PrintNovember 10, 2009
The Accidental Landlords
Fannie Mae, that little spendthrift tartlet and loose date for the Democrats, has found a new way to squander money and wreck America's financial institutions. Fannie's "Deed for Lease" program would allow homeowners who do not qualify for mortgage adjustments to deed the property back to the lender, who would then rent it back to them at market rate. Essentially, homeowners in foreclosure would be allowed to switch from ownership to renting their property.
I work for one of the largest "scattered site" property-management companies in St. Louis, and I have years of experience with rental property. While the Deed for Lease program may sound like a reasonable idea, it is anything but -- when I told my broker about this harebrained scheme, his jaw hit the floor.
For starters, people qualified for the program will be those who cannot pay their mortgages. There is a reason why they cannot get their loans modified: there is simply no way to adjust them so the homeowner can afford to pay them. I frequently explain to tenants that rental houses generally cost more than a home mortgage because the landlord has to pay a mortgage himself, plus pay for maintenance and utilities, obligatory or otherwise. (Sewer service often cannot be taken out of the owner's name, since a sewer cannot be disconnected for non-payment.) Fannie Mae's premise here is that rent will be cheaper than the mortgage, but that is not necessarily so. In point of fact, for the homeowner to convert to a tenant the rent will have to be lowered, likely by a large amount. Already the bank is losing money on its "investment," -- an investment they did not want, but were required to make.
Of course, the new tenants are not likely to be particularly careful with the property that they used to own; many will be angry that they made mortgage payments to the bank only to surrender their property anyway. Since many of these tenants were sub-prime mortgage holders, one can fairly make the case that there will be higher incidents of damage, which the newly minted landlord will be required to repair. Overdue rent will have to be collected, and it seems likely that many of the tenants will find it just as difficult to pay their rent as it was to pay their mortgages. Evictions take time (and in places like California, are notoriously difficult to obtain) and many of these investments will end up as vacant buildings stripped of copper pipes, furnace, appliances, and with windows broken out.
These accidental landlords will find they need a considerable amount of help in managing these properties, so they will have to either create a property management division in their company or hire an outside management firm. Management companies generally charge 10% of all moneys collected (or more) for their services, and that means further financial loss for the bank. Also, banks are large corporate entities, and maintenance issues occur at any time of day on any day of the year; what happens if a tenant's furnace dies at 3 a.m. Christmas morning? Management companies keep people on call to deal with issues like these, and if the bank hires a management company, they will still need someone who can authorize the expenses when the manager calls. If they run their own management, they will have to keep a number of people on call. And there must be maintenance people who can deal with issues like this at any given time. You cannot wait for a contractor to reopen after the Christmas break. Decisions must be made quickly, and banks are just too top-heavy for quick action. This will be especially true of non-emergency maintenance; a simple window repair could take months.
Then, too, there is the matter of a security deposit. There won't be one for the property, so the house in question will not be protected, and the bank's investment will be jeopardized. People who couldn't pay their mortgages will not be able to come up with a large chunk of change on short notice.
The tenants will also be unhappy that they will not be covered by the landlord's insurance policy. They will have to buy renter's insurance or their personal property will not be protected.
Mortgage lenders are in business to make loans, not manage property. Rental property can be an enormous millstone, something that drags the owner under over time. These homeowners-turned-tenants will be very costly to the banks that have to deal with them, and the banks will lose indispensable sums of money over this. These properties may be sold, but the lease must go with the houses, thus considerably reducing their desirability. There are many investors who will not buy a property with a tenant he cannot remove. He may want to rehab it, or tear it down, or sell it to a nice young couple. Now he's stuck with a lease guaranteeing the tenant at least a year. And if that tenant stops paying...
The banks are starting out with no hold over the tenants; their credit is already bad and they have no reason to worry about the property.
Renting may be worthwhile to avoid losing a lot of money on a vacant foreclosure, but to keep people in the property who could not pay for it as owners is a recipe for disaster. Better to rent it to others who can make their payments. What this does is guarantee a steady negative cash flow for the banks, further weakening their financial outlook and giving Obama yet another reason to tighten his grip on them.
Fannie Mae caused this mess, and their fix will only make things worse.
(Hat tip: Jack Kemp. Thanks also to my employer Paul Efthim for making some practical observations.)
