Millionaire Buys All Foreclosed Properties At County Auction

Saw this story and had to chuckle. An investor bought all 650 properties up for auction in a Detroit suburb recently. He made an offer to buy all of them as a package deal for $4.8 million - the total of the minimum bids of each one. Other investors are pissed, obviously.

This houses were all foreclosed on because of delinquent property taxes and the minimum bid amount represented the amount of taxes owed. I understand the ire of the other investors, but I do think the tax collector running the auction has a point. He says "I have to collect the taxes and that's what I did." He also points out that, while some of the properties are in good condition, some are not. Had the properties sold individually, those in poor condition likely would not have sold at all.

But the part that made me chuckle was near the beginning of the article: "Bill McMachen told Fox News 2 this is his first foray into the real estate business."

New California Foreclosure Law

Because all my hard money lending is done in California and to people who buy, rehab, and sell foreclosures, this news story caught my eye. The California legislature recently passed a law making it harder to banks to foreclose on property owners. According to Reuters, the bill prohibits banks from "dual-tracking" loans - proceeding with the foreclosure process while also in loan modification negotiations with the owners. The bill also lawsuits against robo-signing. The bill still has to be signed by the governor before it becomes law, but he is expected to sign it.

On the surface, this law sounds good to me. I will freely admit the first I heard about it was from the above linked article and the facts in that article are the extent of my knowledge of it. I do think robo-signing is a big problem. When your actiosn can result in people losing their home and being forced out onto the streets, you need to have someone carefully look over the documents before foreclosing. This just stands to reason. As to the prohibition against dual-tracking, I'm OK with that as well. Yes, it may result in longer times to foreclose on a property. But if a borrower is in talks with a bank to modify their loan, I think they would reasonably conclude that the bank would pause foreclosure proceedings while they are attempting to work out a settlement. Further, without this restriction, the bank has a huge advantage at negotiating - they would be able to drag out the talks until foreclosure was a day away, leaving the borrower with no choice but to either accept the terms the bank offered or lose his or her house.

How will this affect my lending? I expect to see a slowdown in houses for sale at auction for the 6 or so months after this bill becomes law. This will represent the time banks have to wait while they attempt to reach a loan modification deal before proceeding. There is nothing in this law, to my knowledge, that requires the banks change what loan modification terms they must accept, so they will still be reaching the same decision on modifying loans or not, resulting in about the same number of houses going to foreclosure. There will just be a delay lasting the length of those negotiations.

Common Sense Prevails

Last Friday, the Massachusetts Supreme Court ruled that two banks did not have the right to seize homes from two parties because they could not prove the banks owned the mortgage at the time of foreclosure. While this will undoubtedly slow down the foreclosure process and reduce the inventory of properties for investors who make money off foreclosed homes (of which I am one), I have to applaud this decision. It seems like a pretty basic idea to me - in order to foreclosure on a home, you must be able to show proof you are the mortgage holder.

Man Stands On Principles, Dares Bank To Foreclose, And Wins

I wrote last month about a guy who was willing to let his bank foreclosure on his house over $25 in fees the bank erroneously charged him and refused to reverse. Turns out the bank blinked and has agreed to the man's (entirely reasonable) demands and has canceled the foreclosure four days before the auction. Nice to see someone at the bank has some common sense.

Now this takes some guts (or lack of brains)

This guy is letting his house go into foreclosure because his bank erroneously charged him a $25 fee and refused to refund it. If he can buy his house back at auction for less than what he owes, he'll come out ahead.

Not sure if he fully understands what he's doing though. He seems to think that at the foreclosure, it will automatically become owned by the bank and then he can buy it back as a REO property. Does he not realize that when it is at auction, anyone can buy it? It only becomes an REO if no one buys it at auction. And if he intends to buy it himself at auction, does he realize that when you buy a house at auction, you need to pay for it in full?

GMAC Finance Halting Foreclosures **Updated*

If you are a foreclosure investor, you might want to start paying attention to what company is doing the foreclosure on any property you are interested in. We've all seen the reports about mortgage companies foreclosing on the wrong property. Apparently, this is something of an epidemic at GMAC Mortgage, as they told their employees yesterday to immediately halt all foreclosure proceedings in 23 states. They are also halting the sales of all properties they have already foreclosed on and extending the closing date by 30 days. They are allowing buyers already under contract to cancel and get their deposit back, should they want.

Update: Another story says the reason for the freeze by GMAC is that GMAC employees signed about 10,000 "affidavits and other foreclosure documents a month without verifying their accuracy." The Florida Attorney General is investigating the filing of fraudulent documents to the courts.

Time Is Of The Essence

Saw this article today about a couple in California that bought a house at a foreclosure auction. They thought they had a great deal, but it turns out they actually bought the worthless second mortgage, not the first. A few months after the auction, they received another foreclosure notice, this time for the first mortgage. As you know, the first mortgage has seniority, so the couple was pretty much screwed. At the auction for the first mortgage, no one placed any bids, so the property went back to the lender and the couple was able to work out a deal to keep their house. Unfortunately, their daughter and her fiancée, whom the house the purchase for, have decided to move out of state, so they won’t be living in the house after all.

There are a couple of interesting points in this story. This took place in California, where there are some peculiar laws. Apparently, it is easier for a second mortgage to foreclose than a first, which is why the bank proceeded the way it did. It sounds like the buying couple did do some basic research – they saw the recorded docs for the two loans, but since they were recorded on the same day, they thought they were the same loan. That’s where they made their mistake. There are a couple warning signs they should have seen. First, check out the loan amounts as stated in the recorded documents. They should have seen they were different. They should have also seen that the loan that was doing the foreclosing was the lesser amount, which should have tipped them off that it was a second mortgage, not a first. Second, they should have looked further than the date. I know, at least in Arizona, documents are recorded not only with a date, but also a time. I would imagine California does the same. If two documents are recorded on the same day, check the time to see which was recorded first. Personally, a friend of mine encountered a similar situation here in Arizona. He was buying a foreclosed property and someone else was trying to save it from foreclosure. It came down to the time each party recorded their document. My friend’s document was recorded about 15 minutes sooner, so he got the property.

Man Bulldozes Foreclosed Home

An Ohio man lost his home to foreclosure and bulldozed his house rather than let the bank take it back. It seems he was sued and the IRS placed a lien on his home. The bank claimed the home as collateral.

From what I can tell, it sounds like the guy got a loan from the bank and built the house himself. He owed $160,000 on it. The bank started foreclosure. The home was supposedly worth $350,000 and the owner had an offer to buy it for $170,000. The bank rejected this, saying they could get more for it at auction. So the man decided he would return the property to the way it was when the bank gave him the loan - just an empty lot - and he bulldozed the house.

As much as I hate to say it, I have to agree with the owner here. The bank was just plain greedy. He had an offer that would have paid off the bank completely, but the bank rejected it because they thought they could get more money. That was just stupid.Whoever made that decision at the bank should be fired.

Now there is probably more to this story. For example, why did the IRS put a lien on his house and how much did he owe them? It might be that the $170,000 was not enough to pay off the IRS and the bank, which is why the bank rejected it. As you know, IRS liens get paid off before any other liens, so maybe the bank would have lost money with that offer. If that's the case, I would have to side with the bank. But, lacking any info to the contrary, I think the bank screwed up.

Strategic Mortgage Defaults Revisited

Back at the end of September, I wrote about strategic mortgage defaults - purposefully defaulting on your mortgage on a property that has a mortgage for more than the property is worth. A story in the L.A. Times reported that these types of defaults were on the rise.

Now, University of Arizona law professor Arizona Brent T. White has published a paper (pdf) stating, contrary to news reports, not many people are doing this - but they should. He cites people's emotional fears as the driving force preventing them from acting in their own financial best interests - the fear of the shame and guilt of foreclosure and an exaggerated sense of the consequences of foreclosure. He also argues these fears are actively encouraged by the government, lenders, and other social agents to induce borrowers to ignore what might be the wisest financial decision for them.

I found this paper very interesting, mainly because it presents almost the complete opposite picture of human behavior that Freakonomics does - namely that people will NOT act in ways which benefit them financially the most. I think the difference here is due to the amounts of money involved, as well as social pressures. The actions looked at by Freakonomics dealt with relatively small amounts of money and with actions whose consequences have fewer social repercussions.

White states:

Homeowners should be walking away in droves. But they aren’t. And it’s not because the financial costs of foreclosure outweigh the benefits. To be sure, foreclosure comes with costs, including a significant negative impact on one’s credit rating. But assuming one had otherwise good credit, and continues to meet other credit obligations, one can have a good credit rating again – meaning above 660 - within two years after a foreclosure. Additionally, in as little as three years, one can qualify for a federally-insured FHA loan to purchase another home.

While the actual financial cost of having a poor credit score for a few years may be hard to quantify, it is not likely to be significant for most individuals – especially not when compared to the savings from walking away from a seriously underwater mortgage. While a good credit score might save an average person ten of thousands of dollars over the course of a lifetime, a few years of poor credit shouldn’t cost more than few thousand dollars.

I find his arguments to be well-thought out and worth thinking about. There is a definite basis against people who walk away from their mortgages:

This is not to say that there is a grand scheme to manipulate the emotions of homeowners, or even that the government and other institutions consciously cultivate these emotional constraints on default. But, to be sure, the predominate message of political, social, and economic institutions in the United States has functioned to cultivate fear, shame, and guilt in those who might contemplate foreclosure. These emotions in turn function as a form of internalized social control – encouraging conformity to the norm of meeting one’s mortgage obligations as long as one can afford to do so

What I find particularly interesting in the concept of how the lender-borrower relationship is an example of a asymmetric relationship - one side, the lender, has all the power. The lender is free to walk away from the loan (by selling it to another company), is free to make loans based on over-inflated property values (without doing any significant research to verify those values and then expect a government bailout when their lack of due diligence catches up to them), and is free to, in effect, modify the terms of the mortgage to include more than just the property as collateral, without any legal or moral ramifications, yet the borrower has no such options. In fact, even though the mortgage document specifically states the lender's SOLE COLLATERAL for the loan is the property, the lender is able to also use the borrower's credit score and self-image as collateral as well.

One obvious response to the above discussion is that society benefits when people honor their financial obligations and behave according to social and moral norms, rather than strictly legal or market norms. This may be true if lenders behaved according to the same social and moral norms. In the case of lender-borrower behavior, however, there is a clear imbalance in placing personal responsibility on the borrower to honor their “promise to pay” in order to relieve the lender of their agreement to take back the home in lieu of payment.

Given lenders' generally superior knowledge and understanding of both mortgage instruments and valuation of real estate, it seems only fair to hold them to the benefit of their bargain. At a basic level, sound underwriting of mortgage loans requires lenders to ensure that a loan is sufficiently collateralized in the event of default... In other words, in appraising a home the lender should ensure that the loan amount, at the least, does not exceed the intrinsic market value of the home...since lenders generally arrange the appraisal (which home buyers must pay for) and home buyers rely upon the lender to ensure the home is worth the purchase price, one might argue that lender should bear much more than 50% responsibility for the bad investment of the homeowner and lender.

So what does he propose be done to help homeowners? One suggestion is to prevent lenders from reporting foreclosures to credit reporting agencies. This sounds crazy, but he makes a good case:

The suggestion that Congress should amend the Fair Credit Reporting Act to prevent lenders from reporting mortgage defaults is premised upon the underlying mortgage contract, in which lenders agree to hold the house alone as collateral. In the case of underwater mortgages, however, the portion of the mortgage above the home’s present value essentially becomes unsecured. Lenders compensate for this by holding the borrowers’ credit score, and thus their human worth, as collateral – thereby altering the underlining agreement that the home serves as the sole collateral. As a consequence, lenders are often able to reap the benefit, but escape the costs, of their bargain.

There are many more arguments he makes, which I don't have the space to go into here. I encourage people to read his paper with an open mind. Needless to say, the banking industry fiercely opposes his ideas.

Foreclosures Still Happening All Over

RealtyTrac has put out foreclosure statistics for September. While the number dropped 4% from August, it is 29 % over a year ago. In my state of Arizona, one out of every 53 houses is in foreclosure. The worst in the nation is Nevada, with one in every 23 houses in foreclosure. There's a big sexy graphic representation here.

Strategic Mortgage Defaults

The L.A. Times reports that a study shows borrowers with good credit are actually more likely to default on their mortgages than borrowers with lower credit scores. These "strategic defaults" appear to be done based on a simple business analysis and with full knowledge of the consequences: if the property is seriously underwater, just give it up.

When I first read this, my thought was the defaulters were mainly people who bought investment properties during the bubble and were now giving up This does not appear to be the case, however. "Two-thirds of strategic defaulters have only one mortgage -- the one they're walking away from on their primary homes." And, not surprisingly, the study found "Strategic defaults are heavily concentrated in negative-equity markets where home values zoomed during the boom and have cratered since 2006."

One site I was reading opined that this would make loan modifications harder to obtain. But I'm not sure that is a bad thing. A report published in April showed "Fewer than half of loan modifications made at the end of last year actually reduced borrowers' payments by more than 10 percent... [while] nearly one in four loan modifications in the fourth quarter [of 2008] actually resulted in increased monthly payments."

The Next Mortage Crisis: Option ARMS

Now that the subprime loan debacle is pretty much behind us, the next threat on the horizon for the mortgage industry are Option-ARMs and Alt-A loans. Alt-A loans are loans made to people just above the sub-prime cutoff. Option-ARMs are loans that allow the borrow to choose from a variety of different payments each months, including payments that are less than the interest that has accrued during the previous month. As the graph here shows, a large wave of these loans are getting ready to reset (have their interest rate adjusted) in the next two years.

Reuters has a story about the Option-ARMs here.

Things Turning Around?

I've haven't spent a great deal of time investigating, but from the signs I am seeing and the news I am hearing, I am starting to think it's getting close to time to get back into local real estate investing. Prices in my area seem to be coming back down to "normal" levels and I am seeing good deals again, especially on foreclosed properties. I am also seeing a large number of "bank owned" for sale signs around town. Of course, you can't just look at home prices to determine if the market has bottomed out. You also need to look at demand and the availability of buyers. As I said, I haven't done any detailed analysis yet, but my gut feeling is things could be turning around soon. Of course, I could be wrong...

Hard Money loan #6 was paid off a couple weeks ago and I have used the principle from that to make another hard money loan. Call this one Hard Money Loan #7. It should be a fairly short loan. This property is a 2,700 square foot house built in 2006. List price is $380,000 and it is already in escrow to be sold. The seller (my borrower) bought it for $186,000. Homes in the area typically sell for $257,000 to $320,000. The loan is for $138,000, so we are fairly well protected. ROI is 10% with monthly interest only payments.

On the landline phone elimination front, everything has been switched from the landline and I am ready to cancel it. I am pretty happy with Callwave's internet fax service. The only thing I don't like is that they have an address book on their website, but you can't use it to select a number to fax to! Seems a bit pointless to me. Other than that, I've been happy with both sending and receiving faxes through them.

And my annual trip to Las Vegas was again fruitful. Well, pretty much for everyone I went with but me. Everyone got royal flushes at video poker except your truly. My wife won $1,300 with hers. My sister-in-law won $1,500. And my brother-in-law won $1,000 with his first one. Not 10 minutes later, he got a second royal flush and won another $1,000 at the same machine! Although I didn't get a royal flush, I did get the most four of a kinds than anyone else on the trip. Those paid between $62.50 and $200 each. I was a bit disappointed though. It seems the economic downturn has hit the Wynn a bit. Last year, many of their video poker machines were set at full pay ("9/6"). This year, there wasn't a 9/6 machine to be found at either the Wynn or Encore. They were all 8/5, which has a lower total return to the player. Oh well. It didn't seem to hinder us to much!

Apartment Complexes Being Abandoned By Owners (Updated)

This article on msnbc.com today brings up an interesting subject: apartment complexes that are being abandoned by the corporate owners as they go into foreclosure. The examples in the article are all in the Phoenix area, which caught my eye since it's where I live. I've passed this info on to my friend who deals with apartment investing to see what he thinks. He already owns some apartment buildings in Phoenix and knows the area well. Could be some buying opportunities here. Phoenix doesn't have the strong economy that the Houston area does, but if the price is cheap enough, these could be worthwhile.

Update: Heard back from my friend. He and several other investors are indeed watching these properties. Unfortunately, he says the banks that are foreclosing are still looking to sell in the $70K per unit range, which is what they were valued at some time ago. Now they are valued at closer to $30K per unit. The banks will come around eventually.

"Official" Vigilantism

I came across this story on CNN.com today. In a nutshell, there is a sheriff in Chicago who thinks there are too many foreclosures and will stop evicting "innocent" renters from properties. I can surely empathize with him. It would not be fun to evict people for no fault of their own. But enforcing the law sometimes means doing things that are not pleasant.

I agree that the tenants are not to blame for the foreclosure - in most cases. It's the landlord, after all, who has not paid the mortgage. However, that doesn't mean the tenants are entitled to live there for free. The law is the law and the sheriff should enforce it and kick the tenants out.

From what I can tell, the sheriff's main beef is that tenants are being evicted even if they have paid the rent on time. His justification for refusing to enforce eviction notices is the fact that the banks are not identifying the people living in the property when they issue him the eviction notices, as they should be. OK, maybe the banks should be doing that (although I think it might be rather difficult for them to do so, especially if the bank is located in another state). But by refusing to evict tenants at all, he is also allowing those tenants who do NOT pay their rent to remain in the property for free. He says he is coming across "innocent tenant after innocent tenant" that are being kicked out. Hmm. The last time I checked, it was a judge's or jury's responsibility to determine someone's guilt or innocence, not a sheriff's. And he obviously is taking the tenant at their word. As any landlord can tell you, tenants are known to tell lies now and again when it comes to rent payment matters.

But suppose the banks give the sheriff what he wants and they do start correctly identifying who is living in the building when they give him the eviction notice. This will not change what he has to do. He will still be required to evict the "innocent" tenants. Loan contracts clearly state that if the mortgage is not paid, the bank gets the property, no matter who is living in it. The tenants will still have to be evicted. Sorry, Sheriff. You have to enforce the law, no matter how unpleasant you find it.

As for wanting legislation to protect the tenants, what exactly does he want to see? The property owner go to jail? Well, that's not going to solve anything. The bank still won't get their money if they can't take back the property. First, there is no guarantee that the tenant's rent will even cover the amount of the mortgage in the first place. (If the owner was smart, it would, but in the midst of the real estate bubble, many, many people rented investment properties for less than the mortgage amount, hoping that appreciation would make them money in the long run.) Second, the bank does not want to be in the landlord business, so having the tenants remain in the property and just pay the bank instead is not an option. I'd be interested in knowing exactly what type of legal remedy this sheriff would like to see. I guarantee you it will not be fair to someone.

Home Sells on eBay for $1.75

Now this could be a sweet deal. A woman bought an abandoned home for $1.75 on eBay. She'll have to pay an additional $850 in taxes and yard cleanup costs. From the looks of the place, she's probably also got some serious rehab work to do. Still, I think she's got a good chance at making some money on this one. If this truly was a bank-owned property, I wonder which bank is selling their inventory on eBay.

More Problems For Those Being Foreclosed On

I wrote two weeks ago about what appears to be a burglary ring that targets people who are losing their homes to foreclosure. Now another scam targeting people in foreclosures is hitting the news. Truth be told, this isn't a new scam and I've heard about it before, but this is the first time I've seen some serious media coverage of the issue. This scam involves stealing the equity out of people's homes. The article details how this is done, but in a nutshell, it involves getting the homeowner to sign over their house to someone and then that person or company gets another loan on the property for the amount of equity. This new loan is never repaid. The previous homeowner usually doesn't know what is going on. They are usually allowed to continue living in the property and often think they did not sell their house or that they can buy it back in 1 or 2 years.

This is very similar to what Live Free Investment Group was doing here in the Phoenix area. I met with them last year to find out more about what they do. Although, and I stress this, I have no reason to believe Live Free Investment is doing anything illegal, immoral, or is involved with the above mentioned type of scams, it was something I was worried about back then. Whenever you take title to a property from someone in foreclosure and allow them to continue to live in the property, I see nothing but trouble. When the person has to move out, there is very little doubt that they are selling the property. But when they can stay, things can get murky in their minds. Even given that companies like Live Free may be 100% legit, the scams that are going on will no doubt bring more regulatory actions down on the entire industry and cause the legal costs, both real and potential, for doing these types of transactions to increase.

This is one of the reasons my step by step guide for buying preforeclosures stresses that the sellers must move out of the property.

Kicking Them When They Are Down

Late last year, I wrote about a co-worker of mine who jumped on the real estate bandwagon and bought a house and rented it for negative cashflow, assuming it would eventually go up in value. Of course, the market crashed and he lost the house. He managed to sell it for a loss, but unfortunately, the losses were too great and he ended up getting behind on the mortgage payments for his residence too. That went into foreclosure and the auction date was last week. He had started to move out, but he had to have some major surgery and went into the hospital before he got the move completed.

He found out last weekend that his house was robbed. It appeared to be the work of professionals. They took everything that was of value and left stuff that wasn't - even to the extent of taking expensive paint sealant but not the cheap paint sitting right next to it. They tried taking some pool equipment, but that was too heavy. A neighbor actually saw the people doing it and spoke with them. I guess the people told her they were moving the rest of the stuff out per my co-worker's request. There were a couple items that the lady told them she thought they wanted to leave, so the thieves left those, but they must have had the woman fooled. She said they had a big truck to load everything and looked like movers. Since this took place either a day before the foreclosure auction or the day of, it would seem there are some con artists going through the public foreclosure records and cleaning places out right before auctions. It could just be a coincidence, but I don't think so.

Something to be aware of...

Good News For Flippers!

Here is some good news for anyone flipping properties. The FHA is waiving it's anti-flipping rules and will now insure mortgages on properties that have been owned by the seller for less than 90 days. The waiver is in effect until June 2009.

Full details here.

Another Investment Made

Today I made another real estate investment. I'm a hard money lender in a first mortgage on a single family home in Oakland, California. This was a property the buyers picked up at a foreclosure auction. The amount owed on the defaulted mortgage was $495,000. The bank set the opening bid at $202,000 and the buyers got it for one cent more than the opening bid. There is probably about $25,000 worth of repair work to be done to it and three independent people have appraised the property at $325,000 to $350,000 after repairs. The buyers are contractors and each is a multi-millionaire. Les, the guy who I partnered with on my previous hard money deal in Louisiana, has known the buyers for over a decade and has found them to be very honorable.

The loan is for 1 year with interest only payments at 12% with a balloon payment for the entire principle due at the end of the term. No prepayment penalties, standard late fees. The net to me is 10% since 2% is taken for the servicing of the loan. The first mortgage is for $156,000, so the loan to value ratio is between 45% and 48%, depending on which appraisal you use.

I'll refer to this investment as Hard Money #3, with #2 being the Louisiana deal and #1 being the small loan I did about three years ago.