Loan modifications are no longer a borrower's only option to stay in their home. Hedge funds can buy up properties, rent it to the former owners, and offer to resell it back to them when they qualify for a loan. The hedge funds win, the buyers win, and the lenders lose. Perfect.
Irvine Home Address … 7 ROANNE Cir Irvine, CA 92604
Resale Home Price …… $750,000
Party time, going down
you better not mess us around
the stakes are rich, take a hit or stay
the price is high, someone's gonna pay
Looking for trouble, now you've found it
you're a drum and we're gonna pound it
Last one standing wins the fight
hear us scream and shout all night
down on the floor and eat the grit
this is gonna hurt a little bit
Megadeth — Crush 'em
The banking cartel has tied up most of the inventory in California. A third to half of homeowners are now underwater and unable to sell without lender approval. Many more borrowers are facing foreclosure as about 15% of homeowners are not paying their mortgages. The lenders already own many properties. Between what they own and what they control, lenders have withheld inventory and kept much of the air in the real estate bubble.
I think this is shameful. I want to see the lending cartel crushed. Californian's have too much of their incomes going to debt service so Goldman Sachs' investors can make a few more pennies.
I have a better idea.
Short Sellers are reviled
Many people have a negative view of short sellers. They feel that short-selling is profiting at the expense of others. The people who really hate short sellers are owners of overpriced assets.
Short sellers borrow assets and sell them only to buy them back later at a lower price and profit from the difference. Short selling has a very valuable place in financial markets. Without the activity of short-sellers, assets become hopelessly inflated in price, and money that should be freed up for more productive uses is tied up in unproductive assets. For money to be released, the assets must be sold. Short sellers actively sell when no other sellers are motivated, and in selling, they re-balance market prices.
Real estate markets are very inefficient, and part of the reason is a lack of short sellers. Nobody, including the banking cartel, is anxious to sell real estate right now. That simply maintains an overly inflated valuation in the market. The activity of owners buying and renting has not been significant, and that only puts people in a "flat" financial position. What the market needs is short sellers — true short sellers. Until now, nobody has known how to be short real estate. Today, I am going to explain how it can be done.
Hedge Fund Basics
Hedge funds are investment pools formed as a company and managed with a specific investment plan. Hedge funds are generally private capital limited to sophisticated investors. Joe Six Pack is not permitted to invest in hedge funds. There are as many hedge funds as their are investment strategies capable of raising money. Some are very successful, most are not.
Since hedge funds are private investment pools made up of sophisticated investors, they are free to invest in whatever they want within the constraints of law. Many hedge funds invest in real estate, and many are forming now to clean up the debris from the Great Housing Bubble.
Real Estate Hedge Fund Investments
Today we are going to discuss the investment strategy of a mythical company, Cartel Crusher, LLC. Limited Liability Companies are a favored form of many hedge funds because they provide limited risk and all gains or losses are passed through to the individual investors.
Cartel Crusher LLC is real estate investment fund that buys rental properties at auction and keeps them in portfolio to obtain the cashflow from rentals. Last week, in the post, Buying a Rental at Trustee Sale, I outlined the math and analysis required to obtain a rental property at foreclosure auction.
In areas where the subprime foreclosures are common, pricing is 50% or more below the peak, and cap rates range from 6% to 8%. For an investment company like Cartel Crusher LLC, this return is sufficient to bring in outside capital to buy foreclosures. A typical deal would be like the Corona property below going to auction on 3 May 2010.
A property like this one could increase returns and free up capital for more acquisitions by applying 15-year debt at a payment with positive cashflow.
This is the type of long-term hold acquisition that is the ultimate goal of Cartel Crusher LLC.
From Cartel Crusher LLC's perspective, it doesn't matter who the renter is as long as they pay the rent reliably and don't trash the place. The landlord's dream is to find a renter that cares for the place as if it were their own and doesn't want to move out. That is difficult to find, but in the aftermath of the housing crash, a special opportunity exists to find that special renter — the former owner.
Making owners a better deal
Cartel Crusher LLC would very much like to keep the former owner in the property. Note some of the key numbers from page 2 above that are improved by this arrangement:
- Real Estate Improvements.
- Tenant move-out allowance.
- Gross Rent
- Vacancy and Collection loss
All four of those numbers improve by keeping the owner in place. There are no real estate improvements, and no tenant move out allowance when the owner stays in place. Vacancy and collection loss is also eliminated because the owner will stay for the duration (more on that later). Gross rents are also higher and more predictable. These benefits to Cartel Crusher LLC are great if the owner can be persuaded to stay in the property.
Why would an owner do this? Why not get a loan modification?
In the short term, if the owner were to obtain a loan modification, they may be able to lower the payment enough to be competitive with a rental for a while; however, loan modifications are a temporary fix, and the debt on the property is still double what it should be. The only way an owner is going to see a principal reduction is through a foreclosure. There is less opportunity for most owners in a loan modification to have equity because their loan balance is simply too high.
The deal being offered to an owner by Cartel Crusher LLC will give them peace-of-mind on their cost of housing, and if they buy the property back later, the debt will be reduced significantly. Basically, Cartel Crusher LLC is offering owners a much better deal.
Owner stays on as a renter
After the foreclosure, no lender will give the newly foreclosed a loan. There is a mandatory waiting period — recently reduced to two years — when former owners must be renters. When most face foreclosure and walk through this valley of death, they have no idea when, where, or if they will be owners again. Very scary.
Cartel Crusher LLC makes these worries go away. Cartel Crusher LLC will go to auction to acquire the property and rent it back to them, and it will give them an option to buy the property back at a later date at a pre-negotiated price.
For this feeling of ownership continuity, the renting former owner will pay a 5% premium on area rents, plus they will agree to an automatic 2% yearly rental increase. Since this rental payment will be much less than the mortgage payment, the lower cost of housing will be a major financial benefit. If they can't afford the rent, then they are hopeless and need to move on.
Owner gets right to repurchase
Cartel Crusher LLC will establish a baseline value from comparable resales on the date of the sale. The price increases 4% per year. After 10 years, if an owner still has not purchased, the deal expires.
There is one very important condition, the price actually paid for the property is the greater of the number in the chart below and appraised value at the time of sale. If California inflates another housing bubble, this right-to-repurchase can't be exercised like an option to a third party to profit from the difference. If the borrower is unable to get their act together to qualify for a loan and resale values are higher than the numbers above, the benefit of the irrational market exuberance comes back to Cartel Crusher LLC. If values never come back, the owner is certainly no worse off by renting.
Consider the resale value chart above compared to the deal the owner gets from the government or their lender if they get a loan modification. In the Corona property, the debt today is $704,000. If it were an owner-occupied property, the owner would not be above water until 2023. Cartel Crusher LLC would sell it to him for less than his current debt for the next 13 years. And in doing so, Cartel Crusher LLC would make a great return on its investment through rent and appreciation while keeping an owner in their home.
The government can't do that.
The lenders won't do that.
Cartel Crusher LLC will do that.
Busting the cartel through strategic default
The private sector hedge funds have the answer. Any fund operating like Cartel Crusher LLC will be able to keep owners in their properties until they can own again. Since this offer is so enticing to underwater homeowners whose payments exceed rent, waves of strategic default will inundate the land. Owners who strategically default and rent from Cartel Crusher LLC will be short real estate. They will be ditching their mortgage and their higher tax basis and buying the same house back later for a lower price. By selling short, stategic defaulters will rebalance pricing at cashflow levels.
The only thing the owner has to do is stop paying their mortgage. The lender cannot evict an owner from a property for being in default. The only option available to a lender to compel payment is foreclosure, and as we have all seen, they are choosing not to foreclose and allowing squatters to live all over the nation. That's fine. The owner is still living in the property, and they are never going to give the bank another dime. From the owner's perspective, this state of affairs can go on forever.
When the lender finally gets around to foreclosing, Cartel Crusher LLC will be at the auction to buy the property. And since Cartel Crusher LLC has established a higher rental rate and knows there will be no improvement costs, holding costs, cash-for-keys and the like, Cartel Crusher LLC will be able to bid higher than others who will be facing those costs.
There are no guarantees at auction, and Cartel Crusher LLC may not be the high bidder, and the property owner may still have to move out, but with the lower cost structure, Cartel Crusher LLC will bid higher than the rational professionals, and most often that will be a successful acquisition.
The banks could defeat this fund by failing to drop bids. If the bank bought every property at auction, the bank could go out of its way to boot the strategic defaulters out. If lenders go that route, there will be millions and millions of REO properties.
Everyone benefits except the banks
The only party who suffers in this process is the lender, and perhaps the US taxpayer who is paying their losses. The aggrieved party in this instance is the one most deserving of pain, the irresponsible lenders who ruined the housing market and the economy. Screw them. Crush them.
What is best in life?
To crush the banks, see them driven into oblivion, and to hear the lamentation of their bondholders.
Will owners really strategically default in large numbers?
The picture above is taken near Canyon View Elementary School in Irvine. There are two closely-spaced signs that say "no parking any time." They are conspicuous and obvious. Whenever I drive by this location, cars are parked in the street, sometimes two or three of them because this parking spot is adjacent to a daycare center. The illegal parking place is 40 feet from the door. The proper alternative is to drive up the street, turn right, and enter a parking lot about 200 feet away.
Here is what happens: A few parents reason that they are not going to be very long, and it is inconvenient to park in the proper location, so they brazenly park between the two signs. Other parents driving by to get their own children see the lawbreakers obtaining the advantage of their disobedience, so they too decide to park on the street in the no parking area.
After enough parents do this, there is a critical mass where everyone ignores the law and does what is convenient for them, park on the street. At that point, nobody really cares about the law. In fact, those that do the right thing (like stupid me) are playing the fool. Those who follow the law are missing out on the benefit obtained by all those breaking the law.
This is the phenomenon lenders fear most. Once people start to strategically default, and others in the same circumstances see how much the defaulters benefit for their actions, many others will join them. After a time, the stigma disappears, and the final holdouts realize they are foolish not to join the default party and obtain the benefits for themselves.
Once strategic default clears out the debt in one community, the substitution effect will lower prices in nearby communities putting more homeowners in position to benefit from strategic default. Like small outbreaks of lender virus, the spread of strategic default will cleanse the land of its excess debt and put prices at cashflow levels everywhere. Houses will be affordable, borrowers will have manageable debt-service payments, and the California economy will benefit from a citizenry with more disposable income — the real kind, not borrowed money.
Driving the message home
Cartel Crusher LLC will extol the benefits to every underwater homeowner facing foreclosure with high payments. It's a simple message:
Are you facing foreclosure? Do you owe more on your home that it is currently worth? Can you rent a similar home for much less? Do you want to stay in your home, reduce your monthly payments, and cut your debt in half? Cartel Crusher LLC is here to help.
Cartel Crusher LLC will send that message to every house in neighborhoods like the one in Corona where a Notice of Default has been filed. It will get a response. After a few of these deals go through, the floodgates will open up and the inflated property debt will be washed away through strategic default. I will feel good about it.
The Lending Cartel is on notice
This is coming, and there isn't much the lending cartel can do about it. Cartel Crusher LLC has arrived, and it's hungry.
Dogs of war and men of hate
With no cause, we don't discriminate
Discovery is to be disowned
Our currency is flesh and bone
Hell opened up and put on sale
Gather 'round and haggle
For hard cash, we will lie and deceive
Even our masters don't know the webs we weave
One world, it's a battleground
One world, and we will smash it down
One world … One world
Invisible transfers, long distance calls,
Hollow laughter in marble halls
Steps have been taken, a silent uproar
Has unleashed the dogs of war
You can't stop what has begun
Signed, sealed, they deliver oblivion
We all have a dark side, to say the least
And dealing in death is the nature of the beast
One world, it's a battleground
One world, and we will smash it down
One world … One world
The dogs of war don't negotiate
The dogs of war won't capitulate,
They will take and you will give,
And you must die so that they may live
Isn't Cartel Crusher LLC helping out HELOC abusing squatters?
Yes, it is.
The nefarious characters of the housing bubble all deserve to suffer. But I have argued that lenders are more culpable than borrowers in creating this mess. If bailing out a few HELOC abusing squatters is necessary to crush the banking cartel, so be it.
- I can't tell what is happening with this property from the available records, but I do see a purchase for $615,000 on 11/3/2004. The owners used a $492,000 first mortgage and a $123,000 down payment.
- Exactly two months later (the required waiting period), the owners obtained a $123,000 HELOC and got their money out.
- On 7/15/2005 they obtained a $253,000 HELOC.
- On 8/31/2006 they obtained a $300,000 HELOC. Since these are all HELOCs after the first, there is no way to know if the borrower took out the money. But why would borrowers keep enlarging it if they weren't spending it?
- Total property debt is $792,000.
- Total mortgage equity withdrawal is $300,000.
Recording Date: 04/07/2010
Document Type: Notice of Rescission
Recording Date: 02/24/2010
Document Type: Notice of Sale
Recording Date: 11/17/2009
Document Type: Notice of Default
This appears to have been sold short on 25 March 2010, but Redfin shows it as still being for sale.
Cartel Crusher LLC isn't soft on the borrowers
Some investors may feel that the investment plan for Cartel Crusher LLC is not balanced because it hurts only the banks and rewards the borrowers. Perhaps some of the proceeds from crushing the banks could be reinvested in foreclosed second mortgages and other zombie debt to even the score with HELOC abusing squatters. Sounds like a winning combination.
Irvine Home Address … 7 ROANNE Cir Irvine, CA 92604
Resale Home Price … $750,000
Home Purchase Price … $615,000
Home Purchase Date …. 11/3/2004
Net Gain (Loss) ………. $90,000
Percent Change ………. 22.0%
Annual Appreciation … 3.6%
Cost of Ownership
$750,000 ………. Asking Price
$150,000 ………. 20% Down Conventional
5.16% …………… Mortgage Interest Rate
$600,000 ………. 30-Year Mortgage
$158,136 ………. Income Requirement
$3,280 ………. Monthly Mortgage Payment
$650 ………. Property Tax
$0 ………. Special Taxes and Levies (Mello Roos)
$63 ………. Homeowners Insurance
$0 ………. Homeowners Association Fees
$3,992 ………. Monthly Cash Outlays
-$808 ………. Tax Savings (% of Interest and Property Tax)
-$700 ………. Equity Hidden in Payment
$305 ………. Lost Income to Down Payment (net of taxes)
$94 ………. Maintenance and Replacement Reserves
$2,884 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$7,500 ………. Furnishing and Move In @1%
$7,500 ………. Closing Costs @1%
$6,000 ………… Interest Points @1% of Loan
$150,000 ………. Down Payment
$171,000 ………. Total Cash Costs
$44,200 ………… Emergency Cash Reserves
$215,200 ………. Total Savings Needed
Baths: 2 full 1 part baths
Home size: 2,225 sq ft
($337 / sq ft)
Lot Size: 7,705 sq ft
Year Built: 1971
Days on Market: 148
MLS Number: S597813
Property Type: Single Family, Residential
Community: El Camino Real
According to the listing agent, this listing may be a pre-foreclosure or short sale.
This property is in backup or contingent offer status.
Fantastic end of cul-de-sac 4 bedroom pool home. Move-in ready! Close to park on cul-de-sac in desirable Ranch/El Camino neighborhood. Award winning school district. Major interior upgrades and remodeling. Granite counter kitchen with center island, Newer double pane windows. Living room with fire place, formal dining room, family room set-up as theater, master with walk-in closet. Tiled remodeled bathrooms, tiled and wood flooring, carpeting in bedrooms. Ceiling fans, Attached 3-car garage, Gas forced-air heating/AC. cable ready. Easy access to 3 major freeways. Must see to appreciate! No HOA, Low tax rate with NO Mello Roos. Home is highlighted by a large Family room and four bedrooms, all on this quiet street. Custom window coverings, wood floor, crown molding, home also has newer pool equipment and much more.