A lease-back proposal for foreclosed homeowners

Here are two questions getting attention in Washington: When homeowners lose their houses to foreclosure, should they be able to stay in the property, leasing it back at fair market rent from the lender?

Should they also get an option to purchase the house from the bank at the end of the lease term, assuming they have the income to afford it?

Before leaving for their August break, Democrats and Republicans in the House took a rare, unanimous stand on both questions by passing the Neighborhood Preservation Act by voice vote. The bill was co-sponsored by Reps. Gary G. Miller (R-Diamond Bar) and Joe Donnelly (D-Ind.).

The bill would remove legal impediments blocking federally regulated banks from entering into long-term leases -- up to five years -- with the former owners of foreclosed houses. It would also allow banks to negotiate option-to-purchase agreements permitting former owners to buy back their houses.

The idea, said Miller, is, “at no cost to the taxpayer,” to “reduce the number of houses coming into the housing inventory and preserve the physical condition of foreclosed properties,” which ultimately should help stabilize values in neighborhoods with large numbers of distressed sales and underwater real estate.

If the bill is approved by the Senate, participation by banks would be voluntary. But the legislation might encourage banks to calculate whether they would do better financially by taking an immediate loss at foreclosure or by collecting rent and then selling the property at a higher price in four or five years.

The bill quickly attracted critics. The Center for Economic and Policy Research, a Washington think tank, said a key flaw was to leave lease-back decisions solely to banks.

“If Congress does want to give homeowners the option to stay in their homes as renters,” the group said, “it will be necessary to pass legislation that explicitly gives them this right.”

Some private-industry proponents of short sales -- in which a bank negotiates a price typically less than the owners owe on their note -- say turning banks into landlords won’t work well, either for the banks or for owners in foreclosure.

Al Hackman, a San Diego realty broker, contends that lease-backs with options to buy are the way to go -- but not if banks run the show.

Hackman and a partner, Troy Huerta, have begun putting together what they call “seamless short sales” as alternatives for banks and property owners. Their short sales and lease-backs are “seamless” because the homeowners remain in their properties, before and after the settlement.

Here’s how they work: First, the bank agrees to a short sale to a private investor, just as is often done now. In the seamless version, however, the investor is contractually bound to lease back the house on a “triple net” basis -- the tenants pay taxes, insurance and utilities -- for two to three years.

The former owners qualify only if they have sufficient income to afford a fair market rent and can handle the other expenses, including maintaining the property. The deal comes with a preset buyout price after the lease-back period. That price is higher than the short-sale price paid by the investor but lower than the original price paid by the foreclosed owners.

Hackman described one “real life” transaction that is moving toward escrow: A family bought a house for $725,000 with 20% down in 2005, then made substantial improvements with a $72,500 equity line. The house now is valued around $500,000 but is saddled with $625,000 in mortgage debt.

Enter the seamless short sale: Hackman has brought in a private investor who is willing to buy the house at current value, all cash. The investor has agreed to lease back the house at $25,000 a year, triple net. In three years, assuming they’ve been good tenants, the original owners have the option to buy back the property for $550,000.

Hackman says the internal rate of return to investors can depend on rents and the buyback price but typically is in the 8% to 10% range.

“It’s a win-win,” he said. “The owners stay in their houses. Private investors get a moderate return on what should be a safe investment.” And the banks are out of the equation.

kenharney@earthlink.net

Distributed by the Washington Post Writers Group.