The announcement yesterday that the Obama administration will consider proposals to sell off large numbers of government-owned foreclosed homes is an important step toward a new system of U.S. housing finance. If designed well, this initiative could generate much-needed revenue for the government, expand the quantity of energy efficient, affordable housing to thousands of American families, and create well-paying jobs.
Government-supported entities own hundreds of thousands of foreclosed homes, mostly from mortgages insured before the housing bubble burst. These owners include the Federal Housing Administration, Fannie Mae, and Freddie Mac. Most of these so-called “real-estate owned” or “REO” properties are currently unoccupied and losing value as they deteriorate.
The White House addressed this issue yesterday by releasing a public solicitation for proposals on how to deal with this growing stock of REO properties. Their goal is to reduce the number of foreclosed homes in a way that minimizes taxpayer losses, expands affordable housing, and addresses property repair and rehabilitation needs.
What would such an initiative look like? The administration’s release suggests interest in one particularly promising approach—converting these properties into affordable rental properties, potentially rehabilitating them to make them more energy efficient and thus more affordable to new tenants, and selling them as packages of homes to investors, who would earn a good return on the pool of monthly rental income.
The idea makes sense. In fact, the Center for American Progress put forth a similar proposal a year and a half ago, focused on the growing stock of REO properties owned by the Federal Housing Administration. We encourage the Obama administration to go one step further and fully adopt the ideas laid out in CAP’s February 2010 proposal, “An Untapped Source of Green Rental Homes.”
The idea behind this proposal is simple. There are roughly 290,000 government-owned foreclosed homes facing a market with a limited number of buyers. At the same time, due to demographic trends (such as the projected growth of young households) and the fallout from the housing crisis, there is a large and growing demand for affordable rental housing. Why not convert some of these REO properties into affordable rentals? And while we’re rehabilitating these homes, why not make them energy efficient as well?
Specifically, the CAP proposal calls for the conversion of foreclosed single-family houses into so-called “scattered-site” rental units. The term “scattered site” means that these homes are close to each other but do not share amenities or utilities in the way that, say, an apartment complex does.
The government would pool these houses by location, focusing on areas with especially high concentrations of foreclosures. It would then renovate them, rent them out, and sell these geographically clustered properties to institutional investors as a portfolio of already-occupied rental properties.
There are several benefits to this proposal. First, taking foreclosed properties off the market for a few years should help to stabilize home prices while the housing markets continue to deal with the overhang of excess inventory. This can have a positive effect on household wealth, as more stable home prices mean more stable home finances.
Second, it should help neighborhood stability, particularly in those communities that were hit hardest by the housing crisis. By repopulating vacant, deteriorating homes, this proposal can help to improve the desirability, and thus home values, of the neighborhoods these homes sit in.
Third, the proposal expands the availability of affordable rental housing. This should improve labor mobility and the ease with which the unemployed can move to find suitable work.
Fourth, it puts people back to work. Rehabilitating, retrofitting, and weatherizing homes will create well-paying jobs that cannot be outsourced, helping a construction industry that was hit hard by the recent recession. And the large pool of rental homes will also require workers to monitor and maintain them. Putting people back to work will be as important as anything else in stabilizing the housing markets and ending the foreclosure crisis.
Finally, this proposal can meaningfully improve the energy efficiency of thousands of homes, lowering the costs of occupying those homes, and reducing our dependence on imported fossil fuels.
One key challenge in successfully converting REO properties into scattered-site rentals is that aggregating a number of geographically clustered properties is difficult for investors to do. They would need to identify properties in a certain geographic location and buy them up one-by-one as they came up for sale. The transaction costs and uncertainty associated with this process may be a major barrier to the successful implementation of scattered-site rentals.
But with the federal government holding hundreds of thousands of REO properties, it can overcome this hurdle to scattered site rentals by offering geographically concentrated bundles of homes, which may be more valuable to investors than the collective value of the individual homes that make up these bundles.
To be clear, this proposal alone will not carry the government out of the foreclosure crisis. Indeed, this initiative should be rolled out on a small scale to start to see if it makes a meaningful dent in the problem. But the yesterday’s announcement shows that the White House is on the right track. By turning non-performing assets into performing ones, the federal government can markedly improve the value of the REO portfolio it is sitting on, help get the economy back on track, and improve the energy efficiency of our housing stock.
We would also emphasize that it is critical for the Obama administration to take a big picture view in determining how to best dispose of the government’s REO inventory. In particular, the administration should emphasize housing market stability—particularly neighborhood stabilization and affordability—as much as they emphasize short-term investment gains.
Ultimately, the goal of long-term value maximization must consider both the short-term proceeds that can be gain from the bundled sale of foreclosed homes in various ways as well as the consequences of these options on surrounding communities and the broader housing markets. Policymakers should avoid the mistake of being penny wise, pound foolish. Toward that end, we are pleased to see that the administration appropriately recognizes the importance of neighborhood stabilization and supporting affordability in its solicitation for proposals.
David Min is the Associate Director for Financial Markets Policy at the Center for American Progress. Jordan Eizenga is a Policy Analyst with the Economic Policy team at the Center. John Griffith is a Research Associate with the Economic Policy team.
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