THE NEXT STAGE OF THE FORECLOSURE CRISIS

Victoria Morales, Esq.

Rodolfo Gil, MBA

June, 2016

Is there a business opportunity hidden somewhere?

In the U.S. as a whole real estate prices are going up. (1) Does this mean that there are profits to be made? How?

One alternative could be, if one was prescient enough to act about two years ago, by cashing out on the increased equity with an equity loan. Naturally for us late comers the point is if that will be happening again any time soon. Perhaps you have noted that the past is as inscrutable as the future and that for instance, in this case, we have little clue as to what made the prices go up so quickly in the last one or two years. But, in any case, if these series of events were to repeat themselves we could profit in several ways. By purchasing and holding for a while and then selling? Sure. Only, again, doubts abound. For instance, do we know if the rate of price increase will be enough to make this an interesting idea? What is an interesting idea?

It would be very helpful if we could, somehow, understand the place that, as a community, we have come to inhabit regarding the housing market. And, also, if because of this knowledge, we could map the territory of our options and proceed therefore with the best probability of success. But the path of life is not easily visible and our next step is always taken with a mix of uncertainty and hope.

The question is, of course, if there is a way to have a profit out of the housing market. And the answer is not easy, because the infamous crystal ball is clouded. If nothing else, prices are increasing. Take a look at the chart "Existing Home Sales (EHS) Median Price".

To contribute to this answer I have tried to write a few comments on the state of the housing market, and the ways in which people are nowadays trying to make a dollar, or, for that matter, to save a dollar in this market. I have tried to see if these ideas are valuable or, more precisely, what their value is. What

To cut to the chase let me say right away that the main way in which people are trying to have a profit in the housing market is by purchasing and renting.

There are deep reasons why this is the main thing happening regarding expectations, but two of the most important are consequences of something else that happened in the recent past. The cost-benefit relationship between rent and purchase has been skewed towards purchasing for a while. It is cheaper to purchase that to rent. But, not just by a little bit. Rents increased powerfully as the community’s preference moved towards renting. After 2008, few had money to purchase or the willingness to acquire that risk.

But also, to own renting property is such a desirable goal is because it can be made. Now it can be made. A few years ago it was not that easy. Not only interest rates have continued to be very low, but there are now lending programs that accept borrowers with less than perfect stories. Or, for that matter, borrowers with a risk profile that would have not let them own investment property just a few years ago.

But this is just one idea. Our question is if this is a safe alternative to make money and if there are other. Can people make money purchasing investment property and renting it? How risky is it? What else can we do to make a buck?

The health of the housing market

The question for the business alternatives in the housing market has another side. It implies the question for the health of the housing market. Is the market recuperating? Or is it still so sick that the activity symptoms that we see are no more than the exertions of a sick body?

How can we know if the increase in prices that is occurring is only a freak thing and does not mean that the market is in better shape? This point of view is not strange to our recent history. One of the most popular explanations of the price increases in the last two years had investors from abroad as main cause. In that story these investors came from Chicago, New York and Brazil, and now that this last country found serious economic turmoil the influence on prices here in the U.S. stopped.

This type of explanation has expanded to include communities located far from the main urban concentrations. People have been buying, the story goes, extensively in communities where prices were still depressed in 2014, as the Treasure Coast in Florida. Prices began increasing very rapidly and mostly this opportunity got exhausted during 2015 as inventories dried up.

Still, when we are trying to ponder the health of the housing market there is still another aspect that is present in the questioning: is the housing market morphing? And if it is, then into what is it morphing?

Strange as it seems this question is also in our collective consciousness. For instance, it could be that the market is going back to 2006. And if for a while it displayed moderation, increased regulation and constraint as its characteristics, now is back to unrepentant tricks. Behold this: now, stated income loans are back, to mention just one thing. If you don’t know what are stated income loans you are missing out.

Therefore, when an entrepreneur is trying to accomplish the purchase of a property at a low price, to flip, let’s say, be that at a foreclosure auction, or from a delinquent owner directly, in his mind he is hoping that another freak push will keep prices going up.

Who are you?

In trying to understand the health of the housing market and the possible business ideas associated with it, it helps to first acknowledge that the market is composed of different participants whose fates are dissimilar.

This acknowledgement seems to be the basis of the understanding of the state and development of the housing market. When we break down general ideas, ideas that cover the whole spectrum of the market, into pieces, some aspects begin to be more evident. The community is composed of different parts and those do not move together, or at the same time. Different folks inhabit different situations and it is in those places that the opportunities lie.

Of course the main participants in the housing market are the usual suspects: home owners, banks, home owners’ associations, Fannie Mae and Freddy Mac, the investors, and so.

The point is that some of those encounter favorable conditions and develop under circumstances that favor them, while the opposite happens to some other participants under the same conditions.

Then, if we find in our research clear cut conditions and circumstances, present in the current state of the housing market, we can risk an interpretation on who will benefit; and if we see sectors profitably pushing forward, we can risk an interpretation of the conditions and circumstances that have affected them.

Who is benefiting from the existing conditions?

Realtors seem to be part of this group. For instance, if you are a realtor it is good news that sales of existing omes are increasing. Right?

Take a look at the chart “Existing Home Sales (EHS) Total Sales Annual Rate”. (2) What

What do we see here? Is there a reason to abandon all other projects and to become a real estate agent? Based in this chart only, the answer to that would be, no. Because even when prices are increasing, sales of existing sales are not. Or, at least, not so much. A caveat is that this is only partial information. But it is not false and based on it we know that sales of existing homes are increasing very slowly. The information goes back to April of 2012.

Are lenders benefiting with the current situation? I don’t think so. If you are a hard money lender, for instance, and your business is to finance for short periods of time people purchasing properties with raw cash, and trying to catch in this way a fleeting opportunity, are you profiting from the existing situation? Some hard money lenders used to charge an interest rate upwards of 20%, but now it is a little more difficult to find clients for that type of product. Why? Because the higher interest rate for private loans in 2009 or 2010 was associated with credit scarcity, and that has changed.

Are sellers able to profit from current conditions? Not all, I would say. If you own a condominium in a community whose association has had trouble qualifying with Fannie Mae, and therefore you are considering a seller’s financing of 80%, for instance, a few questions may pop into your mind. Who would know how to draft the note that you need? Can you sell the note afterwards and is there a secondary market for these notes? What is the higher price that ou can charge the buyer and the lower discount that you would pay the note buyer? These are legitimate questions for this seller that definitely has a problem.

Another chart illustrates a different point. Take a look at the following chart “Total Existing Home Sales, Percent Change Year-Over-Year”. (3) What

In it we appreciate that, if the information is broken down by month the fact that sales of existing homes have not been very strong these past few months becomes more visible.

In November of 2015 there was even a decrease. Is this favorable to purchasers? Are prices being kept low by the will of some powerful agency?

So, are buyers benefiting from current conditions? If somebody is looking to purchase a property, is this a good moment? And, if it is a good moment, how much will it last?

Or, are debtors in a better position now than a few months back? For example, let’s assume that somebody is trying to have a loan modification. Is the current situation favorable? To qualify for HARP, to mention just one instance, is not simple, and if you want to prove hardship to qualify perhaps you need to put yourself in a position that is not convenient in other respects. So, again, under what circumstances present and future, is this a good idea?

Institutional Answer

Let’s narrow our scope a little and talk about the consumers. As a matter of fact, the question that we are trying to place in this paper is related to them. But more than that, I think that the clue to understanding the current stage of the housing market crisis lies with them.

As people struggle to move forward and reach a new position within the existing circumstances, we can recall that the housing crisis was initially a housing bubble and that it has been argued that one of the functions of it was to provide additional income to the impoverished middle and lower classes. (4)

For a while additional income was a reality as families flipped houses happily or moved to bigger dwellings or purchased houses when in the past they had simply not been able to do it.

When the carrousel stopped, consumers paid dearly.

But, what else happened? Where are consumers today?

The best way to analyze this seems to be to understand the institutional response to the housing crisis. Because the response has been in great part directed to consumers, we can summarize the stages of the crisis following their responses.

The three stages of the foreclosure crisis

We have had foreclosure lawsuits associated to the big real estate boom since 2008. But the way how these lawsuits have been handled has changed overtime. Different ways of handling foreclosure lawsuits have corresponded to changing conditions between the financial institutions and the borrowers in default, mainly, but they include also the courts and the initiatives pursued by government agencies. Several important events have affected the movement of the crisis and its resolution and we must strive to understand them to better steer our actions.

Take a look at this chart published in the website of the Florida Courts (5), “Real Property / Mortgage Foreclosures. Case Filings and Dispositions.” What

It shows that the number of foreclosures began to increase and reached a peak in 2008 – 2009. After that new cases entering the courts started to decrease to the point where increments in foreclosures were smaller than the dispositions and the backlog of pending cases in the Florida courts began to decrease.

At the beginning of the crisis in 2008-2009 the number of pending cases was approximately 400,000 in Florida. he number of cases was growing so rapidly there was no capacity in the judicial system to process the cases at the same pace they were coming in.

The financial institutions started piling foreclosure cases in the courts as the borrowers defaulted. Cases began to accumulate and the panic of the first months worsened the delay. But at the same time, in a case of birds shooting the shotguns, the first reaction of the debtors was to challenge the creditors.

In these circumstances one of the most favored strategies was called ‘foreclosure defense’, as we all know. This was, in its most simple explanation, a set of initiatives directed to scrutinize the validity of the position of the creditor. Some people explicitly tried to simple delay the outcome of the lawsuit by whatever means they could devise.

This was the moment when people stopped paying, or moved out of the property without giving any thought to the fact that turning up the property to the bank in some cases was not enough to extinguish the obligation.

This was the first leg of the foreclosures crisis.

Foreclosure Defense

The first response of consumers to the crisis was a strategy called ‘foreclosure defense’.

From a very general perspective the most frequently mentioned strategies to deal with these situations were, and still are, foreclosure defense, short sales, loan modification and bankruptcy. Of course, there are multitudes of variants and cases that do not fit into this classification. But the point that I am trying to make is that foreclosure defense as a strategy, in itself, expresses better than the rest the essence of the moment.

That was the most frequent strategy used by lawyers and their clients to respond to the initial challenges of the crisis. It consisted in a group of tactics directed to challenge the creditor’s position, and, if possible, to weaken it. Several of these tactics were based on the necessity to verify the credentials of the entity filing the lawsuit and the appropriateness of the documentation. In the first years of the crisis it was somewhat frequent to find that the creditor’s documentation was not complete. In the second stage of the crisis this was changed, but for several years the situation did no change.

Even loan modifications, in this early stage, were part of a foreclosure defense program and if they were not successful in bringing down the terms and conditions of the loan, at least they were in delaying the outcome of the foreclosure.

Loan modifications and short sales are aimed to obtain a decision favoring the borrower. They are a request presented to the bank, the finance companies and the investors. They represent a request to forgive some of the terms and conditions of the original loan. The borrower requests that the duration of the loan be extended, for instance, making the monthly payments correspondingly lower. Or the borrower requests that a lower interest rate and APR be applied. Or, she requests that the principal of the loan be decreased, and the bank puts in its books a loss of some sort.

Because some of these measures are difficult for the bank to accept, for instance to account for a loss in their books, there are several government programs that provide assistance and try to alleviate or speed up these negotiations.

But the public know little about these programs and often expect much more that what the program is designed to deliver. For instance, the Home Affordable Modification Program (HAMP) is one of these initiatives. This program was crafted by the U.S. Treasury, FDIC and other parties. It is meant for homeowners that have fallen into hardship and find difficult to make payments on their mortgage. It is intended to help homeowners stay in their homes. The homeowners need to prove hardship, and that have defaulted on the mortgage payments or that are in risk of defaulting. But they also need to prove that with a little help they can put everything back in order.

Not only is this a very narrow line for somebody to navigate, but some people interpreted that the applicant needed to have defaulted already. Now, that presented a problem for the homeowner. If the homeowner needs to default to qualify, instead of being on the brink she is now over the edge.

In any case, the characteristic of this first stage of the housing crisis, from this point of view, seems to have been a strong difficulty to resolve the issues at hand. Neither the lenders, the borrowers in default or the government agencies involved were very successful in advancing the important issues with which they dealt.

The second stage

As we see that in those circumstances very little of substance was happening, it is also natural to expect that something had to give. It was not that the worse part was being imposed on the banks and lenders. Those entities were without a doubt in very bad shape, but also the debtors were unable to find their feet in that mess. Credit standards were deteriorating, the financial system was stopped, production and consuming were affected and in sum the system was clogged.

Around June 2013 several things happened and one of those was the new foreclosure law. In the summer of 2013 the Florida Legislature passed and the Florida Governor signed on June 7 of 2013, laws that changed how foreclosures were handled in Florida.

One of the most important things addressed by this law was the requirement for appropriate documentation.

In Florida Statute 702.015 Florida banks are held to a duty of providing the courts with proper, valid documentation in support of their foreclosure lawsuit.

It had happened that some of the lenders had not paid the attention necessary to the accuracy of the documentation that supported their claim and many had been dismissed due to that fact. The new law required documentation to be presented in a certain way by the lender. It took a little while, but the banks and other lenders soon catch up with the court requirements. A consequence of this is that nowadays it is not so easy to find a gap in the plaintiff argument and, therefore, the delaying tactics of the “foreclosure defense” are not so helpful anymore.

Some other things happened also at this time. What

The backlog in foreclosure cases was analyzed in the following report: Foreclosure Backlog Reduction Plan for The State Courts System. Recommendations of The Foreclosure Initiative Workgroup April 10, 2013. (6)

In this plan there was a request to increase the courts’ budget to $35,019,015 over the three fiscal years of 2014, 2015 and 2016 to “dispose of the current backlogged foreclosure cases and to ensure incoming cases meet state time standards." (7) Budget was increased, more people were hired to help with the foreclosures backlog and more resources were assigned to this task. Now that the backlog is much smaller, some of those resources have been removed, but at the time they made a big impact.

Recently the Foreclosure Initiative Workgroup, a group established by the Chair of the Trial Court Budget Commission released a group of foreclosure statistics reported by the clerks of court from all of Florida’s judicial circuits. From it we obtained this table on the trend of pending foreclosure lawsuits.(8)

It documents the strong decrease in these types of lawsuits and the court’s efforts to deal faster with the backlog of foreclosure lawsuits.

Another thing that happened about those times was an increase in cash purchases of properties and investor purchases.

Out of nowhere, one could say, there appear hordes of investors purchasing properties at depressed values in Florida. Companies and individuals from up north and foreign countries readily purchased properties at court auctions helping the initiatives to get rid of the old cases. But also these purchasers started to bid on houses either on the early stages of a foreclosure lawsuit or before such event. The house inventory started to diminish noticeably and many transactions were directly cash transactions, without the participation of a bank or lending.

Prices started up and consequently also did rents. Impressed by that recuperation there was the general feeling that the real estate market was back. Building restarted just a little bit.

That was the second stage: the new laws, the increase in court budget, the increase in cash and investor purchases. It was in general a coordinated action to resolve the foreclosure crisis.

Bankruptcy

That is why bankruptcy is such a powerful strategy. But it is often misunderstood.

To begin with, it puts borrower’s finances in order, instead of messing them up. The mess came before. The solution is the order that bankruptcy imposes.

Also important is the type of solution that it provides. It is not that when somebody goes into bankruptcy debts are forgotten. What happens is that an arrangement takes place under which the debtor will get rid of debts in an orderly fashion and under court supervision.

Court supervision is not there to control the debtor. Creditors have also to abide by it and that, for instance if the borrower in default has been the subject of harassing collections, is something that works fully in his favor. The creditors not only have to comply with all the regulations but cannot arbitrarily impose new conditions on the debtor once the bankruptcy is in place.

Both Chapter 7 and Chapter 13 bankruptcy are orderly forms to get out of debt, and that is why conceptually they belong to this new stage where the courts and other instances were trying to bring order to the chaos that existed before.

Important features of bankruptcies were designed and implemented as a tool to bring order and encompass other similar initiatives. Bankruptcies might stop all proceedings against a debtor for a period of time. Some imminent actions might be delayed. This delay can be used to provide a thorough analysis of the debtor’s situation and to produce a strategy to handle the situation.

Most importantly, bankruptcies can accommodate a loan modification initiative. Due to the fact that a short sale or loan modification does not stop the foreclosure, the framework provided by a bankruptcy protects the debtor.

Bankruptcy is not a last resort solution. It is a very reasonable strategy that the courts have devised to help citizens with their financial troubles. It is designed to help. And this is what happened.

The Third Stage: the local markets

After the panorama began improving, there came the third stage. The third stage is the one we are into now. The main characteristic of this stage is that the situation is stabilizing. But the term ’stabilizing’ needs to be explained because here is the clue to understanding the current stage of the housing crisis.

This stage is characterized by an increase in employment, better economics in Florida and the U.S. and in general a bigger push forward.

In the following chart entitled ‘Market Conditions” (9) we see something that is of the utmost interest. What

What we see is something radically different from what came before, something that is a very good augur.

First-time buyers are supporting the numbers. In April of 2016, as opposed to one year before, first-time buyers are increasing, and investors are decreasing. That indicated a prominence of the local markets.

Whatever was the reason of the increase in prices before, now it is beginning to be a process dependent on first-time buyers.

The fact that Cash Sales are approximately the same as one year ago and that Distressed Sales are decreasing, helps to clarify this idea.

That is what ‘stabilizing’ means”: it means that the local markets are rebounding.

The locals, as opposed to the out of town investors, are trying to get back in the game. Families are trying to move out of renting and into ownership again, mainly since leasing prices have sky-rocketed and very often renting prices are much higher that PITI figures (principal + interest + taxes + insurance), for purchasing.

In this stage, loan modifications are moving a little faster and the banks seem to be willing to resolve some difficult scenarios, and lend a hand.

Because house prices are moving up again, sales of foreclosure property at convenient prices for the banks are increasing. Expectations are now that prices are going to catch up with debt owed and that situations where the house is ‘upside down’ will be corrected.

The critical idea of this stage is to put your finances in order and move forward.

Zombie Homes: a gauge of the future

We envision better the character of this third stage of the housing crisis when we look at the number of vacant homes in foreclosure. These homes called sometimes ‘zombie homes’ are abandoned properties in need of maintenance and repairs, that also are in foreclosure. Some were abandoned months or even years ago. These homes are ‘half-dead’, often missing important features that might have been removed as doors or appliances, or simply left to rot. The number of these abandoned houses should give us a gauge on the state of the crisis. If they are decreasing, then we could conclude that the crisis is finally ending.

What happens is that zombie homes are the last trench of the housing market crisis. These are the houses difficult to deal with, the houses that in some cases have been in the foreclosure process for more than two years. They represent the worst of the crisis, many of the most desperate situations. For this reason, as we see each of them being sold, or somehow the corresponding foreclosure ending, we know that the end of the housing market crisis is getting nearer.

And, yes, vacant homes in foreclosure have decreased dramatically in number.

Florida reported the existence of 35,903 zombie homes in January of 2015. (10) They accounted for 32% of all foreclosures in the state, whose total was 109,706 as of this date. (11)

Is this number high or low? In the area of Miami-Fort Lauderdale-Pompano Beach there were 9,560 abandoned homes in foreclosure, at the end of 2014. Is that too low for you? In the area of Tampa-St. Petersburg-Clearwater there were 7,838 zombie homes. What do you think? Is that too high or too low? (12)

One year later, as of April 2016, the number of zombie homes in Florida is 2,467. (13) This is a substantial decrease from the figure for 2015. And the total of foreclosure cases in Florida as of this date is only 77,500. (14) This is also an important decrease.

These numbers help to show that our argument holds. As the abandoned houses in foreclosure decrease so the general situation of the housing market improves. Not because one is the cause of the other, but because both situations move together, the abandoned houses representing a cluster of special problems.

In Conclusion

The housing situation is showing clear symptoms of improvement.

But this will not happen too soon or at once for all types of debt. Taxes and insurance owed, or debts owed to the Home Owner’s Association have to be addressed differently.

The same happens with other debts, as credit cards, installment loans, car loans or other consumer loans.




  1. National Association of Realtors, Summary of April 2016 Existing Home Sales Statistics, at: www.realtor.org
  2. National Association of Realtors, Summary of April 2016 Existing Home Sales Statistics, at: www.realtor.org
  3. National Association of Realtors, Summary of April 2016 Existing Home Sales Statistics, at: www.realtor.org
  4. Raghmuram G Rajan. Fault Lines. Princeton University Press, 2010.
  5. Florida Courts. At: www.flcourts.org
  6. Florida Courts. At: www.flcourts.org
  7. “Foreclosure Backlog Reduction Plan for The State Courts System. Recommendations of The Foreclosure Initiative Workgroup.” April 10, 2013. At: www.flcourts.org
  8. “A Closer Look at Florida’s Foreclosure Statistics in Light of RealtyTrac’s U.S. Foreclosure Report.” At: www.flabusinesslaw.com/litigation. April 2, 2015.
  9. National Association of Realtors, Summary of April 2016 Existing Home Sales Statistics, at: www.realtor.org
  10. John Hielscher. “The Zombies Still Haunt. Zombie homes still haunt our market.” At: www.heraldtribune.com. February 23, 2015
  11. FY 2014/2015 Foreclosure Initiative. Number of Foreclosure Initiative Pending Cases by Circuit. As of April 2, 2015.
  12. John Hielscher, Ibid
  13. “Vacant ‘zombie’ Foreclosures Decreased 30 percent in Second Quarter of 2016 Compared to a Year Ago”. At: www.realtytrac.com
  14. FY 2015/2016 Foreclosure Initiative. Number of Foreclosure Initiative Pending Cases by Circuit. As of April 7, 2016.