Mass. Survey Finds Nearly One-Quarter of Distressed Homeowners Obtain Loan Modifications

An intriguing new survey by the Massachusetts Association of Community Development Corporations finds that nearly one-quarter of homeowners facing foreclosure who sought counseling were able to obtain a loan modification from their mortgage lender. Drawing from 1,143 people who have sought assistance from non-profit agencies providing housing counseling, the survey also contains information about the percentage of successful resolutions, an overall satisfaction rating by counselors, and a letter grade.

An interesting study would compare these results with people who have not sought assistance from a counselor to measure the role of this assistance. I’m also curious about the nature of the loan modifications. Nonetheless it presents a window to what’s happening at the local level - thousands of homeowners facing hard choices and negotiating with lenders to find solutions.

> Boston Globe: “Lenders graded on response to troubled homeowners”

The Economics of Redevelopment

The photo above is a beautiful sight. No mere pile of dirt, the picture shows excavation for the foundation of a new house in a formerly vacant lot. Located at 1502 10th Street NW, the lot has been vacant at least as long as I’ve lived nearby (2 years) and most likely much longer. Although estimates range, the city of D.C. has thousands of vacant buildings and lots (the official list of buildings alone has over 3,500). Many other cities have much more - roughly 30% of the land of Detroit is vacant. While perhaps some should be reserved for public use, much of this should return to residential and commercial uses.

Holding aside the related issues of housing cost and neighborhood change, redeveloping vacant property in the center city is a good thing. The address discussed here near public facilities, served by public transit, and served by existing infrastructure. It’s also located close to jobs, and it’s a safe bet the future tenant will drive very little, if they own a car at all. It’s smart growth.

Up the street, another long-vacant property is being converted into housing at the corner of Q and 9th. Neighbors celebrated when a property owner evicted a used car lot at 9th and P, posting a large banner advertising the land for sale. Through a rough economic analysis, I argue these events are related. Vacant property is being developed in this part of Shaw because housing sale prices have reached the cost of construction.

My simple model of redevelopment is this: residential development will happen on vacant land when it can be sold for more than it costs to construct. I assume land costs and taxes are sunk costs, and land owners are rational and build when they can make a profit, not speculators. Luckily both sale prices and building costs are available. Let’s see how the numbers work out. (For simplicity I’ll discuss home and condo sales, however from an economics perspective the reasoning should also work for rental properties through a net present value calculation.)

Sale Prices

A review of recent sales (I used Zillow.com) in the Dupont Circle neighborhood finds sale prices ranging from $500 per square foot to over $710 per square foot for homes and condominiums. Conversely, recent sales in eastern Shaw are less, ranging between $303 per square foot for a property on 7th to $502 per square foot for a condo at 6th and Q. Although there is some variation in each neighborhood, sale prices generally follow a pattern when measured by the square foot.

As for our property, just up the street at 1516 10th Street, a 756-square-foot condo sold in 2005 for $332,000, roughly $439 dollars per square foot.

Zoning

Zoning determines how much housing can be built on our lot. The parcel, measuring 1,285 square feet, is zoned R-4, a standard residential zone in the district for row home neighborhoods. Here’s the summary of what the zone requires:

Permits matter-of-right development of single-family residential uses (including detached, semi-detached, row dwellings, and flats), churches and public schools with a minimum lot width of 18 feet, a minimum lot area of 1,800 square feet and a maximum lot occupancy of 60% for row dwellings, churches and Flats, a minimum lot width of 30 feet and a minimum lot area of 3000 square feet for semi-detached structures, a minimum lot width of 40 feet and a minimum lot area of 4000 square feet and 40% lot occupancy for all other structures; and a maximum height of three (3) stories/forty (40) feet. Conversions of existing buildings to apartments are permitted for lots with a minimum lot area of 900 square feet per dwelling unit.

Note the actual lot size is smaller than the zone’s “minimum” size, this is typical for historic neighborhoods. I’m not sure if this affected the owner’s actual lot occupancy, but I can find no mention of the property on the Board of Zoning Adjustment website. It was subject to historic preservation review but the report does not mention the planned lot coverage. If we assume the owner is allowed the 60% coverage, that results in a building footprint of 771 square feet. Multiplied by the allowed height of three stories we get 2,313 square feet for the new building.

Building Costs

Costs of construction can vary depending on a host of factors and the design and character of the structure. The RSMeans website provides a free calculator for zip-code specific costs for various types of buildings. Each estimate includes the building cost, contractor profits, and architectural fees. Using their free cost estimator, I estimated the cost of a 2,313 square foot wood frame apartment building. The estimates ranged from $806,766 on the low end to $1,120,508 on the high end. Recently contractors have been affected not only by increased costs of gasoline, but also increasing costs for metals, piping, and other raw materials. Furthermore, the historic preservation review process may have resulted in additional architectural fees.

Adding it Up

If the new house sells at $300 a square foot, the going rate for condos farther east in Shaw, the property would net $693,900, over $100,000 below RSMean’s lowest cost estimates. At $400, the property would bring in $925,200, and at $500 the property would be worth $1,156,500. Although the calculations are rough, they do seem to corroborate the theory. According to the RSMeans estimate, housing cannot be profitably built in the neighborhood at $300 a square foot, but at $500 a square foot a small profit looks possible. Of course, there are a host of variables that can make housing profitable in neighborhoods with lower prices, including the greater economy of larger buildings and public subsidies like tax credits. Nonetheless, the exercise serves to underscore the role of construction costs in neighborhood investment patterns. If you’re wondering why nothing’s happening with vacant land in your neighborhood, get calculating. Or ask a developer, since they would likely know best.

Subprime Mortgages and Race

The map to the right shows the overwhelming majority of subprime loans and foreclosures in New York City have been in minority neighborhoods. (Created by NEDAP via NY Times) The map tells an often-overlooked fact: the subprime crisis has hit minority neighborhoods harder than white ones.

The banking industry sometimes claims the differences in lending between whites and blacks and Hispanics are due to differences in credit and income. Although income plays a role, last year the New York Times reported that after controlling for the size of the loan and income of the borrower, blacks were 2.3 times more likely and Hispanics two times more likely than whites to have a high-cost loan. They cite the example of two neighborhoods in Detroit, both with median incomes around $50,000 — 70% of loans in the black neighborhood had high interest rates, while only 17% did in the white neighborhood.

Another study found that homeowners in upper income black neighborhoods (income above 120% AMI) were twice as likely to have subprime loans as homeowners in low-income (income below 80% AMI) white neighborhoods. Almost 40% of the loans in the affluent black neighborhood were subprime, versus 18% in the low income white neighborhood.

One article (PDF) thinks it is precisely that statistic that suggests something more - whether discrimination or a simple lack of prime lenders — is to blame:

The finding that upper income African-American borrowers rely more heavily on the subprime market than low-income White borrowers suggests that a portion of subprime lending is occurring with borrowers whose credit would qualify them for lower cost conventional prime loans. There is also evidence that the higher interest rates charged by subprime lenders cannot be fully explained solely as a function of the additional risks they bear. Thus, a greater presence by mainstream lenders could possibly reduce the high up-front fees and interest rates currently being paid by residents of low-income and minority neighborhoods.

The Times speculates in addition to a lack of prime lenders, other reasons could include aggressive sales in minority neighborhoods, less financial saavy, and lower net worth of minority lenders. Regardless, the stark numbers show that while the worst redlining may be behind us, the problem of equitable housing finance for urban neighborhoods still eludes us.

> NYTimes: What’s Behind the Race Gap?
> W. Post: Subprime Mortgages and Race
> HUD: Subprime Market Growth and Predatory Lending (PDF)

The Equity of Housing Tax Benefits

The wide-ranging housing bill recently passed by Congress includes a program to help homeowners avoid foreclosure, money for community development, and other measures. One of its important provisions is a one-time tax benefit of $7,500 (or 10% of the home’s purchase price, whichever is less). Unlike many of the existing tax benefits of home ownership, there’s an income limit and the benefit must be repaid, although without interest. The income limit is $75,000 for singles and $150,000 for couples.

The National Association of Realtors explains the the pay-back requirements:

It is not a full credit because you do have to pay back this amount over a 15 year time period from the second year. The payback provisions also have many conditions, which we are further researching. But in the worst case, you would need to pay back the $7,500 over a 15 year time span from 2010. So in your 2010 tax filing, you would need to pay $500. Even in the worst case scenario of paying back the tax credit fully over a 15 year time span, the tax credit is still a huge benefit to homebuyers. First, money today is worth more than money tomorrow - far more than money 15 years from now. Money loses value over time due to inflation and from the interest income one would receive on that money before fully paying it back.

Let’s take a look at the effects of the existing homeowner tax benefits.

This 2004 report from the National Low Income Housing Coalition has some interesting analysis. This graph breaks down the estimated size of the various housing tax benefits, including the mortgage interest and property tax deduction and housing capital gains exemption. They point out these three benefits were more than double HUD’s total outlays in 2004.

The particularly interesting things about these benefits is how deeply regressive these benefits are. When housing programs and tax benefits are factored, we spend 2.2 times more money on housing for the richest two-fifths of the population than the poorest two-fifths. The richest fifth of society — with incomes above $86,585 in this 2004 report — get over $50 billion in benefits.

Since the benefit is something of a sacred cow, I don’t expect it to go away anytime soon. We should just keep them in mind when debating funds for affordable housing or the equity of congestion charges.

> National Low Income Housing Coalition: Changing Priorities: The Federal Budget and Housing Assistance 1976 – 2005
> USAToday: Housing rescue bill may fall short; Who benefits?
> The Tax Foundation: Who Benefits From the Mortgage Interest Deduction?

Preventing Another Subprime Mortgage Crisis

I think this article describes the origins of the mortgage crisis as good as any, and outlines the drawbacks of any bailout. However, I’m interested in the root of the problem. What can we do to minimize the number of foreclosures to begin with?

First, a bit on where we are. Although hard facts are hard to come by, the best data indicates the subprime crisis will continue through this year, and perhaps longer. This chart from an IMF report shows that the majority of subprime loans resets will have ended, but the next three years the rates on a number of option adjustable rate and alternative (”Alt-A”) mortgages will also reset. Although considered better quality than subprime loans, option adjustable rate loans can feature increasing minimum payments if borrowers have been choosing to pay the minimum. The worsening economic picture won’t help, and the dry language of the IMF puts it this way: “borrowers experiencing payment difficulties are expected to have fewer refinancing options, since falling house prices reduce the amount of homeowner equity, while tighter lending standards limit the range of mortgages available to nonprime borrowers.”

What regulations could be considered?

Some argue greater disclosure requirements are needed. An Ann Arbor attorney complains the HUD-1 form, the standard disclosure form for all mortgages, needs improvement:

While RESPA has standardized the information available in mortgage transactions somewhat through the familiar HUD-1 or settlement statement, much of the information is still very hard to decipher and true costs of a loan are often obscured. The Good Faith Estimate that RESPA requires is toothless since there are no penalties for errors, and is often used to bait borrowers with attractive terms that are then switched into unfavorable, expensive loans at closing.

Barack Obama also proposes additional disclosure requirements through something he calls a Homeowner Oblication made Explicit (HOME) score, stating “today’s subprime mortgage problem stems in large part from the lack of easy-to-understand information that borrowers receive from mortgage brokers.” His score would

provide potential borrowers with a simplified, standardized borrower metric (similar to APR) for home mortgages. The HOME score will allow individuals to easily compare various mortgage products and understand the full cost of the loan. The HOME score would also help borrowers understand their long-term obligations and would be required to include mandatory taxes and insurance.

Others place blame on brokers who profit from selling mortgages, and propose broker regulations. This report on the racial disparities in mortgage lending describes the problem well:

Brokers do not work on behalf of the borrower or the wholesale lender or investor who funds the loan. Instead they receive compensation from the borrower in the form of origination fees and points, and often they receive an origination fee from the mortgage banker at the time that the loan is funded. A mortgage delivery system wherein brokers are compensated for making loans but have no long-term interest in loan performance is subject to what economists call “principal agent risk.” A broker (the agent) has little or no incentive to worry about whether the information presented in the mortgage application is accurate as long as the information gathered is sufficient to cause the mortgage banker (the principal) to fund the loan, triggering payment of the broker’s fees (which is not to suggest that all mortgage brokers mislead borrowers; many work hard on behalf of borrowers to match them with the best product). Without a long-term interest in the performance of the loan, brokers are immune from the potential adverse consequences of both failing to match the borrower with the best available mortgage and failing to provide accurate data to underwrite the loan. Both affect the odds that the loan will default, which can have devastating consequences for the borrower.

The article continues to explain reports show broker-originated loans are more likely to default than retail loans, even after controlling for credit and income. A separate study concluded setting a higher minimum net worth requirement for brokers is associated with fewer subprime loans and foreclosures. Rules regulating mortgage brokers vary widely by state, which may explain why the foreclosure crisis has been so uneven by state, with some states being particularly hard hit. I found this map a striking illustration of the uneven pattern.

However, even while showing that more regulations is statistically associated with fewer foreclosures, the paper cited above showing regulations cut foreclosures warns against possible “unintended negative consequences.” Here’s the crux of the regulation problem — in a quest to maximize home ownership, the federal government has socialized the risk (through mortgage insurance and occasional bailouts) and cut mortgage regulations to push mortgages out to the maximum number of people. Because no market is self-regulating, when lenders go too far taxpayers are left holding the bag in the form of bailouts of banks or the GSEs.

I support more aggressive measures than are generally discussed. Hard limits should be set on the terms of the most usurious “exotic” mortgages, brokers more tightly regulated, and some loans prohibited. The Center for Responsible Lending is rare in their support of prohibitions of certain loans to people with bad credit.

Of course, many argue additional reforms are needed in the financial markets to restrain the market demand for bad mortgages, but this goes way beyond my expertise. What regulations do you think are needed?

O Street Market Zoning Hearing March 6th

The weekly newsletter circulated by my representative on the D.C. Council, Jack Evans, contains this personal plea for community members to attend an upcoming zoning hearing regarding a mixed-use redevelopment of the O Street Market:

O Street Market needs support from residents

The DC Zoning Commission will hold a Public Hearing on the O Street Market project on March 6 at 6:30 pm at the Zoning Commission Office, 441 4th Street, NW Suite 210S.

“I am personally asking those concerned to show support for this important project in the heart of Shaw by attending this hearing,” Councilmember Evans said.

If you wish to testify, you can sign up at the meeting. For more information, contact the Office on Zoning at 727-6311 or Evans’ Shaw liaison, Windy Abdul-Rahim.

The site currently contains a Giant Supermarket, surface parking lot, and abandoned market structure. The developer is asking the Zoning Commission to re-zone the parcel from C-2-A to CR or C-3-C, commercial zones supporting higher density. The official notice generated by the zoning commission contains a description of the request and information about how to testify.

For more discussion of the project see my original post, or this interview where Roadside Development founder Armond Spikell discusses it with DCmud.

Who Wants to Live in Pabst City?

Soon, Pabst-loving hipsters will be able to live in the buildings where the beer they saved was once brewed.

Founded in Milwaukee in 1844, the Pabst Brewing Company’s flagship beer earned its name during the 1893 Columbian World’s Exposition in Chicago, where it was awarded the blue ribbon as America’s best beer. However, economic realities began to catch up with the company in recent years, and they closed their massive Milwaukee brewery in 1996, transferring all production to the Miller company in 2001. However, after decades of declining sales, around 2001 Pabst Brewing Company sales executives discovered sales of Pabst Blue Ribbon were beginning to pick up in unlikely places — cities like Portland, Seattle, San Francisco, and the Williamsburg neighborhood in Brooklyn. The beer’s low price and working class cachet had led to a modest rebound in popularity among hipsters across the country.

From the start, the brewery’s former facility in Milwaukee was eyed for redevelopment. Located adjacent downtown Milwaukee, the complex contains a collection of ornate 19th century buildings almost begging to be converted into hip lofts. The first redevelopment proposal, a $300 million behemoth called PabstCity centered around the conversion of the complex into an entertainment district, collapsed when city officials voted down the subsidies demanded by the developer. The project became controversial in the city as citizens questioned the long-term viability of the plan, and its potential impact on downtown. Since I first wrote about the PabstCity project on this website, hundreds of people looking for more information have found their way to the site from search engines.

A year and a half after the first deal collapsed, real estate investor Joseph Zilber purchased the land and design work for $13 million. He moved quickly to draft plans for a much more pragmatic scheme to redevelop the complex into a mixed-use district with multiple owners. City officials approved the plan last year, and an official groundbreaking was held in January. Although unfortunately isolated from surrounding neighborhoods on two sides by freeways, the project seems on track to become a successful rehabilitation of a unique collection of historic buildings. The project’s first residential building, dubbed Blue Ribbon Lofts, will target low-to-moderate income artists and entrepreneurs. Other buildings will contain offices, shops, and yes, even possibly a brew pub.

> The Brewery Project Website
> Milwaukee Journal Sentinel: Pabst Project Moves Ahead (8/06), Pabst Revamp Coming Together (1/07)
> Undercity: Abandoned Pabst Brewery
> Previously: Pabst City? (2003), Pabst City Project Falls Through (2005)

Photos courtesy The Brewery