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Choices, Risks Ahead If Feds Rent Out Foreclosed Homes

How can government best turn repossessed homes into rentals

The feds are asking. And experts are weighing in on methods and consequences.

Officials want to cut the huge glut of foreclosed homes stuck on the books of mortgage-backers Fannie Mae (OTCBB:FNMA.OB - News) and Freddie Mac (OTCBB:FMCC.OB - News). They see renting as one way to do it, and maybe stabilize neighborhoods and home values.

But should repo rentals be government-owned, privately held or handled in partnership? Would this improve the housing market? Would it hurt the rental market

Opinions vary, and the government wants ideas in by Sept. 15 on the questions it raised last month. It all comes a little late, in the view of former Federal Reserve economist David Jones.

Taking foreclosures out of the housing market could reduce the drag on housing prices, "enough to possibly make a difference," said Jones, CEO of economic consulting firm DMJ Advisors in Denver. But "we're five years into the worst housing crisis we've seen. .. . Asking for suggestions now strains the imagination.

Any big move to rent out repos could "flood the rental market and reduce rents," he said, yet it's an impact "we may have to tolerate.

How Rentals Could Arise The request for ideas on how to clear out repos comes from the Treasury Department, the Federal Housing Finance Agency (which manages Fannie and Freddie) and the Housing and Urban Development Department.

Uncle Sam: top U.S. landlord? Housing experts get nervous about Fannie and Freddie managing repo rentals — although they already handle some, due to tenant-in-place rules making foreclosing lenders respect existing leases.

Fannie and Freddie should sell the foreclosures into the private sector, rather than "become the biggest landlords in America," said David Shulman, senior economist for the UCLA Anderson Forecast in Los Angeles.

But Rick Sharga, senior vice president of foreclosure watcher RealtyTrac, would like to see Fannie and Freddie turn "nonperforming assets into assets generating cash flow, which could then be sold when some of the value recovers." If the agencies sold off the rentals at today's depressed prices, they wouldn't recover anything from potential future appreciation.

New Fannie or Freddie rentals should be managed by professional rental companies, not "the lowest bidder that was super aggressive in getting their name to the government," said Tony Drost, president of the National Association of Residential Property Managers.

Sell foreclosures to investors? Bruce Norris, a partner with Southern California property firm Norris Group, would like to see repossessed homes end up in the hands of investors. If Fannie and Freddie provided loans to these investors, he suggests, the lending agreements could specify that properties be maintained as rentals.

Norris has met with Fannie executives and told them he'd like to see any programs for turning foreclosures into rentals made available to small investors.

"Selling only to hedge funds would really irritate me," he said.

Yet finance expert Jones says that getting a promise from investors to maintain properties as rentals could prove "a little slippery.

Public-private partnership? Jones likes the idea of Fannie and Freddie teaming up with private investors to turn more foreclosed homes into rentals. Others say a partnership program would be difficult to manage and cause Fannie and Freddie to bleed more red ink as they set up a bureaucracy to manage the contracts.

Perhaps one size doesn't have to fit all. "Fannie and Freddie can implement multiple strategies," said Steve Ozonian, chief real estate officer at Santa Ana, Calif.-based Carrington Mortgage Holdings. It manages 4,000 rental properties, including some Fannie-owned ones.

Government could sell off some homes to investors as rentals, in other cases partner with investors, and keep some homes as government-owned rentals, he says.

Risks Of More Rentals While big on the notion of rentals, the government's open to how else it could clear out its stack of repos, curb losses and aid the housing market.

Some observers worry about the effects of a big rise in the nation's rental inventory. John Hussman, president of Hussman Econometrics Advisors, is dire in his predictions. More rentals will not only push down rents, he says, but will also hurt home sales.

Depressed rents would lower demand for homebuying, "resulting in roughly the same depressing effect on the housing market as if the homes were sold outright," he said.

If rents do drop, it would hurt homeowners as well as landlords, says NARPM's Drost, who's president of First Rate Property Management in Boise, Idaho.

Many owners who've had to move somewhere else for their jobs "are renting their homes for far less than their monthly payments," he said. So "a drop in rents would hurt homeowners who are scraping by.

Others note that vacancies are tight across the nation and rental demand is high. So they don't see a collapse in rents from more rentals coming on the market, especially more single-family home rentals.

Not only are vacancies low, but also "there's hidden demand in the rental market" from families that consolidated households, Norris said. "You do get sick of living with relatives.

If not renting, what else could the feds try? Shulman's advice: How about massive auctions in some markets

Hussman suggests to curb foreclosures by splitting underwater loans in two — a reduced principal amount plus a lender claim on future appreciation.

Perhaps some loans should be assumable (as they used to be), suggests Norris. So if a homeowner defaults, a new buyer could make the loan current and take over ownership of the property in an expedited process.