Will the U.S. Face Another Foreclosure Crisis in 2020?

Will the U.S. Face Another Foreclosure Crisis in 2020?

4 min read
Matt Faircloth

Matt Faircloth, co-founder and president of the DeRosa Group, is a seasoned real estate investor. The DeRosa Group, based in historic Trenton, N.J., is a developer and owner of commercial and residential property with a mission to “transform lives through real estate.” DeRosa creates partnerships to finance select real estate investments and has a proven track record of providing safe, profitable investment opportunities to their clients.

Experience
Matt, along with his wife Liz, started investing in real estate in 2004 with the purchase of a duplex outside of Philadelphia with a $30,000 private loan. They founded DeRosa Group in 2005 and have since grown the company to hundreds of units in residential and commercial assets throughout the East Coast. Under Matt’s leadership, DeRosa has completed tens of millions in real estate transactions involving private capital, including fix and flips, single family home rentals, mixed-use buildings, apartment buildings, and office buildings.

Matt is an active contributor to the BiggerPockets Blog and has been featured on the BiggerPockets Podcast three times (show #88, #203, and #289). He also regularly contributes to BiggerPockets’ Facebook Live sessions and teaches free educational webinars for the BiggerPockets Community.

Matt authored the Amazon Best Seller Raising Private Capital: Building Your Real Estate Empire Using Other People’s Money. The book is a comprehensive roadmap for investors looking to inject more private capital into their real estate investing business and is a must-read for anyone looking to grow their business by using private lenders and equity investors. Kirkus, the No. 1 trade review publication for books, had this to say about Raising Private Capital: “In this impressively accessible introduction to a complex subject, Faircloth covers every aspect of private funding, presuming little knowledge on the part of the reader.”

Matt and his wife Liz live in New Hope, Penn., with their two children.

Education
Matt earned a B.S. in Industrial and Systems Engineering with a minor in Business from Virginia Tech. (Go, Hokies!)

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A hot conversation topic in today’s real estate community is the potential emergence of the next foreclosure crisis due to COVID-19. Why? Because people are comparing the last housing crash that occurred in 2008-2009 to today’s situation.

While the two periods share some similarities, like a high unemployment rate and an economy on the decline, now is not then, and then is not now!

Besides the Dr. Seuss verbiage, there are certain things that make this correction different. I am going to go over some of these differences in-depth and show you why now is not the time to be rubbing your hands together and waiting for foreclosures to flood the market.

To kick things off, let’s do a comparison between the last recession and today.

The Great Recession of 2008 vs. the Great Lockdown of 2020

Then

In 2008, banks were the problem. There was a debt crisis. A majority of lenders that were offering loans to real estate investors, commercial real estate investors, and residential buyers were being backed by Wall Street securities.

For a lot of different reasons, there were misaligned incentives to write as many loans as possible—even if they were bad loans—with the hopes of bundling them up and later selling off the portfolio. To expedite the underwriting on these loans, some reduced standards to the point where allegations were accepted and documents were not necessary for a loan to be approved. These loans were called no-doc loans.

Eventually, the bad loans became toxic and overwhelmed the entire portfolio of loans. As the crisis deepened, the real estate market crumbled under the weight of the bad loans.

They created bad debt with toxic loans, which froze the bank’s liquidity when the loans couldn’t be resold. The aggressive no-doc underwriting left very little recourse for the banks, except to start the foreclosure process since they needed liquidity. This in turn caused a crash in real estate prices.

It became a vicious circle because as the prices came down, more properties went underwater (negative in equity), incentivizing borrowers to default, which then caused more foreclosures. Eventually, the banks offered loan modifications, but it was too late and the damage was done.

As these bad loans came due, the banks had no option but to foreclose, which overloaded the courts. They eventually worked their way through all their cases and flooded the market with foreclosures and short sales.

Related: The 4 Phases of the Real Estate Cycle (& What All Investors Should Know About Them)

Graphs representing the stock market crash caused by the Coronavirus

Now

Today, we are experiencing an income crisis. There is an enormous disparity of income from so many people losing their jobs all at once. While this could become a recession, it isn’t a foregone conclusion.

As banks were a part of the problem then, banks are part of the solution today. The stress tests that the banks have been subjected to since the last crash have left them in a much stronger financial situation.

In addition, the major banks have suspended share buybacks to maximize their liquidity. The result: the banks have been preemptively working with property owners since early March by providing workouts for existing loans. This includes forbearance, deferments, and other deals that allow an owner to skip a payment until a later time.

This might mean the payments get moved back to the end of the loan, to a short period after everything reopens, or anything in between. This might cause hardships later on, but it alleviates the negative effects of the current income crisis now.

It’s important to note that the banks are able to work with owners because of their own increased liquidity and because the underwriting used for today’s loans is more conservative. There’s more incentive for the bank to pause a temporary bad situation on a good loan than start the foreclosure process.

The signal the banks are sending with the workouts is clear: Now is not then.

Another immediate benefit of the increased liquidity is the increase in refinances that are taking place. Rates are at historic lows, allowing for property owners to save money by refinancing their current loans.

In commercial real estate, the lower rates mean it’s generally easier to refinance out of higher-interest debt. While you may not be able to pull out as much money as you planned due to the stricter lending guidelines, these restrictions will be offset by the gains of the lower rate. The net effect is the borrower lowering his or her risk for foreclosure.

Beyond all this, many foreclosures currently in the system are stuck. Most courts closed for evictions and foreclosures because of the coronavirus pandemic, resulting in no new supply hitting the market and cases that were already started just sitting in the pipeline going nowhere.

However, foreclosures have started again in some places (and more will follow suit), but it may be late 2021 when you start seeing some of these deals hit the market.

Real-estate

Where Does That Leave Us?

The bad news is property values will drop. This is almost inevitable with the current unemployment rate and changes in the economy. That said, the drop is not going to be anything near what we saw 10 years ago, and most owners selling will not be banks or involve short sales.

At the end of the day, people need jobs to pay their rent. To offset the current income crisis, landlords may need to provide concessions to keep a healthy tenant base. That might mean a lost rental payment or a general reduction in rent.

My estimate is that these concessions will result in a decrease in earnings of about 5-10%. Which in turn, will lead to a 5-10% drop on the valuation of commercial real estate since valuations are based on earnings. It’s not 50% like some are anticipating, but there will be a drop nonetheless.

Related: 6 Ways to Prepare for the Next Market Crash

If Not Foreclosures, Where Can I Find a Deal?

You can approach this market with the understanding that there will not be foreclosures on every corner and that the prices will not plummet. You can still get a good deal, though, by approaching tired owners.

These are owners who were thinking of selling prior to all the problems that came along with COVID-19. These are the landlords that have been doing this for 10-15 years, baby boomers looking to retire, or people who tried real estate and realized it’s not for them. These owners are going to be more realistic and motivated to sell.

Don’t expect a 50% reduction from them, but a 10-15% reduction may be worth it in order to get their money out and into something else.

To sum it up, I don’t think that we are looking at a major foreclosure crisis anytime soon in residential housing. The equation just doesn’t add up for it. That said, there are deals to be had out there—and if you know how to find them, you can still do well.

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Do you have any predictions for our upcoming economic situation?

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