When Investment Is a Bad Thing

When Investment Is a Bad Thing

In 2008, we saw the dangers of getting real estate markets mixed up with the vagaries of increasingly convoluted capital markets. Allowing the debt on real — historically unmovable — property to be turned into something so illusory led to awful on-the-ground realities; while the credit crisis had far-reaching economic impacts, the sources of the crunch — foreclosed homes bought with subprime mortgages — exist in actual neighborhoods. And, they’re often in clusters, which is even more problematic.

But like you’ve been told by your boss and/or Bush administration officials so many times, the Chinese character for crisis is also the character for opportunity. With so many distressed and foreclosed properties available at below-market rates, the crisis has presented a great opportunity to investors who have the means to purchase and hold onto these properties, and then turn a profit once the housing market rebounds.

For this reason, PolicyLink recently released a report, called “When Investors Buy Up the Neighborhood”. The report uses two distressed neighborhoods in Minnesota’s Twin Cities — North Minneapolis and East St. Paul — as focal points to examine, in incredible detail, the various options municipalities have to prevent unscrupulous investors from having a negative effect on the neighborhoods they invest in. To be clear, though, PolicyLink draws a distinction between scrupulous and unscrupulous investors; they aren’t against investors making money off of the crisis, so long as its done responsibly, with concern for the community.

For example, investors buying a distressed single-family home and turning it into an affordable rental home — not surprisingly — is considered to be one of the better business models. Whereas investors buying blighted properties and sitting on them in anticipation of a “windfall years away” — this is called “mothballing” — has a negative effect on a neighborhood. Responsible investors, and the municipalities that can stand in for responsible investors, have an unfortunate disadvantage when it comes to buying distressed or foreclosed properties: a lack of cash. As the report makes clear, lenders prefer cash transactions to dealing with banks and escrow, and all the other parts of home sales that slow things down. Also, lenders also prefer to sell in bulk, when possible. These two factors make it difficult for local governments and/or responsible investors to do much to intervene in the destabilization of their local housing markets.

I spoke with PolicyLink Senior Associate Sarah Treuhaft over the phone and via email about the report’s findings and suggestions. In Sarah’s words, the report was created to help local governments “put in place strategies and tools that attract positive investor business models – and that deter irresponsible ones”. The report identifies 36 specific strategies grouped into three broader approaches. The first approach is to encourage “homebuyers and responsible investors to buy and fix up foreclosed properties”; the second describes how local governments and nonprofits can “strategically [take] control of foreclosed properties”; and the third describes local policies that can hold “property owners responsible for property condition.”

The most promising programs that the report identifies are called First Look programs. Sarah explains that they were pioneered by a national nonprofit group called the National Community Stabilization Trust. “They negotiated agreements with [the banks] so that community organizations that were working with public dollars…can have a first look at these properties before investors can bid on them. And so that allows communities a chance to compete with investors who are operating with cash, and without any restrictions on their dollars. And, they don’t need to bring their mother by to check out the home they’re going to live in. So it levels the playing field some.”

The largest source of funding for community organizations and local government efforts to purchase foreclosed homes is HUD’s Neighborhood Stabilization Program, reauthorized last year in the American Reinvestment and Recovery Act as NSP2. NSP2 is a continuation of NSP1, a competitive grant program that was established after the foreclosure crisis to help communities facing disinvestment and abandonment. PolicyLink sees it as an important tool for competing with potentially predatory investors. Sarah says “those funds can be used for landbanks, or homebuyer incentives and for nonprofit and public agencies to purchase foreclosed properties and rehabilitate them and sell them. So, NSP is already helping with the positive strategies in the report.” And, Sarah points out, there is a proposed third round of funding on the table, for the years ahead.

The potential for investors to buy up large swaths of housing in poorer neighborhoods and flip them for profit has an ugly precedent: blockbusting. Blockbusting was the practice of scaring urban middle-class white homeowners into selling their homes for significantly less than market value based on the assumption that property values would decline as the neighborhood became ethnically mixed, then turning around and selling the property to minority homebuyers at above-market values for a large profit. It decimated urban neighborhoods, and one could argue — as I have in the past — that it was this private-sector activity, not just poor federal urban policy, that helped destroy inner-city America in the decades following World War II.

Blockbusting, like most unscrupulous real estate deals, relies on an informational asymmetry between the investor, the seller, and the buyer. A similar informational disadvantage exists in neighborhoods hit hard by foreclosure: the properties are sold in bulk, or at auction, or with cash, and rarely make it to the regular housing market. This, I think, is the greatest benefit of First Look programs: leveling both the financial and informational gradients that exist in distressed housing markets.

Sarah points out that when “dealing with housing markets, there’s different ways in which prices get distorted and the real value is very hard to find, and I think that investment activity can make it difficult to find the real value of properties.” Not knowing the real value of properties and the bundled debts associated with them is the reason we’re in this mess in the first place. For those reasons, First Look programs are so effective when coupled with grant money from the NSP; communities and local investors can compete and invest in the future of their neighborhood.

And investment is exactly what places like North Minneapolis and East St. Paul need right now. In that spirit, let’s hope HUD comes through with a third round of NSP funding.

Tags: governance

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