Is Real Estate Investing Over?
A new Bill, HR 1728, passed through the House with an overwhelming majority in a record 3 days. It’s now at the Senate. If the Senate passes as expected, you may soon see the end of creative real estate investing. There was also a little rider attached to the bill at the last minute that would also allow the government to take away any multi-unit property they deem to be at risk of default.
You can read the entire bill here.
There are a number of things wrong from this bill, from the standpoint of the real estate investor.
First of all, the definition of who the law is applicable is incredibly broad. If you sell more than one residential property every 3 years, then you have to comply. That pretty much means anyone who is involved in real estate investing needs to look out! It also means if you are currently buying real estate and using creative strategies to do so, you’re about to lose your ability to buy because the people selling are likely to get caught in the net as well.
If you have to comply with the rules (and that’s just about anyone selling residential real estate), you can not do seller carry-backs. No second mortgages. You can’t have any balloon payments due. Every loan, every installment sale, must comply with very rigid rules including full 30 year amortization, escrow accounts, stringent truth in lending requirements and more. Basically, it just put pretty much every seller who used to carry paper out of business.
That’s enough to get the creative real estate community up in arms. There have been some grass root letter writing campaigns started. It’s hard to say how much of an impact it’ll have on the Senate though. The fact that this Bill passed so fast, with little debate, shows how powerful the lobbying groups behind it are.
But there is one more last minute add-on the Bill that has me even more concerned. It’s Title IX. If you look at the entire Bill online, make sure you skip over to this section and especially if you have any multi-unit residential property. That section of the Bill gives the government the right to take your property if you’re in default (a late payment) or RISK of default (and they get to define what risk of default means). The property will then get converted to low income housing. There is a strong movement to create low income housing and I”m concerned that government could get a little out of hand here. What constitutes risk? They decide. It could be because of the neighborhood, it could be because you’re upside down on the property (even though you are current with payments) or it could be that someone else defaulted on their property and yours was similar. Or it could be someone in the local government decided your property would make a nice low income housing project.
And just like that, you lost an income producing asset and, if you had personal guarantees on the property, your credit got trashed too. And there is NOTHING you can do about it!
You can imagine what that section of the Bill will do to multi-unit housing sales. Who would buy one knowing the government could take it at anytime?
Bills like this are going to further deepen the recession and plummet real estate values.
If there’s time, and I hope there still is, write your Senator. Meanwhile, please stay tuned here. We’ll keep posting what is happening and how that will impact you and your real estate investments.
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Ok, I jumped right to title IX, and I agree that the phrase “at risk of default or disinvestment” is ambiguous and could conceivably lead to gov’t abuse, but I don’t see where in here that indicates that anything taken over would be converted to low-income housing. 901.b.3 says “facilitating the transfer, when necessary, of such properties to responsible new owners.” This would indicate to me the gov’t doesn’t want to keep these properties.
In fact, it sounds like they will be creating a financing organization to provide financing for these properties, which would seem to help investors - 901.b.1 says “creating sustainable financing of such properties that is based on— (A) the current rental income generated by such properties; and (B) the preservation of adequate operating reserves”.
Seems like “current rental income generated by such properties” would mean they wouldn’t be low-income properties.
I’m sure I don’t have your skill for reading between the lines, though.
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Charlie
Bill Bronchick does not seem to be concerned:
http://bronchick.wordpress.com/2009/06/09/false-rumours-on-new-law-affecting-owner-financing/
If the bill really is heinous you should mobilize the national RE gurus who are also lawyers (like Bill) beating the drums against it. If they will not - maybe it is because it’s impact is not as significant as you believe it to be?
Do a search on Google for “HR 1728” and then click on ‘blogs’. You’ll see dozens of blog posts by the real estate gurus about this very thing. There is a letter writing campaign occuring right now.
I’m not sure why Bill Bronchick isn’t concerned, but he is definitely in the minority in that community.
Here’s an update I saw from a real estate investing site. Hopefully, this bill will fall in the bit bucket where it belongs.
http://realestateforfunandprofit.com/2009/06/12/update-on-hr-1728/
Seems there is a bit of paranoia in the fear about this bill… the phrase used is “stabilize the multifamily market” and its apparent intent is to prevent tenants from suffering when investors collect rent but default on their mortgages… this would indeed impose damages on investors who fail to maintain their financial integrity. As an investor, owner of more than 200 units, and as owner of a firm that manages an additional 500 units, I have seen properties where the tenants had been paying their rent on time, while the owner collects it but then fails to meet mortgage payments, with the result that the tenants are screwed… this bill is designed to remedy that situation. Investors who responsible, and keep current on their mortgages, will not be harmed. In fact, they may be able to gain additional financing options via the instrument being created for that purpose under this law.
Paul - thanks for providing that perspective. While the intent appears okay, I think where the problem lies is in the vagueness of the language in section IX, i.e.
at risk of default and
facilitating the transfer, when necessary, of such properties to responsible new owners.
What constitutes at risk of default or when necessary? Who defines a responsible new owner? Lots of potential for unintended consequences there.
I’m conflicted somewhat on this.
First, and foremost, I don’t like the threat to our right to private property. The “risk” of default is way too nebulous. I’ve heard from others platitudes that “they would never make it that bad” etc… but the fact is if the law is written that way, there will always be a big gaping hole that government can use. And that concerns me.
On the other hand, I’ve heard stories about renters in foreclosed properties that astounded me. I don’t know how foreclosure law works really, so I was surprised when I heard stories of people even in places like California (where it can take months to get a non paying tenant out) who are kicked out with only a few days notice due to a foreclosure. The stories I’ve heard seem to indicate that if the mortgage isn’t paid, there is no responsibility to notify the tenants and when the property is then foreclosed on any existing leases are immediately broken. Deposits are seized and there is no refund given for unpaid rent. If that’s true, I think that’s where the law needs to be looked at.
I suspect that situation is the one given for government having the ability to step in and stop people from getting kicked out on the street.
When we were in Phoenix, we were active supporters and volunteers at a family homeless shelter. Unlike single, often chronic, homeless men and women, families are almost always ones who got caught with the one paycheck away from the street syndrome. Someone loses a job, gets sick or something else catastrophic and they are on the street. Typically they stayed just a few weeks while they saved up the money for rent and deposit. That was in the good times. It’s much harder to get work now and will take longer to save up the money. And more people are even closer to the edge.
So I think the law is intended to protect the people who pay their first and last month’s rent, pay their deposit and then suddenly have to move out. They don’t have the money saved for the next place. Now take a 100 unit apartment building with tenants all having the same story. That would absolutely overwhelm most city’s homeless shelters.They wouldn’t have the resources.
That all said, though, I still don’t like this law. I think some kind of cushion that foreclosing lenders have to give would accomplish much more.
One more point in an overly long comment already - Since I posted this initial blog post I’ve read a LOT of economic reports on the coming commercial real estate melt down. I wonder now if this is an attempt to protect against some of the fall-out that is coming soon. Apartment buildings are commercial real estate and are going to get caught up in this same turmoil. But it’s not businesses that are affected, it’s families this time.
Here in MA, banks are not bound by the leases on rental properties when they foreclose, and they like to have them empty because they don’t want to be landlords and it is easier to resell them. So they kick the tenants out right away, usually by offering them money (“cash for keys”) to get them out.
In heavily hit neighborhoods, you can wind up with half the buildings vacant and unmaintained, and that doesn’t benefit anyone.
There is a law in the MA legislature now to prevent tenants from being evicted in a foreclosure if they are paying the rent, and to prevent the banks from raising the rents to drive them out. This last part of course has one of the nuttier landlord groups screaming “RENT CONTROL!!!” to anyone who will listen.
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Charlie
This is all a matter of state law. CA already passed laws that require renters be given 60 days notice AFTER foreclosure that they need to vacate; rather than 5 days…and it is about to be passed to 90 days. Also, law being considered that require lenders to HONOR leases, and/or accept rent from tenants that is fair market….. we’ll see a lot more of these kinds of laws being passed to protect renters who pay.
Commercial financing is often done with balloons that force refinancing every several years. While commercial properties are appraised using comps, replacement value and income approaches, it’s the income approach that drives the bus.
The amortizations can be as much as 25 years but often the loans terms are only 5 years with balloons. So if you are a commercial property owner and have higher vacancies due to tenant job losses, then the income needed to refinance won’t be there to support an income based appraisal. That could easily create more upside down situations where more is owed than the property is currently worth.
Can you say pop!