Can the Feds Save the Housing Market?

An ambitious new program would transform foreclosed homes into rentals. But will it help the cities that need it most?

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Reuters

Zeke Morris spends his days roaming the south side of Chicago managing foreclosures. As an agent working with real-estate owned (REO) properties, his job is to match these vacant houses with buyers. In some of his neighborhoods, investors are swooping in to nab the properties, renovating them to quickly turn them around or holding them tight in the hope of a market improvement.

But in other neighborhoods, like Englewood and Bronzeville - areas brimming with foreclosed homes - they just aren't. “It's tough to get an investor to go there,” Morris says.

The Obama Administration wants to give these investors a good shove. At the beginning of the month, the Federal Housing Finance Agency took the first official step in a plan circulating since the fall: allowing investors to buy pools of foreclosed homes backed by the government and turn them into rental units.

By pooling the properties, the FHFA hopes it can move these homes off the federal books in bulk. The pilot phase deals with homes held by Fannie Mae, the mortgage giant in government conservatorship, but the plan aims to expand to properties backed by Freddie Mac and the Federal Housing Administration.  

In theory, shifting the estimated 215,000 houses these agencies hold nationwide to the rental market would have the dual effect of lifting sinking home prices and lowering rising rents.

Skeptical economists have questioned the projected impact of the program. But there’s a bigger question beyond how the plan would affect the housing market: Will it work in the cities it was designed to help?

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As the plan gets off the ground, city governments remain uncertain of what their role will be. And on-the-ground realtors and housing experts are unsure whether cities will really be able to lure investors into notoriously blighted neighborhoods, like Chicago’s Englewood.

The metropolitan region with the largest pool of these REO properties is Atlanta. In a white paper [PDF] soundly endorsing the program, the Federal Reserve suggested Georgia’s largest city would be a prime target. But the sprawling metropolis has a diverse housing market that will surely complicate the plan.

Residential rental vacancies in Atlanta are above the national average for major cities, for example, which means there isn't a huge queue of Atlanta residents lined up to rent. And the federal government’s plan is so nascent that the real estate community is uncertain of its potential impact. “We don't understand the details,” says Nancy See, the President-elect of the Atlanta Board of Realtors. “I don't know how investors would react right now.”

A recent report from the Federal Reserve Bank of Cleveland walked through potential problems with the plan in weak market cities like Atlanta. The ritzier parts of these cities, where renting is attractive, don't overlap with areas packed with REOs. Foreclosed properties are often bought briskly, flipped, and then, within a few years, returned to vacancy. 

"In Atlanta and Cleveland," explains Dan Immergluck, an urban planning professor at the Georgia Institute of Technology, "just bringing these investors in may exacerbate blight."

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But other cities could see a boost from this plan. In Los Angeles, where renting is popular, the program may ease the rising costs of living by increasing the number of viable rental properties. And it may help Phoenix, the metropolitan area with the fourth highest tally of government-backed REOs. Foreclosures there, while plentiful, are less concentrated in tight patches. Local investors are active and the rental market is heating up. At the end of 2011, the rental vacancy rate hit 10.9 percent, a sharp decline from three years ago when 1 in 5 rentals in the city were empty.

Deirdre Pfeiffer researches housing at Arizona State University, and lives in a converted rental unit in Phoenix. She believes the program can be a success there, although it depends on the degree of maintenance and oversight. “People who are investing in foreclosures now,” she says, “have [not all] been landlords before.”

That points to a concern that city officials and real estate professionals bring up again and again: compliance. Some foresee an influx of absentee landlords. Peter Strazzabosco, spokesman for the Chicago department housing and economic development, notes his fear of “irresponsible investors” flooding the program.

On the flip side, realtors are concerned that compliance loopholes may dampen investment. Converting vacant parcels into rental units is costly, particularly with dilapidated properties. Brian Bernardoni, government affairs director of the Chicago Association of Realtors, details how city ordinances can quickly add to these costs if buyers unknowingly skirt building or rental codes."The penalty provisions are pretty serious," he says.

Bulk buyers will also have to grapple with different compliance laws across and within cities. "They will have to wait, sometimes months, for cash-strapped and under-equipped municipalities to inspect the homes," write the authors of the Cleveland Fed report. For many investors, the potential costs may be too steep.

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Finding willing investors and reliable landlords is a responsibility that will mainly fall to cities. To make the plan work, city officials, realtors and community advocates agree that local investors need to be involved in the purchasing and rental conversion - they know the real estate market and the political terrain. With the banking and mortgage market rapidly lining up behind rentals, large investors will have little trouble finding financing. It’s financing for smaller investors that housing observers are concerned about.

Some cities will have to grease the wheels if they want local investors to sign up. Chicago would likely need to waive water bills and forgive some property taxes, Bernardoni says. But it also needs to balance these subsidies with the end goal of the program: moving vacant eyesores onto the city tax rolls.

Right now, though, most city policies aimed at foreclosures are focused on owners, not renters. "In our direction from the Federal agencies," says Rob Sherwood, a spokesman for the Phoenix mayor, “the stress has been on homeownership.”

This structure doesn’t lend itself too well to the huge need for quality control in the FHFA plan - making sure that new rentals don’t slip back into vacancy. For a feasible REO-to-rental program, the Obama Administration should partner with cities to get these controls in place, argues Immergluck.

Yet the program arrives as local government are stretched thin, and cutting back. “Local governments really aren't prepared,” he says. “The problem is that you give them these resources, but they don't have the staff.”

Photo credit: Lucy Nicholson/Reuters

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