means I have to pay less for properties and drive down the value with my cheap comps which cause more people to give up and stop paying their mortgage.  

In the end banks can fix this negative feedback loop by designing a highly profitable program aimed at cheap rental housing.

Another program banks should look to create are blanket loans across a set of properties.  Investors are buying distressed assets and they should be able to leverage their capital by going to a bank with repaired and leased inventory.  The ability to create a blanket loan across a set of properties will give the bank greater security and enable the investor the chance to recycle their capital.  The recycling of capital means more distressed assets get turned into performing rentals increasing the value of all properties.

In the end the banks need to become the oil for this four team effort.  The first thing they must do enforce the contracts and kick people out of houses quickly that don’t want to or can’t pay their mortgage.  

Second the banks need to design lending programs that fit the market.  Currently there is a great current need for cheap rental property loans.  It really is pretty simple; if investors can get leverage on rental properties they will pay more and increase the general value of properties than if they have to pay cash.  If cash is the only way deals get done then prices will continue to fall.  

The final thing banks could do is look to establish blanket loans for investors with several rental properties so they can recycle capital and continue buying distressed assets.  I am hearing about blanket loans but I haven’t seen any proof of them in my market.

Next we will look at how Builders and Investors can complement the programs created by the government and lending options designed by banks.

Good Investing and let me know what you think