Quantifying the Distressed property Market

Distressed Property Defined

The definition of a distressed property is:

A property that is in poor physical condition.

A property that is or will soon be in some stage of the foreclosure process.

1. A property that has an owner who is experiencing a period of financial instability.
2. A property on which the mortgage obligation exceeds its current value, causing its owner to sell.

Current Market Trends

In 2005 foreclosure rates increased on a quarterly basis all four quarters of the year.' In October 2006 over 115,568 properties fell into the foreclosure process nationally which represented a 42% increase over October 2005.² In 2006, there were a total of over 1.2 Million foreclosure filings nationally: This equated to 1 out of every 92 households nationally. In Florida, there was 1 foreclosure for every 59 households. In California, 1 out of 86 and in Colorado, 1 out 4.33." In the first half of 2007, foreclosure activity was up 55% over 2006 with a total of 925,986 filings in only the first 6 months of the year. October is highlighted only because many news outlets and the National Association of Realtors: reported that during this month the market had seen the worst of the subprime mortgage crisis and that “Temporary problems in the mortgage market (were) easing and are expected to free some pent-up demand "⁵ Unfortunately these optimistic predictions did not hold true.

An article on September 5, 2008 on HousingWire.com derailed even more amazing numbers for mortgages nationwide. According to the article, "More than nine percent of U.S. mortgages were delinquent or in foreclosure at the end of the second quarter; as both major categories of bor­rower default activity hit new records."⁶ This number is astounding and only expected to climb as more mortgages reset and homeowners are unable to pay.

According to the industry Web site, Mortgagelmplode.com, the current mortgage crisis has claimed 276 major US lending institutions since late 2006.  Many people are under the misconcep­tion that the majority of these lenders are smaller regional companies. However, major brand names, such as: Wachovia Mortgage, FSB—Wholesale, Lehman Brothers FSB, Chase Subprime­ Wholesale, Citi Residential Lending, Countrywide, Indymac Bank, and more are included!'

The Sub-Prime lending market began to show major signs of issues in 2005. In 2006 mortgage companies and lenders actually began closing and declaring insolvency at alarming rates. These closures were due in large part to the types of loans that were being written by just about every lender in the US. They are also known as the "B or C Paper" marker (not "A paper") and sometimes referred to as 'second chance' loans. It has been said that in recent history anyone with a social security number and a pulse could get a mort­gage. In Florida, Nevada, Arizona and California, the market routinely saw individuals making $50,000 a year purchasing $400,000 properties with mortgages that were almost guaranteed to go bad unless the person could sell when needed and the market continued to appreciate. In high appreciation areas people would purchase a property and refinance it within 6 months only to take a short break and refinance again in 6 months pulling tens and sometimes hundreds of thousands of dollars out of their properties. Even worse, borrowers would buy and sell their homes each year, trading up each time due to the rapid appreciation of the market around them. The availability of funds to potential buyers who could not have previously qualified for a loan grew larger than at any time in history. This increase in the total purchasing power of prospective homeowners drove market prices up with appreciation rates never before seen.

The rapid appreciation of the real estate market created a new category-of homeowner—the "Investor." This person, in an attempt to build personal wealth, purchased second and third properties that may or may not have been generating cash flow, all the while betting their finan­cial futures on continued real estate appreciation. The National Association of REALTORS' reported that in 2005, 4 in 10, or 40% of home purchases, were investment or second homes’. These investors caused a boom in the condo and new construction markets. In high appre­ciation areas like California and Florida, a person could purchase a new construction condo or home, wait for it to be completed, and due to market appreciation, sell the home only 9 months to a year later for a profit of sometimes as much as 40% to 50%.

This mania caused a number of conditions that we are now dealing with:

1. In many areas, property values have plummeted, because of the factors below.
2. Home sales have continued to slow, driving real estate inventories to highest point in 22 years. Nationally there was over 10 month's inventory in November, 2007.¹"
3. Money Magazine predicts that 1.4 million Americans will see their mortgage pay­ments more than double in the next five years."
4. By November 2007, over 63% of the sub-prime mortgages once available have disappeared and this figure continues to increase as more and more lenders exit the market completely.' ²
5. Many borrowers who may have the credit and income to refinance no longer have the equity in their properties due to the depreciation in their homes' value.
6. The decrease in the number of lending institutions has decreased the number of options that buyers have, making it difficult for those now buying a home to qual­ify for financing.
7. In many areas of the country, homeowners who have to sell, are in the position of having to compete with builder closeouts, REO’s, and other distressed properties that are driving down the values

The Downfall

When experts are asked what actually caused the current crisis the range of answers is varied and often emotional and defensive, depending on the individuals' allegiances. It is my opinion that the current crisis was set up by one simple underlying issue—borrowers were allowed to gain mortgages that they were never qualified for.

In fact, CNN Money contributor Les Christie derails in his February 20, 2008 article "Subprime Loans Defaulting Even Before Resets" that of the loans written in 2007, none of which had reset at the time of the article, 11.2% of those loans had defaulted prior to a reset. This indicates that the borrowers could not afford even the low introductory rates offered in order to secure mortgages. Many of these loans were written at 90% or more of market value. The mortgage industry simply could not sustain this level of immediate losses against an overleveraged port­folio and the downward spiral began.

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