Fixing the Foreclosure Mess?

It doesn’t look like 2011 will be the year the U.S. foreclosure mess is finally cleaned up. That’s unfortunate, because the continuing high level of foreclosures pushes prices down and makes it more difficult for builders and developers to increase their production, even though the number of households continues to rise across the nation.

The foreclosure problems over the past few years have been compounded by the foolish way our country has been dealing with the problem. Many lenders have done a poor job of working with borrowers who have a chance of staying in their homes with some realistic loan modifications. I have seen lenders refuse to budge on terms and mortgage reductions for the end user, only to wind up selling the homes to investors at a loss. Why not negotiate with the owner first and avoid the heavy costs associated with foreclosure? In these cases, I believe that the financial institutions that made unrealistic loans back in the boom years have a responsibility to explore every realistic opportunity to keep a borrower in place before they foreclose.

That’s a different situation than foreclosing on an investment property.  Many investors who bought homes and condominiums during the boom hoped to flip them quickly for an immediate profit. That wave of speculation contributed mightily to unsustainable price increases – one of the key reasons for the housing bust.

Today, many residential properties are once again being sold to investors whose primary motivation is to hold them until market conditions turn favorable. Then, they will place them on the market to compete with new homes sales just when home builders are hoping for market recovery. So these investment sales – including many foreclosures – will ultimately delaying the housing market recovery. It’s a postponement of sales, not a permanent reduction in inventory.

When making their plans for 2011, builders and developers need to be wary of this “shadow inventory,” which varies from market to market. Otherwise, they may be in for an unpleasant surprise just as their plans come to fruition.