New wave of foreclosures coming- Worse than first wave??!!

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New wave of foreclosures coming- Worse than first wave??!!

Rich Weese
Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes

I've not been bullish on the market for sfrs lately as many of my posts have stated. I continue to be cautious. When everyone is jumping on any bandwagon, the wagon may overload and break down.
If you're buying STRICTLY for existing cash flow, I think it is still ok. Buying to flip or short term is foolish, imo. Here is ANOTHER article backing up my concerns.

http://www.msnbc.msn.com/id/35832152/ns/business-washington_post/page/2/

Here is the reason this really worries me. There is a feeding frenzy, auction scenario in many areas like FL, Vegas, Phoenix and others. Prices are being bid up with NO logical reason.(does that sound familiar to previous times?) The first wave of foreclosures was primarily due to the subprime loan mess. There are now millions MORE homes in jeopardy with more problems to come. As article explains, it normally takes 6-7 months of missed payments before lenders start foreclosure. Millions of homes are falling into that area now. Lenders are still not lending, which means purchases must be for cash.
It is also obvious that many lenders have been delaying foreclosures and then delaying resale of these REOs. These HAVE to hit the market sometime! There are numerous reasons why lenders are witholding properties , but imo, one is front and center.
If the lender shows on their balance sheet a note/mortgage, it shows as an asset of full value. When they repo and sell this asset for 50% of loan, the balance sheet drops by 50% on that asset, even though the 50% is cash. When they do this too much, too fast, their balance sheet drops considerably and then they risk not being able to pass the govt stress test required for banks! They may even face closure by the fed govt. if their "health" looks bad. That is why their reos are trickling into marketplace.
If we have round 2 of foreclosures, no one knows what this will do to the fragile RE rebound currently manifesting itself. Never before did we have a subprime meltdown. No one was ready for it nor knew what the results would be. I also don't believe anyone knows what will happen with this coming round 2, which is the GOOD prime loans!

Here is a top ten to address:

1. will banks loan?
2 will banks take the losses on balance sheets and release more reo's?
3.will investors still buy?
4.will investors still have cash?
5. will prices/rents continue to drop?
6.will tenants still have jobs and money to pay rents?
7.will govt create more "giveaway" programs to "fix" mess?
8.will these new programs create a false temp value of homes?
9.will these homeowners being bailed out be a temp fix?
10.will the weight of new giveaways be the last straw that crushes our economy and status in the world and start the dominos falling?

I think 10 is enough! I'll continue to voice my reasons for concern. All is not well, yet, and may get even worse. I know that no one wants to think that, but your livlihood could depend on decisions and choices you make now, imo. Tortoise and the hare----Right now, the tortoise method seems better, imo. Rich.

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Ralph S.
Real Estate Investor · Sacramento, CA · Member since 2008 · 566 posts · 356 votes
16y

Rich
I'm only responding as you and J have earned, IMO, a well earned and highly respected reputation here on BP, but you've missed on the accounting points the FinanceExaminer brings up.

It is not something called "Bank Accounting" that rules the day. It is GAAP (Generally Accepted Accounting Principals), and accrual accounting, that banks and all publicly owned and government regulated businesses must adhear to.

GAAP requires that when an asset becomes impared, such as when collection of receivables, or the value of an asset comes into doubt, a reserve must be established and the financial impact be recognized at that time. This would be before any foreclosure or collection efforts occur.

To accept your points that the financial impact occurs when the REO is sold, would be considered fraud on the part of the financial institution for having overstated the value of their assets prior to that time.

The missing part in your statement:

Is that when the $100K note is written off, and $50K is received in cash, the reserve is reduced by $50K. Since all of these are assets, and the two 50's offset the 100, there is no change in assets when it is sold. If there were a difference, such as when the reserve was estimated too high or two low, that difference would land on the income statement, not the balance sheet, and still, assets remain unchanged. Since you reduce the reserve (and eliminate the "troubled asset"), the % should remain roughly the same.

While the in depth debits and credits applied by the banks when loans go bad are out of my experience, the concepts of accrual accounting, reserves and GAAP are not, and are not hard to understand. They are all designed to make sure every company is measured on an equal basis (GAAP) by following the same rules, and that the financials at any given point in time are as accruate as they can be as to the value of assets, liabilities, equity and income.

When they don't, you get Enron and Bernie Madoff, and perhaps the bank where you sat in their board meeting.

Guess I've been through too many audits, having to defend many of these reserve balances of the companies I've worked for. It's not Banker Boardroom stuff, they have no say in the matter, just nuts and bolts accounting.

Bummer. Guess we'll just have to agree to disagree, since you're done.

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  • Shanti S.
    Real Estate Investor · Longmont, CO · Member since 2009 · 208 posts · 109 votes
    16y

    In addition to the wave of upcoming foreclosures being talked about, I've been hearing more about the "shadow" foreclosed homes as well - getting close to a million homes that have already been foreclosed upon, but have been held off the market.

    So this would be for the same reason - once they're sold, the bank takes the hit in its assets? But foreclose and let it rot, and their assets are unaffected in the short term? What a system!

    If they were to dump these shadow homes into the REO system, yuk.

    I'm planning on selling my primary res SFR this spring if possible - yes I'll take a hit but I can find a bigger bargain that's a better fit, so it should at the worst be a wash :-|

    1Reply
  • Rich Weese
    OP
    Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
    16y

    Drone- you may even find a lower price couple years from now! I've actually bought a property back that I'd previously SOLD, and both times, I bought it for less than I'd sold it for!! What a country. Rich

    2Reply
  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    16y

    Hi Rich, The assumption concerning the devaluation of the loan to booking and REO applies to a private lender, but the effects on a banks books are realized before the property is taken in foreclosure. It's a reserve account called Loan and Lease Loss Reserves. This effects the capital requirements made by regulators so the balance sheet takes a hit before a property is taken back. This loss reserve effects the earnings, not the balance sheet as it is an asset.

    Why properties are trickling through really has no bearing on the balance sheet until it sells and is written off as you mentioned. But the offset is the capital requirement. So this follows through to the banks statement of conditions. Holding real estate delays the adverse conditions but it also effects earnings since the real estate held is a non-earning asset, which is of more concern than the number at the bottom of the balance sheet. A banks earnings are more of a concern than its size!

    The impact on earnings is really known when the mortgage/loan becomes a slow paying asset. Since earnings are measured quarterly, there really is no incentive to get any property sold today, you'll never find a banker in a hurry to much of anything. They are probably more concerned about getting compliance reports submitted than getting a property listed for sale on any day.

    I have received properties with deeds in lieu of foreclosure. In those cases I now own the property, it's not just holding collateral for liquidation. If the market is slow, say due to winter months where selling just slows down, I would simply keep the property for the expected upswing and then put it on the market.

    I think the questions you pose will largely depend on where you are, again what local market conditions happen to be. As to lending, banks in my area are making loans. So far rents are stable and unemployment is at 7% (functional unemployment is higher, but then those people have always been out there).

    Seems like there is just alot of fear mongering going on, mostly with underlying political agendas For all I know, there may have been instructions to banks to slow down bringing REOs to market. What does it do when you dump properties on the market? It creates and oversupply, values drop and it becomes a self feeding economic monster.

    I think that banks should hold properties, say by value brackets, as a per centage of properties held for sale in that market. By doing so it keeps any local market in equalibrium for properties say in the 100K to 125K and any such value range. If every bank in town dumped 25% more inventory in a price bracket, they would just end up holding the properties longer on the market and driving prices down. Sorry it's so long...Bill

    5Reply
  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
    16y

    I completely agree with Rich that things are likely to get worse in the short term in many markets...with alt-a and option arm loans coming due in higher volume than at any point in history, there is sure to be greater foreclosure supply over the next 6-12 months.

    For the reasons Bill mentioned, I don't think it will have an impact on the banks any more so than it's had the past couple years, with the exception that banks may hold off the foreclosure process in many cases to keep their reserve levels within regulatory requirements (what they're currently doing with commercial property on the books).

    As for whether this is a bad time to flip properties, I think that's going to be market dependent. In areas where property replacement cost is comparable to the CMA, there probably isn't a whole lot of room for the price to continue to drop, and there are still plenty of opportunities for flipping.

    In other markets, there is probably still some room for prices to drop, and in those market, flipping can be more risky (as it has been in those markets for the last few years).

    Of course, any time you flip a house, you should ensure that you have multiple exit strategies. When I buy a house to flip, I want to know that I also have at least two other exit strategies (for example, wholesaling, renting, lease/option, rezoning, etc).

    Podcast Guest on Show The Truth About Real Estate Investing in 2024 (What Investors NEED to Know)
    6Reply
  • Justin S.
    Residential Real Estate Agent · Chandler, AZ · Member since 2009 · 1k+ posts · 928 votes
    16y

    I have been seeing the slow down on the short sale side as well.

    Banks are generally slower now than 6 months ago approving short sales. My philosphy on that has always been that the banks can hold them as REO's or Short Sales, and why not keep someone in them to ensure no vandlism takes place.

    I do not fully understand the insides of how a bank works or from an accounting standpoint with short sales vs. REO's, but my guess is they continue to look at them as inventory and whether they release for sale as Short Sale vs. REO is really up to them and they do not care which one it is as long as they sell when they need to. I continue to try and create myself a huge inventory of short sales, and when the bank decides to release them I buy and sell as quickly as possible.

    2Reply
  • Rich Weese
    OP
    Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
    16y

    Bill- I agree with a lot of what you say. However, as J Scott pointed out, if bank fails to have adaquate assts, their required reserves fluctuate up and down. When their reserves are higher, less funds to loan out, less earnings and the same results. It is all connected. The assets, troubled assets and liabilities are all evaluated, and tabulated as a whole. When they take a 100K note 0ff their balance sheet and replace it with 50K in cash, the balance sheet weakens and the "troubled assets" as % increases.

    J Scott- I really like your last paragraph. I'm afraid most posters and investors on BP think things can ONLY go up. Those of us that have been around forever, know better. I just try and convince all investors to be prepared for the worst and hope for the best.. Rich

    2Reply
  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    16y
    Originally posted by Rich Weese:
    The assets, troubled assets and liabilities are all evaluated, and tabulated as a whole. When they take a 100K note 0ff their balance sheet and replace it with 50K in cash, the balance sheet weakens and the "troubled assets" as % increases... Rich


    Rich, while this is logical thinking, it is not bank accounting. "Troubled assets" don't increase with any balance sheet entry. Reserves are not really non-earning asstets, it's not cash in the vault hedl in boxes, it's it's the ability to cover capital requirements through the maturity distribution of securities held.

    Anyway, your point is that it is not a good thing and you're right, it's not a good thing!

    J. Scott, you're right as there is little impact so long as earnings can absorb the write offs. This is not so hard to overcome since the banks can borrow money to invest to hedge the losses. As interests rise and investment returns remain constant or don't rise as quickly, in the short term, there will be be a squeeze. Bill

    3Reply
  • Rich Weese
    OP
    Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
    16y

    Bill- we'll have to just agree that we don't agree. I've been in banker board meetings to know the way it works in normal times. These aren't normal.I'm involved in a bank currently with over 100% of troubled assets. It has been served with a cease and desist order as to ANY more lending! Hard for a bank to make a profit without lending, unless buying foreign currency.
    I think you come from a VERY pro banking aspect. I don't. We can parch words and take bits and pieces, but I'm done. I'll just let article and thread stand as is. We'll see how the banks "loan" during the next wave of sfrs being foreclosed on as well as 700 BILLION in bad commercial loans. I'm sure the lenders will be lined up to loan on those deals... Rich

    2Reply
  • Ralph S.
    Real Estate Investor · Sacramento, CA · Member since 2008 · 566 posts · 356 votes
    16y

    Rich
    I'm only responding as you and J have earned, IMO, a well earned and highly respected reputation here on BP, but you've missed on the accounting points the FinanceExaminer brings up.

    It is not something called "Bank Accounting" that rules the day. It is GAAP (Generally Accepted Accounting Principals), and accrual accounting, that banks and all publicly owned and government regulated businesses must adhear to.

    GAAP requires that when an asset becomes impared, such as when collection of receivables, or the value of an asset comes into doubt, a reserve must be established and the financial impact be recognized at that time. This would be before any foreclosure or collection efforts occur.

    To accept your points that the financial impact occurs when the REO is sold, would be considered fraud on the part of the financial institution for having overstated the value of their assets prior to that time.

    The missing part in your statement:

    Is that when the $100K note is written off, and $50K is received in cash, the reserve is reduced by $50K. Since all of these are assets, and the two 50's offset the 100, there is no change in assets when it is sold. If there were a difference, such as when the reserve was estimated too high or two low, that difference would land on the income statement, not the balance sheet, and still, assets remain unchanged. Since you reduce the reserve (and eliminate the "troubled asset"), the % should remain roughly the same.

    While the in depth debits and credits applied by the banks when loans go bad are out of my experience, the concepts of accrual accounting, reserves and GAAP are not, and are not hard to understand. They are all designed to make sure every company is measured on an equal basis (GAAP) by following the same rules, and that the financials at any given point in time are as accruate as they can be as to the value of assets, liabilities, equity and income.

    When they don't, you get Enron and Bernie Madoff, and perhaps the bank where you sat in their board meeting.

    Guess I've been through too many audits, having to defend many of these reserve balances of the companies I've worked for. It's not Banker Boardroom stuff, they have no say in the matter, just nuts and bolts accounting.

    Bummer. Guess we'll just have to agree to disagree, since you're done.

    7Reply
  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
    16y
    Originally posted by Ralph S.:

    I'm only responding as you and J have earned, IMO, a well earned and highly respected reputation here on BP, but you've missed on the accounting points the FinanceExaminer brings up.


    Just wanted to reiterate that I completely agreed with Bill (FinanceExaminer) in his points about how assets are accounted for and the impact the banks will see due to these troubled assets (they've already written off much of the asset value *before* a foreclosure)...

    I was also completely agreeing with Rich that I believe there will be a spike in foreclosures over the next 6-12 months.

    Both points (in my opinion) were right on the money (as are yours, of course)...

    Podcast Guest on Show The Truth About Real Estate Investing in 2024 (What Investors NEED to Know)
    1Reply
  • Christopher Davis
    Real Estate Investor · St. Louis, MO · Member since 2010 · 153 posts · 104 votes
    16y

    Thanks guys,
    This is like a peek behind the curtain for a guy like me. Your discussion , the back and forth of it helps me understand some of the nuances of what is going on. At least on some level

    Chris

    1Reply
  • Ted Harris
    Real Estate Investor · Portland, OR · Member since 2009 · 660 posts · 244 votes
    16y
    There are now millions MORE homes in jeopardy with more problems to come. As article explains, it normally takes 6-7 months of missed payments before lenders start foreclosure. Millions of homes are falling into that area now. Lenders are still not lending, which means purchases must be for cash.
    It is also obvious that many lenders have been delaying foreclosures and then delaying resale of these REOs. These HAVE to hit the market sometime!

    Hearing or reading news like this excites me ... means the window of opportunity on buying cashflowing properties remains wide open for awhile. Buy, get tenant, build up reserves, buy, get tenant, build up reserves ....

    1Reply
  • Mark N.A
    Real Estate Investor · North Carolina · Member since 2008 · 1k+ posts · 483 votes
    16y

    To me, the most important point Rich made was:

    >>10.will the weight of new giveaways be the last straw that crushes our economy and status in the world and start the dominos falling?<<

    While I've enjoyed the discussion so far, I sure hope this isn't like two guys on the Titanic arguing whether they should speed up or slow down, turn left or turn right........

    1Reply
  • Rich Weese
    OP
    Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
    16y

    Mark- no argument here. I just posted the article, listed my thoughts and asked everyone to consider the 10 questions. I'm making my decision from an experience based history with NO ulterior motives.
    If some want to assume everything is rosy, so be it. Only time will tell how many dominos will fall. Once they start, it is my belief the rest will fall quickly. I'm basing my investments accordingly. Good luck to all. I hope everyone makes their decisions the same way. Research, knowledge and experience continues to serve me well. Rich

    1Reply
  • Ted Akers
    Centennial, CO · Member since 2009 · 758 posts · 251 votes
    16y

    Great thread here. I have read estimates of +1M foreclosures versus last year. J Scotts comment on Option Arm's is very appropriate. Option ARM recasts are about to start increasing substantially and reach huge numbers by October 2012. Most of them will be underwater when they recast and will have no option to refinance. The national average payment increase when they recast is +63%. IMHO they are one of, if not the, large dominos Rich may be thinking of.

    1Reply
  • Vikram C.
    Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes
    16y

    I understand that assets are supposed to be marked down when it is clear that they are impaired and not when the impairment is realized through a sale.

    But did the Emergency Economic Stabilization Act of 2008, which allowed financial firms to not use mark-to-market rules when it suited their convenience, change things? I believe the relaxed rules only applied to securities and not loans, but considering that most loans are securitized, I would suspect that we no longer have realistic reserves since the accounting standards no longer require them to be based on market values.

    1Reply
  • Rich Weese
    OP
    Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
    16y

    Ted- That is one of the LOCAL dominos. I'm still worried about Greece and country dominos...

    Vikram- You've been less active on here recently than me! Banks have so many tricky accounting methods, I only trust them slightly more than the IRS. They'll rob you blind if they have a chance, and they have numerous ways to do it, imo. Rich

    0Reply
  • Ted Akers
    Centennial, CO · Member since 2009 · 758 posts · 251 votes
    16y

    I just came across a Reuters article and posted it in Bulletins yesterday. PRIME mortgages delinquencies are now at 14%, and 4.7% of those are 90+ days late. These are huge numbers for the prime category. Without employment improvement many of these are heading to short sales or the auction block. Opportunity for investors but room for concern regarding values, IMHO.

    2Reply
  • Rich Weese
    OP
    Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
    16y

    Ted- good heads up. Unfortunately, most won't see the handwriting on the wall. I do believe prices will drop more. I just hope it doesn't lead to a recession. Rich

    0Reply
  • Tod R.
    Investor · Southlake, TX · Member since 2009 · 950 posts · 338 votes
    16y

    I don't completely understand the bank regulations and accounting, but what I do know is that banks are not making real estate loans. I was naive enough to think that last year's bank bailout would get the banks back to lending again, rather than being kept to support their liquidity.

    I agree that most of their real estate loans have been written down, requiring larger capital reserves. However, I've been told that the banks are restricted to the total real estate loans they can have on their balance sheet, and as a result, will not make consider such a loan unless it is a 50% LTV collateralized with cash and guarantees on top of the real estate itself. As a result, we see the exploding cottage industry of private lending.

    I have myself convinced that we have not seen the end of high foreclosures, high unemployment causing depressed real estate values until the economy can right itself. How and when that happens I think depends on the lesser of two political evils we choose in the next couple of years.

    1Reply
  • Ted Akers
    Centennial, CO · Member since 2009 · 758 posts · 251 votes
    16y

    Todd,
    I have seen a few posts and blogs saying that even though the administration wants banks lending the FDIC is putting the hammer down on them, especially related to real estate loans. I agree we have not seen the peak of foreclosures.

    As to voting, mine will go to anyone I think is less susceptable to special interests. Just posted an article where Goldman is applying for a $1.4 Billion Tax Credit - some obscure piece of legislation passed lat year allowing banks to offset 2007-2008 back five years. Insane - the lobbyist are earning their keep and bank bonuses are back to normal thanks to the bailouts, but real estate lending is not happening.

    2Reply
  • Tod R.
    Investor · Southlake, TX · Member since 2009 · 950 posts · 338 votes
    16y

    Ted, you're right. The lobbyists are running the asylum!

    0Reply
  • Jeffrey K.
    Real Estate Investor · Milwaukee, WI · Member since 2008 · 1k+ posts · 671 votes
    16y

    For those of us who dont invest in SFR, does anyone have any ideas on the number of investors defaulting? I have not see very many deals in the past two years (saw about 20 REOs bought 10). I guess in my city the desireable areas did not have too many go back to the banks. I have been looking at big buildings also, but the local banks seem to want to be landlords and keep the buildings and try to ride this out. Is anyone seeing local banks putting PM companies in place and renting them out?

    0Reply
  • Robert Mack
    Real Estate Investor · Bergen County, NJ · Member since 2008 · 390 posts · 72 votes
    16y

    I was looking into my counties properties going up for auction and saw a huge spike in properties being auctioned off in April compared to any other months. There are 510 properties scheduled to be auctioned off when usually there are under 100 properties being auctioned off.
    I'm trying to understand the reasoning behind this. Is it just coincidence of the timing of peoples defaults and when their properties are going to auction or is this the banks shadow inventory that they are strategically putting up for auction in April...?

    Heres a link to the numbers, you'll see the small graph "number of scheduled auctions"

    http://www.bergenjerseyforeclosures.com/

    0Reply
  • Account Closed
    Real Estate Investor · Flushing, NY · Member since 2010 · 77 posts · 20 votes
    16y

    To add onto J Scott's posting about Option Arm's, I know from personally working for a lot of the major mortgage lenders as a wholesale account executive for banks such as Washington Mutual that there will be a new wave of distressed loans because of the recasting of option arm loans. I personally worked on originating a ton of business from mortgage brokers within the New York Metropolitatn Area.
    Banks like Wachovia, Indymac, WAMU, and World Savings sold these option arms like hot cakes when the market was doing well!

    The major hitch in the option arm loan is the negative amoritization component that borrowers ignored or were not fully made aware of. The way the banks would attract borrowers into the loan was through a teaser rate which was usually around 1% along with 3 other payment options. (Interest Only, 30 year, 15 year payment.)

    Borrowers would only make the minimum payment off the 1% and not payoff any of the principal or all of the interest. Thus it's like only making the minimum amount on your credit card statement and that results in you owing more then you borrowed.

    When you combine a ballooning loan balance through negative amoritization and house values plummeting that accelerates the negative equity in the property.

    Here's an article about option arm loans in January from CNBC with some good statistics on the next wave of foreclosures.

    http://www.cnbc.com/id/34729005

    Important Notes From Article:

    -From 2004 to 2005 1.3 Million borrowers took out $389 Billion worth of Option Arm Loans alone.

    -Some 88% of Option Arms originated between 2004 to 2007 are going to adjust higher from now to 2012. Those Option Arm Borrowers could see their housing bills go up as much as 63%, according to Fitch Ratings.

    -If Fed starts raising rates then Option Arm Rates go up also because their rate is tied in with the Treasury Rate.

    -Option Arm borrowers can't refinance because of declining home values and tighter credit restrictions.

    -The number of foreclosures is projected to be 4 million within the US for 2010.

    2Reply
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