What are the obstacles to being a landlord?

By Felix Salmon
August 29, 2010
Joe Nocera addresses the question of who might buy houses to rent them out:

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Joe Nocera addresses the question of who might buy houses to rent them out:

It’s even become nearly impossible for well-heeled investors to buy rental properties. This is no small matter. At the peak of the bubble, the rate of homeownership approached 70 percent. Now it is falling toward 65 percent — which is more or less where it was before all the housing madness of the last decade. That means that millions of Americans who were briefly homeowners need to become renters again. They need a place to rent.

But somebody has to buy the homes they are leaving behind and turn them into rental properties. The most likely buyer is a professional investor who purchases rental properties for a living. Yet, absurdly, government rules have made it exceedingly difficult to make loans to investors who want to buy up rental properties. This only adds to the shadow inventory.

I wish the online version of his column had a hyperlink in there somewhere, so that I could work out what government rules he’s talking about. As far as I can tell, the most recent change to government rules took place in February 2009, when Fannie Mae amended its rules on loans to investors. The changes made it easier for professional and semi-professional investors to buy houses, but a bit harder for someone wanting to get their toe in the door; they were understood at the time to be an easing of Fannie Mae policy.

The new rules allowed investors to have Fannie-backed mortgages on up to ten different mortgages; the previous maximum was four. At the same time, however, Fannie Mae closed a few loopholes which allowed people buying an investment home to have liquid reserves of less than six months’ worth of payments on the new home. And the definition of what was considered to be a monthly payment, for such purposes, was expanded beyond just mortgage costs and taxes to include things like ground rent and owners’ association dues.

This seems like sensible underwriting to me. The days of lending only against home values are long gone; we have to move back to a world where lenders look at borrowers’ wealth and income too.

That said, it’s worth remembering, in this context, that mortgages in most of the US are, to all intents and purposes, non-recourse. Some states, including California, have no-recourse laws, while in others it’s simply vanishingly rare for a mortgage lender to go after a borrower personally for funds they haven’t been repaid. And I’d assume that individual landlords lie somewhere between homeowners and businesses on the spectrum of how likely they are to simply return a property to the bank if it falls into negative equity.

As a result, even Nocera’s “well-heeled investors” can be bad credits, if they don’t put down a substantial downpayment which gives them real skin in the game. Does that make it “nearly impossible” for them to buy rental properties? Maybe it does, if they don’t want a lot of equity. In which case it might be worth trying to construct a parallel mortgage system which gives bank a bit more recourse than they have at the moment, at least for investment properties.

Nocera’s bigger point stands, though: it’s in everybody’s interest for landlords to be able to buy up properties without silly obstacles being thrown in their way. If such obstacles exist, let’s try to find a way to remove them.

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Comments
7 comments so far

i’m not sure about legal and government matters, but during the boom it was quite possible to get a standard mortgage on a rental property by claiming that you were going to live there for a year even if you were lying. this is probably not allowed now?

Posted by q_is_too_short | Report as abusive

How about this obstacle: Landlords strongly prefer tenants with good credit.

Presently there is an enormous wave of people who destroy their credit and then enter the rental market.

Posted by DanHess | Report as abusive

Do we really want to subsidize investors and landlords the same way we do owner-occupants? Maybe it would be better for rentals to be equity fueled, not debt fueled ventures. Shouldn’t owner-occupant mortgages have a little more wiggle room, as they are considered different than pure investments?

Posted by winstongator | Report as abusive

Felix,

I think there are two different sorts of requirements that are in play here. One set is the standard GSE rules that applied before the crash. I don’t know that I’d characterize these as onerous; more accurate to say that Fannie and Freddie were set up to encourage home ownership, and have never made it nearly as easy to buy an investment property. That sort of lending was peripheral to their mission. They did it, for the most part, when risks were quite low. The difference is that there used to be an array of other lenders out there, happy to cater to that market. Now, there are vanishingly few, and most of those who remain (private portfolio lenders, a handful of local banks) are charging sky-high rates and fees. So this is, in part, less about new rules than about the collapse of the private mortgage market – and I think that’s the biggest factor to keep in mind. The government has used the GSEs to prop up the secondary market for individual purchases of primary residences; its efforts in the realm of investment properties have been far more modest.

But there is a second set of concerns out there. I’m most familiar with it in the urban context. The GSEs have issued incredibly tight guidelines for condo purchases, and properties that don’t conform need waivers – in fact, each lender needs to apply for and receive a separate waiver. Take, for example, a modest 4 unit condominium. Since the standard condo guidelines bar projects in which any single individual owns more than 10% of the units, and each owner in such a project owns 25% (that is, one unit apiece) the building is ineligible. Then there are the new projects that are stuck in the 70% limbo – Fannie won’t write a loan until 70% of the units are sold; the developers can’t sell 70% of the units unless Fannie writes loans. So, often enough, the developer tries to convert the remaining units to rentals. Which would be good, except it means that none of the owners in the building can sell, because the building now violates multiple guidelines. It’s an absolute mess. Most buyers operating in the market whom I’ve encountered make their purchases in cash, and then refinance to take money out after the closing. But that, obviously, limits the available pool of buyers rather sharply.

I’m less familiar with the single-family-home guidelines, but I imagine similar problems abound. In general, lenders are skittish about writing mortgages in neighborhoods plagued by foreclosures – which is precisely where we might want investors to buy properties.

Posted by Cynic | Report as abusive

Cynic nailed it spot on… Issue #1 is that the private market for home loans has nearly vanished. On today’s rate sheet at my bank you can get a conforming (Freddie) 30 year fixed rate for 4.25%. If you’re looking for a loan for a non-conforming investment property than you’re looking at 7.25%. Massive difference.

So to illistrate how different the world is today from 4 years ago lets say you want to buy a 4 unit. The property is fully rented and you’re buying it at such an advantageous price that when just 2 of the units are rented it covers everything… (the mortgage, the taxes, the insurance… the whole ball of wax.) Lets also assume that you’ve got some long-term tennents and that you’ve also got some positive expierence as a landlord yourself. In this best case scenerio… my bank wants 25% down to write that loan.

4 years ago you could have had lenders falling all over themselves to lend you 95% LTV and a few of them would have given you 100% LTV. So it is a different world.

Posted by y2kurtus | Report as abusive

y2kurtus, if the price is really that advantageous, I might ask 40%. The market is telling you something is wrong. Perhaps you rented at the peak of the market in what is now a high-vacancy neighborhood, and your local job market is punk.

In the real world (at least in San Francisco), cap rates are not rising, they’re falling. Maybe all the multiunit buyers have cash, maybe other banks are less cautious than yours, or maybe SF is an outlier and the rest of the country is in some weird twilight zone where banks won’t lend, cap rates are 15% but no cash buyers are interested despite Treasury yields at half-century lows.

It could be happening. I doubt it.

Posted by wcw | Report as abusive

wcw, I think y2k is correct. And at 40% down, why not just pay 100% and skip the loan altogether? If you have enough money to pay that kind of down payment, why bother with the housing market, you are too rich to take on the headaches and risk. Most investors can’t/won’t tie up that kind of cash.

I am a landlord and wanted to get a loan, my bank told me 8% for an investment property and lots of red tape. They really seemed like they didn’t even want to do it, and complained the government has really cracked down. I checked other banks, same thing.

Looks like the government has gone from one extreme to the other.

The problem with the 8% btw is that it makes the mortgage payments too high to make money, because due to the economy rents are low too. A lot of people have moved in with relatives and there is a glut of rentals too, not just for sale homes.

Posted by napablogger | Report as abusive
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