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.
Wow Alistair, scary stuff indeed!
I’m currently listening to the audio version of the all time classic “The richest man in Babylon”. Amongst other pearls here are a few:
1. Gold cometh gladly and in increasing quantity to any man who will put by not less than one-tenth of his earnings to create an estate for his future and that of his family.
2. Gold laboreth diligently and contentedly for the wise owner who finds for it profitable employment, multiplying even as the flocks of the field.
3. Gold clingeth to the protection of the cautious owner who invests it under the advice of men wise in its handling.
4. Gold slippeth away from the man who invests it in businesses or purposes with which he is not familiar or which are not approved by those skilled in its keep.
5. Gold flees the man who would force it to impossible earning or who followeth the alluring advice of tricksters and schemers or who trusts it to his own inexperience and romantic desires in investment.
Chapter summary here for anyone interested:
http://en.wikipedia.org/wiki/The_Richest_Man_in_Babylon_(book)#Chapter_Summary
Amazing to look at the satellite photo of Merced where you can zoom right in and see all the unfinished subdivisions.
I note that it is directly in line of on the flight path of an airforce base a few kms to the north!
Using street view you can actually “drive around the town of Merced even the abandoned empty streets have been photographed! See http://tinyurl.com/yfpd4sq
If the median is only US $144,000 – what would these be worth? http://tinyurl.com/yhf8cqy
Much of the town appears to be trailer park type housing.
Ross
Thanks for the additional content contribution – wiki-like post this!
The US market is a disaster zone for sure. It’s actually beyond ridiculous…
This New York Times Story http://www.nytimes.com/2009/10/09/business/09fha.html?_r=2&ref=business
published yesterday shows how the US hasn’t learnt the lessons they needed to. It seems absurd that private banks won’t lend unless the borrower has 20% deposit, yet the FHA, a Govt agency that may soon implode & now has reserves below their allowed congressional minimum, is lending $1billion per day (yes per day!) to people with only 3.5% deposit.
A borrower profiled in the story had this to say:
“The government,” she said, “is doing what it needed to do — taking a risk on people.”
Green shoots – yeah right!!
Correction to my comment above, the FHA is not a lender but insurer of the loans. It’s insuring loans with 3.5% deposits. Probably most of those loans are being made by Fannie and Freddie, both Govt institutions (pseudo banks) now. Where’s the money coming from? I’d say the printing presses.
Another interesting twist. Fannie Mae is insolvent. I read their latest financial report on their website. It blatantly admits they should not be operating. Their own report states that they can only hope to continue operating as a company if the US Treasury continues to inject funds. The last injection was around $10 billion for about 6 months life. They’re using the TARP bailout funds. The Govt is just pumping money into these organisations hoping that the housing market will turn around. If it doesn’t they’re toast. What hope do they have if they’re lending on 3.5% deposits to people who’ve already declared bankruptcy and can’t demonstrate an ability to repay? Where does it all end?
Wow! Very interesting topic you have here. It’s a dilemma for the people who bought property at Merced.