Lender-Abandoned, Non-REO Foreclosures

by: Barry Ritholtz

Consider this troubling question: Do mortgage lenders have any obligation to take over a property that has defaulted on its mortgage?

The short answer, it appears, is no: I hadn't previously considered this, until a recent article in the Chicago Tribune started me down this path.

Foreclosures and REOs properties are impacting more than the neighborhoods they are in -- they are actually adversely impacting the real estate business -- especially when it comes to foreclosed homes in possession of lenders (REOs).

First, have a look at some recent data regarding REOs:

"Across the country, federally chartered banks held more than $12 billion worth of foreclosed properties at the end of 2007, about 100 percent more than a year earlier. Of those, $6.6 billion are residential properties of one to four units, said Keith Leggett, senior economist at the American Bankers Association.

One housing data firm said it found the same extraordinary doubling in the Chicago area in what's known as REOs—real estate owned by lenders and investors. First American CoreLogic, based in Santa Ana, Calif., said it determined that 2.5 percent of all housing in the region is in this category, though two other firms calculate a lower figure.

Still, the 100 percent increase carries profound implications for the real estate economy because decisions by individual banks—to wait out the slump or dump properties on a deadened market—almost certainly would affect property values."

Okay, that's typical of most situations: Delinquency leads to default, then foreclosure proceedings. Once a lender retakes the property, the REO leads to a decision on when to best resale -- immediately, or wait it out.

Some lenders are approaching the Foreclosure process a little bit, how shall we delicately call this -- differently. They are considering the sale decision prior to even taking possession. Their conclusions may surprise you:

"In some cities that have low property values, where there are dense concentrations of foreclosures, you see lenders who file foreclosure proceedings but don't actually take control of the properties, because the lenders have to maintain them and pay taxes on them."

"There are areas in some parts of the country where property values are quite low, and there are no large-scale expectations of them going up. They don't know that they will ever recoup those costs," and so the lenders never re-take title to the properties, allowing them to become derelict." (emphasis added)

There you have it: Abandoned, Non-REO Foreclosures.

The local market conditions are what seems to determine the abandonment decision. In a region where the job and real estate market is doing anything better than "a little soft," I would surmise that abandonment makes no sense at all.

However, at a certain point, in a weaker region, with declining neighborhoods, certain lenders might make the decision to simply walk away from a large swath of (potential) real estate holdings, on the simple basis that it might be cheaper to do so.

There are very significant costs to this. Consider what the potential impact of these property abandonments by the lender means:

- Total write off of the loan;
- Boarded up homes/neighborhoods;
- Loss of tax revenue to the local school district or town;
- Long delays before the local town, municipality, or state can take possession due to tax arrears.

Thus, these incomplete foreclosures/abandonments can have very significant impacts.

If this becomes widespread, we could be in the process of creating an entire new universe of suburban slums...

As owners default, lenders move in
Mary Umberger, Becky Yerak and Tara Malone
Chicago Tribune, March 31, 2008