March 31, 2008

Once a relatively obscure slice of the real estate business, foreclosed homes that are now in the possession of lenders loom much larger as the economy flattens and housing sales stagnate.

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.

Large numbers of properties are indeed being dumped on some of the markets hardest-hit by the housing crisis, though experts say the Chicago area so far is escaping that fate. Lenders here seem more willing to take title to properties, said Geoff Smith, vice president of the Woodstock Institute in Chicago, which has studied foreclosures and predatory lending.

Betting on economy

Smith said lenders who take full possession of foreclosed assets, with all the attendant costs, probably are betting the housing economy is poised to improve.

"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," he said.

"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, Smith said.

"If my scenario is true, it means there's some optimism about the future of the Chicago real estate market," he said.

Chicago-based Harris Bank's REOs grew to $11.5 million at the end of 2007, up from $4.9 million at the end of 2006, according to documents filed with the Federal Deposit Insurance Corp. That includes commercial and residential properties.

The $41 billion asset institution said it's working with real estate agents to sell the foreclosed residential properties. But because of market conditions, "we are seeing assets stay on the books longer," Harris spokeswoman Amy Yuhn said.

"Our philosophy is that these properties are in the communities we lend in, so we're not just going to dump them on the market," she said, noting that such a practice could have an impact on local neighborhoods. "So we do hold onto them on the balance sheet longer because we do go through a longer selling process, just as if it were anyone selling a house."

Neighborhood considerations also are a high priority for ShoreBank, which knows an increase in the percentage of vacant bank-owned homes could be as harmful to a neighborhood as banks dumping the properties.

"When a bank owns a home, you have an empty house," said spokesman Brian Berg. "A house owned by a bank is boarded up, so it's all very counterintuitive to a sense of community."

Nationally, home foreclosure filings continue to rise at an alarming rate. They jumped 60 percent, and bank seizures more than doubled in February from the same month last year, and there is increasing concern that it's not just mortgage holders but those tapping home equity lines who are at risk of losing their homes.

Home equity loans

The Federal Reserve estimated that the value of home-equity loans outstanding was $1.1 trillion in the third quarter of last year. About 5 percent of these loans were at least 30 days past due in January, up from 4.4 percent in December and 3.4 percent one year earlier, according to data from Equifax and Moody's Economy.com.

Janice Lee fears she will lose her 1,400-square-foot Wilmette home next month.

Lee, a former pharmaceutical representative from Minneapolis who owns Chinoiserie restaurant in Wilmette, found herself heading for trouble after she was diagnosed with lymphoma in 2003. To keep pace with her medical bills, Lee sought a $70,000 equity line on her home in 2004. Two years later, she sought a second line.

Nearly half of her $130,000 loan, or $60,000, went toward her mortgage and property taxes. But that pushed her monthly payments to $4,000 from $2,500 in two years.

In January 2007, she refinanced, pushing her monthly payments to more than $6,000, she said. She missed her first payment last March and received a foreclosure notice in June.

Lee said she has tried to get the terms of her loans modified and still hopes to work something out. She's due back in bankruptcy court next month.

"It's like quicksand. ... I went from a very normal, upper-middle-class existence to 'Oh, my God, I can't pay anything.' It's just crazy," she said.

David McCarthy, chief executive of Integrated Asset Services LLC, a Denver-based company that manages and disposes of REOs, said it will take three to five years to work through the properties on lenders' books. The REO manager has 7,500 foreclosed homes in its inventory--double the amount from this time last year.

"Some lenders want to explore leasing properties in hopes the market will turn around, and others are just churn-and-burn, get it off the books," particularly in struggling housing markets such as Detroit and Cleveland, McCarthy said. "They think, 'The first loss is the best loss.' "

Ultimately, banks must sell off foreclosed property because it ties up assets unproductively.

Judith Heaney, a supervisory operations officer for the Midwest office of the Department of Housing and Urban Development in Chicago, sees Illinois in good shape.

She pegs HUD's foreclosure inventory in the state at 1,188 properties as of February, including 797 in the Chicago area.

"They're for sale now. Our contractor closes some every day, but they come in every day," she said. "New acquisitions have been edging up. Year to date, from the same 2007 period to 2008, we edged up 6 percent in the Chicago area. Detroit edged up 62 percent.

"So Illinois is in good healthy shape as far as FHA [insured] foreclosures, but by no means am I applying our experience to all foreclosures. Chicago is a stable market; it tells us properties are able to be sold. It tells us when we do get foreclosures, they are marketable and that the market here is strong enough to absorb them."

Heaney said foreclosure inventories for HUD are at historical lows for FHA-insured properties in the Chicago area because its lending dropped off 65 percent when subprime and alternative-credit products surged in the marketplace.

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