Imagine listening to talkback radio purely on the subject of real estate – in some ways this is what a recent podcast episode of The Real Estate Guys felt like – as they provided advice to a questioner who was severely “underwater“.
For reference The Real Estate Guys radio show is a US syndicated programme which through the marvels of iTunes you can listen to via podcasting wherever and whenever you like. It is a weekly show on all things to do with property, primarily based around real estate investing. It provides some great insight, discussion and ideas – thoroughly recommend!
Anyway the question the team were challenged with on this past week’s show “Ask the Real Estate Guys” was as they highlighted, not atypical of many properties in the US.
Mr & Mrs A had bought an investment property a couple of years ago in “an up and coming” satellite town of Merced, California. They were employed earning a reasonable salary and owned their family home with a good degree of equity presumably not in Merced. This investment property had presumably been an opportunistic purchase to support their retirement income.
The investment property cost them US$198,000 and they bought it with a $190,000 mortgage. It has been rented out, however the rent falls short of the mortgage payments by US$400 per month – Ok’ish when the depreciation is taken into consideration – right?
NO ….Merced is unfortunately as described by Business Week as “Ghost Town”, USA and the property is now worth around $110,000. As the Business Week article states the median price in Merced in 2007 was US$230,440 and in 2008 it had fallen by 38% to just US$144,000.
So the question asked by Mr & Mrs A to the Real Estate Guys was “what should they do?” – hold or fold. Stick with this devalued investment and the hope that in time it may be worth more than they paid for it, or foreclose and live with the repercussions on their credit score (and let the lender take the hit – this is California after all!).
The team provided guidance for the alternatives.
HOLD and based on 4% annual appreciation after 18 years and a US$4,800 per annum loss, then the net proceeds of sale in 2027 might just pay off the mortgage!
or.. try and finance someone into the house based on a sale and lease back deal based on the good mortgage that the owners had
or.. try and negotiate a short sale with the lender and in so doing mitigate the negative credit impact.
Whilst the team was not there to definitively advise the owners, there was a clear view that the best option was to FOLD – foreclose on the property. Hand back the keys and the title to the property- walk away not owing a $. All that would eventuate, would be a negative credit rating. Something that could be rectified in time (c. 5 years).
However what I thought was very telling was the comment that in the context of this issue with the bad credit rating – if ever in the future they were to be asked about it “you could always say – but that was 2008/9 – remember how bad things were in that recession – everyone was falling over!!”
I find this a salutary example of the double whammy of the US housing disaster – houses that should never have been built, in areas with no demand – sold to people, who should never have taken the risk – financed by debt that was fictitious – then the debt was on-sold to people who were hoodwinked. Then when the house of cards collapses everyone runs for cover – leaving ultimately the government, and thereby by default all tax payers to pick up the pieces. Unfortunately the ripples from this debacle have washed up on most shores of the world and ultimately we all end up paying.