Thursday, October 18, 2007

Three-decker Windfalls Cause Worry

Would you pay $355,000 for one floor of the three-decker shown to the right, at 310 Fuller St in Dorchester? That’s how much two buyers paid this year, one in May and the other in July. Even if it turns out the buys are phantom acquisitions, the mortgages for each newly converted unit are real. The documents at the Suffolk County Registry of Deeds leave no doubt there was financing--$337,250 for each unit, from Wells Fargo and Homecomings Financial. Just as real would be any of that money passing on to the owner who sold the units, at least what remains after the cost of repairs and acquiring the whole house. In this case, the entire house was purchased from a previous owner for $585,000. There may have been some renovation before the condos were sold, but there appears to have been a need for a good deal more—at least to attract the buyers who would meet the sale price and lenders who would feel the property had value.

So, what about the value of the units? Mortgage payments, property taxes, water and sewer bills, and a condo reserve fund would easily make for monthly payments greater than $2,200. Unless a condo buyer simply wanted to live in the building, and wasn’t concerned about the fall-off in values (which began well before the units were sold), the purchase might make sense. But, for an absentee owner, the only way to have a chance of breaking even would be to use the unit as a one-floor rooming house.

Despite the credit crisis that took hold after the transactions on Fuller St, three- and six-family conversions in Dorchester have continued, with unit sales continuing into October (though with some fall-off in prices). Some of the buildings look much better than the one on Fuller St, and there are reasons to believe these conversions were preceded by upgrades. But even in converted buildings with upgrades over the past three years, some units have entered the foreclosure pipeline. Some of those have been resold at lower prices. And one was even bought by a developer who played a role in converting the same building less than 15 months earlier. After his foreclosure purchase, he sold the unit again, less than two weeks later, with a mark-up of $110,000.

If the investors doing conversions can make money even from distress, they must be getting help from appraisals. And, during the housing boom into 2005, many parts of Dorchester and Roxbury that suffered the most in past housing slumps were seeing noticeable improvements. But prices for some converted units in those neighborhoods—in one building as high as $375,000 for units purchased in April 2006 (with 100% financing, adjustable interest and a balloon rider) look scary.

If unit loans go bad, that’s certainly a problem for lenders, though not necessarily the ones originating the loans. Among two dozen condo unit loan defaults tracked in Dorchester over the past couple of years, nearly all the foreclosure filings were not by the originator, but by another company holding or servicing the loan. So there’s little wonder that the original lender had little reason to care about the unit-buyer’s ability to repay. And, if it mattered little that the buyer was a hapless would-be owner-occupant with good intentions, it might also matter little if the buyer were a transactional avatar, partly vouched for by a creative appraisal and, in some cases, represented by a proxy granted power of attorney. In other words, instead of targeting real buyers who might be more vulnerable, lenders could, in some cases, be leveraging a trade in the real estate market’s equivalent of “dead souls.”

When loans go bad, there are other repercussions. The fire sale prices for units foreclosed in one building can depress the values next door. As bad loans transmigrate through financial markets, more investors are spooked. And, as lenders get spooked by capital markets, they tighten the reins even on legitimate loans. That leads to a sharp drop in the pool of qualified buyers, which depresses property values even more. While some areas or parts of the housing market won’t feel much of that pain, others will be hit hard.

Housing markets have been through slumps before, only to bounce back. But what has changed since the last cycle is the shift of home mortgage lending from banks and credit unions—regulated by the Federal Reserve Bank and other federal and state agencies—to the much more loosely regulated mortgage companies. During a hearing earlier this week at the Reggie Lewis Center in Roxbury, the chair of the US House Committee on Financial Services, US Rep. Barney Frank, noted the effect of the lending shift away from banks and credit unions.

“If they were the only originators of mortgages,” said Frank, “we would not have this crisis.”

That’s why Frank envisions a new law that, as he put it, “will cover all mortgage origination with the same set of rules.” That would even include the requirements that currently apply to banks under the Community Reinvestment Act. But, even at this week’s hearing, fellow Democrats on the Frank’s committee (US Rep. Stephen Lynch and US Rep. Michael Capuano) acknowledged there could be difficulty getting the regulatory upgrade approved by the Senate and President Bush.

Even if there were new laws to make home mortgage lending less predatory and less volatile, some things cannot by undone by the next upswing in the market. As one housing investor in Dorchester pointed out, conversions of three-deckers weaken the pervasive (if less than universal) element of owner-occupancy that provides stability in hard times. It also appears developers doing the conversions bought some of these buildings from populations that put down roots and added social capital to the community—whether Irish-American, African-American, Cape Verdean, Haitian-American, or Asian-American. It could turn out that unit buyers—if they’re real people to begin with—might engage with their community in comparable fashion. But, for now, there’s reason to wonder.

See also story in the Dorchester Reporter for October 18.