8
Real Estate Speculation and Foreclosure

We are bombarded with television, radio, and print ads telling us that real estate speculation is the easiest way to get rich. Testimonials like “I’ve gone from a negative net worth to $1,500,000—our cash flow is over $300,000 a year” abound. Remarkably, these people were able to get rich with “no money down” and using the creed of the savvy investor: buying with OPM (“other people’s money”).130

As with most entrepreneurial activities, the key to successful real estate speculation is to buy low, and sell high and fast. We’re told that smart investors buy properties at a minimum of 20% below market value and then flip (resell) them at closing or soon after. Real estate speculation is a seductively simple idea: find a desperate seller who has to dispose of a property quickly and then offer a cash price well below market value. Spice up the deal by promising to close right away and pay cash. Then find a desperate buyer who is willing to pay the full market price or above. In the process, find out how much the buyer can pay each month, and then manipulate the terms so that they appear affordable. In the meantime, plan on getting the property back.

The human cost is rarely factored into the equation. Foreclosure is often the result of speculation and is the final stage for homeowners trapped in the fringe economy. This chapter examines how the poor are separated from their money or assets by rent-to-own housing schemes, by housing speculators, and through foreclosure scams. It also suggests ways to reform the fringe housing economy.

Javier and Ana Trevino migrated to the United States from Honduras in 1990 and settled in Albuquerque, New Mexico. They have four children. In 1996 they brought Ana’s parents to live with them. Ana did home child care and Javier owned a mobile food cart. Although Javier’s business was good, most of his income was in cash and therefore not reported. Ana was also paid in cash. In fact, the family never filed a tax return. Nor did they have credit cards, since their purchases were in cash. The Trevinos didn’t have a bank account; instead, they kept their money in a safe place. Consequently, the family didn’t meet the eligibility criteria for a conventional loan. Finding a rental house large enough to accommodate them was almost impossible, and they knew they needed to buy a house. In 1998 the Trevinos believed they had found the perfect home to buy.

Mountaintop Investments bought a residential property in central Albuquerque for $80,000 in a foreclosure sale. It was a larger home located in a low- and moderate-income neighborhood with average home prices of $95,000, and Mountaintop priced it at $150,000.131

Mountaintop sold the house to the Trevino family for $150,000, with $7,500 down and a three-year balloon note at a 13% APR. It was essentially a lease or rent-to-own option since Mountaintop still retained deed to the property. Javier and Ana came up with the down payment by using their savings and borrowing from friends. They were excited about their first real home and decorated it with loving care. Javier and his friends also did some remodeling and structural repairs. By the time the balloon note came due in 2001, Javier had sold his food cart and opened a small restaurant. He was doing well. Ana found a job in a day-care center. They also began paying taxes and opened a bank account.

The Trevinos were in for a rude awakening when the balloon note came due. For one thing, the bank appraised their house at only $115,000 rather than the $140,000 they still owed to Mountaintop. Second, the bank would finance only 80% of that amount, or $92,000. Plus, they would have to pay $3,000 in closing costs. To pay off Mountaintop, the Trevinos would need $43,500 in cash. Although they tried subprime lenders, none would finance the home for more than 80% of its appraised value. The Trevino family ended up losing their $7,500 down payment, 36 months of payments, the sweat equity they had in the house, and, perhaps more important, their dream of home ownership. It would take years for the Trevinos to save enough money for another down payment.

Mountaintop came out well. Had the company taken an 8% loan for the $80,000, its monthly payment would have been $600. Since the Trevinos were paying $1,575 a month, the $975 difference over 36 months totaled $35,100. With the $7,500 down payment for the lease option, Mountaintop made $42,500, or half the cost of the house, in just three years, excluding the appreciation. Had Mountaintop used the $42,500 to refinance the house again at 8%, its new monthly payment would have been $275, allowing it to make $1,300 a month from the next buyer, plus another $7,500 for the down payment. In the second three-year go-round, Mountaintop would make $54,300, enough to pay off the property. Not surprisingly, the company immediately put the house back on the market.132

Rent-to-Own Housing

Real estate speculators employ various strategies to make money. One way is by owner financing, which is becoming increasingly popular as more lenders start to tighten credit guidelines. Owner financing is attractive to potential buyers who can’t qualify for a conventional mortgage because of excessive debt, insufficient income, lack of time on the job, a poor credit score, little or no credit history, or bankruptcy. Some home buyers choose to forgo conventional financing because of privacy issues, such as having income from the nontaxed gray or black markets or from illegal activities. Buyers who cannot or choose not to qualify for a conventional loan have two alternatives: a lease option or non-qualifying financing.

The fringe housing sector’s answer to the furniture and appliance rent-to-own industry is a lease option, whereby a renter theoretically moves toward home ownership. In this arrangement, the “buyer” chooses a property from a list of houses owned by an investor or investment company. The list is small, usually 5-10 homes for a medium to large city. For instance, one Kansas City company specializing in owner-financed houses listed 35 homes in the area, but only 10 were available.¹ This was out of a total housing stock of roughly 10,000 broker-listed homes.

After the buyer chooses the property, he or she provides a nonrefundable “option consideration”—similar to a down payment—which is usually 5% of the purchase price. This option locks in the price of the property during the lease term and gives a buyer the exclusive right of purchase. Buyers are not required to purchase the property. If they exercise the purchase option, the down payment or “option consideration” is applied toward the sales price. If they walk away, the money is used to compensate the investor or owner for having removed the property from the market.

Lease options are generally short-term (lasting from one to three years), and after they expire, the prospective buyer must find financing or relinquish the home. Although some lease options are renewable, this typically involves a new down payment and a higher purchase price. The investor usually pays the property taxes and insurance until the closing. The tenant/buyer is responsible for upkeep and repairs. Monthly payments are referred to as rent rather than mortgage payments. Since the lessee is technically a tenant, he or she receives no financial benefits of owning a home, such as tax deductions and other perks that can translate into $3,000–$6,000 a year.² According to real estate investment guru John Reed, lease options have failure rates as high as 90%.³133

The second option is “no-documents” owner financing, which may involve little or no criteria for qualifying. In this scenario, the home buyer purchases the property directly from the investor or company through a short-term loan. The seller is the bank, and the buyer pays it monthly. Loans are usually short-term (one to three years), and the financing agreement explains the length of the loan, the interest rate, the monthly payments, and other terms. Required down payments are higher than with the leasing option, often about 10% of the sales price. Buyers lacking the necessary down payment can sometimes negotiate an arrangement whereby the seller folds it into the loan, which thereby entails separate monthly payments. ⁴

Lease option and no-documents buyers are often young couples who can’t afford to purchase a house through conventional channels and are convinced that this is the backdoor to home ownership. Unfortunately, the vast majority lose thousands of dollars, and when the lease option expires, they are less able to afford a home than when they started. In fact, losses associated with lease options may permanently prohibit some people from ever owning their own homes.⁵

Lease options and owner financing are dangerous in other ways. First, conventional lenders require an independent appraisal to determine the fair market value of a property. While this appraisal safeguards a lender’s interest in the property, it also assures home buyers that they are not overpaying. For example, in 1998 there was a large home for sale in my neighborhood. Strapped for room, we looked at the house. While it was in decent shape, the owner wanted $165,000, which at the time was too high for the neighborhood. After six months the sign went down, and the house lay vacant for almost a year. We later found out that it had gone into foreclosure. Six months later a new “For sale or lease” sign was on the lawn. Curious, I called and asked about the price. Now the house was owned by an investment company, and the manager told me the asking price was $320,000. There was a brief silence as I caught my breath. Sensing my disbelief, she added “But we finance it.”134

Some mainstream lenders require a home inspection, by a licensed independent inspector (most home buyers opt for this even if it’s not required), that’s designed to uncover costly structural and mechanical problems. The results of the inspection are often used to lower the price or to compel the seller to make the necessary repairs. Lenders also require a property survey to determine that the house and other buildings lie within the property boundaries and that all easements are respected. Finally, lenders require the purchase of title insurance, guaranteeing that the property has a free and clear title with no liens against it.

Fringe economy home buyers are often denied these safeguards. For one, an independent appraisal is not required in a non-conventional sale, because the price is determined solely by the buyer and seller. A home buyer may be unaware of the fair market price in a neighborhood and can find herself with an overpriced home that’s impossible to sell or refinance. Second, some investors may not inform buyers that they can hire an independent inspector, while others may not even permit a home inspection. A home buyer might therefore end up with a property that has chronic and costly problems. Third, non-conventional home sales don’t require a property survey, and a buyer may face serious problems costing thousands of dollars to correct, if they are correctable at all. Private home sales are legal and are at the buyer’s risk.

HomeVestors: Bringing Real Estate Speculation to a New Level

While small companies and mom-and-pop operations have been involved in owner-financed housing for years, the late Ken D’Angelo elevated this to a new level when he founded HomeVestors of America (HVA) in the 1990s. HVA is a Dallas-based franchise system that trains and supports its franchisees, who purchase distressed properties in need of repair. By 2005, HVA had more than 200 franchisees in almost 20 states; by 2007 it plans to have at least 500 offices across the United States. In 2005, Entrepreneur ranked HVA 138th among the nation’s top 500 franchises.⁶135

HVA is a privately held company that chooses to not release its financial information. It’s also a corporation that plays its cards close to its vest. For example, when I contacted HVA to acquire brochures, I was told that there weren’t any and I should go to the company’s Web site. In turn, the HVA Web site was remarkably general and provided little information about the company or how it does business. The only other way to get information about HVA is to express interest in a franchise. When I inquired about that, I received a terse e-mail informing me that there were no franchises available in my area. No other information was offered. Eighteen months later I received another e-mail, inviting me to inquire about opening a franchise.

Getting into real estate speculation the HomeVestors way isn’t cheap. The initial franchise fee is $46,000. Franchisees must buy another $5,000 worth of computer equipment and pay an ongoing monthly fee of $495. Plus, franchisees pay a royalty fee for each piece of property sold. In the first two years, this fee is $775 per property acquired; in the third year the fee drops down to $675. HomeVestors franchisees are also expected to have enough working capital to cover operating expenses for six months. The company’s estimates for starting a franchise range from a low of $139,150 to a high of $219,450.

In return for their money, franchisees receive an intensive 10-day training program consisting of class and field training directed at learning how to buy, repair, and sell properties; a lead-generating software program; a list of remodelers who work cheaply; discounted ad rates; and so forth. HVA franchisees bought about 3,500 homes in 2002 using the same training, software, and advertising strategy.⁷ Perhaps most important, franchisees get the brand-name recognition of the company’s high-impact “We Buy Ugly Houses” billboard campaign, giving them increased respectability in the eyes of sellers and buyers. In fact, HomeVestors spends about $18 million annually on billboard advertising and some radio and television spots, which initiate roughly 70% of its business.⁸

HVA franchisees target older, economically stable middle-class neighborhoods, often buying the most run-down house on a block. The company offers subprime financing, since the typical buyer is a first-time homeowner who can’t secure conventional financing.⁹ In effect, HVA franchisees buy houses from people who can’t easily sell them and sell them to people who can’t easily buy them.136

In addition to buying and selling houses, HVA has also entered the rent-to-own market. One Dallas-based HVA franchisee listed a house for $72,900 with a rent-to-own option. To close the deal, the buyer had to come up with a $2,500 down payment and pay $995 a month on a two-year lease. Of that $995, $100 was applied to the sales price. After two years the tenant/buyer could buy the house for $68,700, assuming he could find financing. If not, he lost the $2,500 down payment plus the $2,400 in lease payments. As the listing agent explained, “This is for people who can’t get credit.” But the chances aren’t good that a credit-challenged buyer will be able to build or rebuild his credit in only two years.

HVA’s success is related to the increase in used-housing stock due to an aging population, a growing pool of indebted homeowners desperate to sell, and families unable to qualify for conventional mortgages.¹⁰ Other targets include the elderly who need quick cash or can’t manage the upkeep on their property, divorced couples who must sell quickly, and those who inherited a home they don’t want.

Like most real estate speculators, HVA is interested only in undervalued properties. It warns buyers that “HomeVestors offers you the option of selling your property to us at a DISCOUNT PRICE.… Therefore, please DO NOT SUBMIT INFORMATION about your property if you are NOT INTERESTED in receiving a DISCOUNT PRICE OFFER.” True to its word, franchisees generally buy homes at roughly 65% of their fixed-up market value.¹¹

The HVA concept represents a sea change in real estate speculation. Specifically, the company is attempting to “McDonaldize” speculative real estate in much the same way as other large and well-financed fringe market corporations have revolutionized the used-car industry, pawnshops, and rental furniture and appliances. It’s also following the lead of other fringe economy corporations by legitimizing predatory real estate speculation through intensive advertising coupled with a large network of franchisees.

The Wannabe Millionaires

Real estate speculation is big business, but coaching wannabe millionaires is potentially even more profitable. John Reed runs a Web site that rates and investigates real estate gurus. Reed notes, “If you go to a live presentation… you can see… the customers of the guru in question. B.S. artist gurus have audiences that look sleazy, unkempt, the bottom of the socioeconomic barrel.”¹² The “bottom of the socioeconomic barrel” that Reed criticizes is made up of the targets for real estate hucksters who help exploit the near-poor.

Trusting “get-rich-quick” real estate gurus, wannabe millionaires get ripped off as their bank accounts are depleted by expensive seminars, overpriced course materials, and “boot camp” training sessions costing thousands of dollars. Best-selling guru Robert Kiyosaki’s three-day real estate seminar costs $4,750, excluding travel and accommodations. The lesser-known “wealth trainer” Vena Jones-Cox charges $600 for a real estate training package.¹³ Robert Leonetti charges almost $10,000 for a package that includes coaching. Carleton Sheets, probably the most recognized real estate guru after his 20-year stint with infomercials, charges $400 for his initial training program. The rest of the money is bilked from customers through personal coaching (with one of his associates), $3,000 seminars, newsletters, and other necessities. As with most “coaches,” there’s little evidence that Sheets has ever sold much real estate by himself.¹⁴

Foreclosures

Helen Wisankowski is a disabled middle-aged woman who lives in Chicago with her two older children on a modest income generated by a small trust fund. In 1998 she found herself in default for $10,000 on the mortgage on the home she had lived in for 15 years. Helen was approached by an investor specializing in “foreclosure rescue,” who promised to save the home and keep her and the children from being homeless. The investor covered Helen’s overdue payments in return for the title. In turn, she would pay off the loan in payments. Helen signed the papers despite being confused by the legal mumbo-jumbo. In early 1999 she received a foreclosure notice from a bank she’d never heard of. Helen later discovered that the investor had sold her house to someone else and that the buyer had taken out a $50,000 loan on the property and defaulted. She had unwittingly deeded the property to the investor.138

Keeping a roof over one’s head is becoming increasingly difficult in the United States. A 2002 study by the Mortgage Bankers Association found that foreclosures in every category were the highest since these numbers were first tabulated in 1972.¹⁵ From 1999 to 2002, foreclosures among the 26.4 million conventional loans climbed 45%, the highest number in more than a decade.¹⁶ In late 2004, about 435,000 mortgages nationally were in the foreclosure process and 1.7 million were delinquent. Moreover, about 60% of all loans that enter the foreclosure process will eventually result in the loss of a home.¹⁷

According to foreclosure expert Alexis McGee, there are 1,300–1,500 homes in foreclosure in any given week in the six Chicago-area counties.¹⁸ McGee’s observation is borne out by a National Training and Information Center study showing that Chicago foreclosures doubled from 2,074 in 1993 to 3,964 in 1998.¹⁹ Not coincidentally, the rise in foreclosures corresponds to the increase in subprime loans.

A wide range of foreclosure scams are foisted upon vulnerable homeowners. For example, homeowners behind in their mortgage payments will have notices of default entered against them by the lender, which then become a matter of public record in the county recorder’s offices. While foreclosure notices have been public record for years and could be found by investors who checked newspapers ads or government offices, records are now computerized, and firms are set up to sell the lists. Real estate speculators comb these files to target people for “foreclosure rescue” services. These homeowners are then inundated with unsolicited visits, phone calls, mailings, and flyers. Street corners and telephone poles in low-income neighborhoods are plastered with signs promising to “stop foreclosures” or “save your house.” Those preyed upon are the most vulnerable, such as the elderly, who are often house-rich but cash-poor and desperate to stave off foreclosure. This vulnerable group also has the fewest legal resources to fight scams.

In a Washington Post article, Sandra Fleischman told the story of Idriis Bilaal, 77, who got a foreclosure notice in 2003 on his run-down row house in northeast Washington. ²⁰ Bilaal accepted an offer from one of the many “foreclosure rescue specialists” who had contacted him after his foreclosure notice was published. After signing papers provided by Calvin Baltimore, an ex-con and former minister, Bilaal realized that this wasn’t a loan. In fact, he had signed away the title to his 100-year-old house to Vincent Abell, who had been convicted of real estate fraud in the 1980s.139

Although the house had appraised for $255,000, Bilaal received only $17,000—the $7,000 he owed in mortgage payments plus $10,000 in cash. Because Abell’s company hadn’t agreed to pay off or assume Bilaal s mortgage, he remained responsible for the $714 monthly mortgage payments. But now Bilaal was also responsible for monthly rent payments of $500 to Abell’s company. According to the contract, Bilaal would rent his home and have the option to repurchase it for $110,000 after a year. However, he would have to initiate a new loan on top of his existing mortgage. Even if Bilaal understood the terms of the buy-back option (which he claimed he didn’t), it would be impossible for him to qualify for a $100,000 loan on top of his current loan. Why did Bilaal sign the contract? “I was under duress when Baltimore walked through my gate and said he could save my house. Every time I saw people’s stuff on the street, I would say that was me next.”²¹

Predatory activity around foreclosures can take several forms. For example, “We’ll save your credit—just pay a fee and sign the house over to us. The foreclosure will be recorded against us, not you.” In reality, a foreclosure is reported against the original borrower regardless of any subsequent purchasers. Another scam goes like this: “We’ll give you money; just sign the house over and we’ll pay off the debt.” In that scam, the seller often doesn’t know how much equity she is selling. Homeowners face other risks in foreclosure scams. Will the speculator really cure the debt? Will he make the payments knowing the homeowner is still responsible for the loan? Once a speculator has the deed to a property, he can treat it as his own. He may borrow against it or even sell it to someone else. Because the homeowner has released the title, she will not realize any money if the property is sold. Moreover, the speculator treats the homeowner as a tenant and the mortgage payments as rent. Hence, she can be evicted if payments are late.140

Still another scam is “We’ll buy the property and lease it to you. You can then buy it back.” To repurchase the home, the homeowner will need another loan, larger than the original. Mortgage payments will be greater, qualifying will be more difficult, and the interest rate will be high. And then there’s “We’ll get you a new loan that will solve your problems.” Almost every instance of refinancing involves a higher loan balance and higher monthly payments. Another scam involves a speculator’s giving an owner facing foreclosure a cash amount for the equity in the home. With this small cash payment the speculator gains control of the property, which is then rented out with no payments made to the homeowner. The speculator pockets the rent while delaying the foreclosure as long as possible.

Several cases cited by Robert Heady in a St. Paul Pioneer Press article help explain how mortgage foreclosure scams work.²² Heady outlined the case of Ruth B., an 85-year-old Minneapolis woman who fell behind on her $41,000 mortgage and was facing foreclosure. Ruth was contacted by a lender who promised to help her keep the house. The speculator purchased her $125,000 house for $50,000, then rented it back to Ruth for $800 a month, knowing that she couldn’t afford the payments on her $818 monthly pension. When Ruth was unable to pay, the lender began eviction procedures. Ruth eventually secured a reverse mortgage and bought the house back from the lender for $96,000. In another case, Denise B. bought a house for $88,000 with a 6.5% mortgage. Shortly afterward, she suffered a heart attack and was facing foreclosure. Denise got a call from a lender who explained that he could find a buyer for the house and then sell it back to her, thereby allowing her to remain there. In addition, she would get $10,000 at closing. The company appraiser, a private investor, valued her house at $135,000 and explained that with an outright sale Denise would see a net gain of $40,000. The investor bought the home for $135,000, but the proceeds were divided as follows: an $85,000 payoff on Denise’s mortgage; $5,300 in closing costs ($4,000 went for sales commission); $15,000 for other closing costs, management fees, and other items; and $26,000 for a down payment so that she could repurchase the house. Denise received only $4,000 in cash.141

Refinancing loans and other shenanigans might be presented as a “rescue,” but they only postpone the inevitable loss of a home while draining the remaining equity. The essential fraud is that these companies are not really making loans, but rather expropriating houses at discounted prices and then pocketing the difference. Although speculators may promise to let an owner stay in his home, once the door is opened, they usually find legal ways to evict him.

Reforming the Fringe Housing Market

Despite mountains of federal and state laws designed to protect home buyers, U.S. housing policy exists in the gray area between an unregulated market commodity and one containing more consumer protections than most. For fringe economy operators the stakes are great, because housing is a $10 trillion industry in which stunning profits can be made at every stage in the process. Consequently, many homeowners risk losing their property through predatory lending practices employing a variety of tactics that strip home equity, artificially inflate the costs of monthly payments, and make claims on future equity.

The lifeblood of the mortgage industry is the initiation of new loans and the refinancing of existing ones. To that end, young families are pressured into overbuying through “creative financing”; financially stressed homeowners are coerced into refinancing; and the more affluent are lured into second mortgages to pay for new cars, pay off mounting credit card debt, or purchase expensive vacations. While predatory lending practices are not novel, they are becoming more widespread in the wake of soaring housing prices, the growth of the subprime lending industry, and rising consumer household debt.

One of the most troubling long-term implications of the fringe housing economy is its impact on the intergenerational transfer of assets and wealth. Property and home ownership have always been important means for transferring wealth and assets. A free and clear home valued at $300,000 and divided among three heirs may provide enough capital for getting an education, setting up a small business, or purchasing a home with a substantial down payment. But instead of being a vehicle for transferring wealth, home ownership is quickly becoming a means for the inter-generational transfer of debt. The Joint Center for Housing Studies of Harvard University notes that the present generation of Americans is wealthier than the preceding one. However, if current housing trends continue, subsequent generations won’t be able to lay claim to the same honor.142

Problems in the fringe housing economy cannot be solved through a piecemeal approach aimed at ending one or more inequities. Even if the worst features of this economy were legislated away, they would be likely to resurface in other forms. Simply put, the fringe housing economy exists because it addresses needs not being met in the conventional marketplace. The following are a few general recommendations for reforming this fringe sector.

First, mandatory nonessential insurance, such as credit life, should be prohibited. Second, predatory lenders routinely charge home buyers a variety of loan fees, such as mortgage broker fees, origination fees, service release fees, processing fees, and discount points, that have a negative impact on home equity. These fees should be regulated and capped at the state and federal levels. Third, prepayment-penalty-fee clauses should be abolished, since their sole function is to keep borrowers enmeshed in high-interest loans. Besides, no prime-rate mortgages contain these clauses, and there’s little justification to include them in subprime loans. Fourth, all forms of financing designed to systematically strip home equity, such as SAM loans, 125% LTV loans, and negative amortization, should be outlawed. According to the U.S. Department of Housing and Urban Development, alternative-financing schemes make it more likely that borrowers will go deeper into debt or lose their homes through foreclosure.²³ Fifth, balloon loans should be prohibited. In fact, any loans that jeopardize home ownership and equity formation should be disallowed. Sixth, scams such as nonrefundable lease options on home purchases should be outlawed. Tricky lease options function as down-payment traps, since 50%–90% of lessees are unable to exercise the purchase option.²⁴ Seventh, federal and state regulators must develop a clearer definition of the difference between predatory and subprime lending. Without a firm definition, it is harder to promulgate and enforce federal and state regulatory policies.143

Federal housing policy should focus on core issues that are driving up housing prices and making home ownership increasingly unaffordable for middle-income families, let alone poor ones. Housing prices should be stabilized through governmental intervention, and “creative financing” should be regulated to where it doesn’t inevitably lead to foreclosure. But this must occur in a way that doesn’t harm the poor, who would be bereft without fringe housing services. To implement this delicate balance, the federal government must initiate new and robust loan programs that are complemented by a large increase in governmentally subsidized low- and moderate-income housing stock, which may require aggressive new construction goals.