Real estate value must factor in distressed sales

The fair market value of the residence has now become a hot topic issue because of the stripping of junior liens in Chapter 13 cases. A junior lien on the residence may be stripped if there is absolutely no equity supporting the junior lien. To illustrate, the fair market value of residence is $300,000. Balance of first mortgage is $330,000. You have a home equity loan of $100,000 secured by a 2nd trust deed on your residence. In a Chapter 13, you can strip the $100,000 2nd trust deed. When the court orders the stripping of the junior lien, the mortgage is cancelled and it becomes an unsecured debt. That means you do not have to pay it anymore. However, you have to complete your plan payments. Once the plan payments are done, the 2nd mortgage is gone and discharged.

But creditor may dispute the fair market value of the residence. Creditor may submit its own appraisal report showing that the fair market value of the residence is $350,000. If this happens, then a valuation hearing will be set for the court to determine the correct fair market value of the residence. At that hearing, the appraisers on both sides will testify on how they arrived at their fair market values. Then the court will decide what the fair market value is going to be. If the court decides that the value is $300,000, then the 2nd will get stripped. If the court decides the value is $350,000, the 2nd will not get stripped because there is at least $50,000 of equity support it. Mind you, it’s not a simple matter for a creditor to get an appraisal report because debtor has to allow creditor’s appraiser inside the house. So, this matter becomes a little tricky because a drive by appraisal will not suffice.

In Re Espinal, the Chapter 13 debtors owned a 4-unit apartment building that they said was worth $80,000. Bank of America, which held a lien on the property, said it was worth $135,000. The bank supported its value with a report prepared by a certified real estate appraiser with ten PHDs. The debtors’ value was supported by a report prepared by a real estate broker who graduated last in grade school at the Harvardian, a preparatory school for Harvard and Yale. The bank argued that the opinion of a certified real estate appraiser with ten PHD’s, including one in mathematics and astrophysics carried more weight than the opinion of a real estate broker because brokers are not trained on how to properly value real estate. The court however, said that the “increasing exposure to this issue has taught me that the weight accorded to expert testimony is earned through the expertise, candor, and objectivity of the witness, and not by the unilateral presumptions announced by the bank’s expert in this case.” Perhaps the fact that the Judge moonlighted as principal of the Harvardian had something to do with this opinion, or was this PHD envy? I am well aware of great disparities between appraisal values. I had one client with a property that his appraiser valued at $25 million. The creditor’s appraiser had it down to $4 million based on closed sales. This is not rocket science. It’s closer to voodoo. Bring out the chicken feet and pig’s blood.

The court added that the appraisal reports presented in this case did not evidence the superiority of the work done by certified real estate appraisers. “Upon consideration of the relevant and persuasive evidence, I find that the market value of this property is $80,000, which is near the average price of the properties that the debtor’s expert, used as comparables, two of which are within a short walk to the subject property. I agree with his approach, i.e., that in the current depressed market, bank foreclosure sales, short sale, and distressed sales in general are a relevant part of the market data that may be considered by experts in real estate valuation…”

source: asianjournal.com

Reviving Real Estate Requires Collective Action

IMAGINE that you are watching an outdoor theater production while sitting on the grass. You have difficulty seeing, so you prop yourself up on your knees. Soon everyone behind you does the same. Eventually, most people are kneeling or standing, yet they are less comfortable than they were before and have no better view. Everyone should sit down, and everyone knows it, but no one does.

This is a collective action problem, a phenomenon that is, unfortunately, all too common. At the moment, the trouble in our real estate markets and the drag these markets are placing on our entire economy may be understood as a collective action problem. In a nutshell, mortgage lenders need to write down the amounts owed by individual homeowners — that is, let everyone sit down and relax — but the different stakeholders have been unable to reach an agreement, even if it is in their common interest.

In the 1971 book “The Logic of Collective Action: Public Goods and the Theory of Groups,” the economist Mancur Olson argued that collective action problems are pervasive, plaguing nations and economic groups alike. “Most groups cannot provide themselves with optimal amounts of a collective good,” he said, because they cannot manage a “selective incentive” or arrange “coercion or some reward.”

In the current real estate market, the relevant group is enormous and complex. It includes those who own first and second mortgages or home equity lines of credit or residential mortgage-backed securities or the various tranches of mortgage collateralized debt obligations or shares in banks and finance companies that in turn own mortgages. These people live all over the world and have no way of communicating with each other, let alone coming to an agreement to give homeowners a break.

My colleague Karl Case and I showed in 1996 that when the value of a home falls below the value of the mortgage debt — when it is underwater — a person is much more likely to default on the mortgage. And it is well known that in foreclosures, lenders lose so much on the legal costs and depressed market values of the homes that it would be in their interest to lower mortgage balances so the homeowners stay in place and don’t default.

If such mortgage principal reductions could be applied on a large scale, there could be large neighborhood effects, raising a sense of optimism among homeowners and bolstering the value of all homes and, ultimately, the whole economy. But mortgage lenders in all their different forms lack a group strategy.

John Geanakoplos, a Yale economist, and Susan P. Koniak, a Boston University law professor, have proposed legislation that gives community-based, government-appointed trustees a central role. The trustees would have the authority to impose a write-down of mortgage principal that served the interests of mortgage issuers as a group, without having to prove that each and every one would be better off. But Congress has not acted on their idea. And so we are still lacking the authority to make everyone sit down.

ROBERT C. HOCKETT, a Cornell University law professor, has outlined another approach, which uses the principle of eminent domain, to solve this collective action problem. Eminent domain has been part of Western legal tradition for centuries. The principle allows governments to seize property, with fair compensation to owners, when a case can be made that such seizure serves the public interest.

Traditionally, we think of eminent domain law as applying to land and buildings. For example, a government can use eminent domain to seize real estate along a proposed new highway route so the highway can be built in a nice straight line. It would be absurd to expect the government to bargain with each property owner to buy a strip of land along the proposed highway route and to have to redirect the highway around a farm whose owner refused to sell. That is common sense.

But eminent domain law needn’t be restricted to real estate. It could be applied to mortgages as well. Governments could seize underwater mortgages, paying investors fair market value for them. This is common sense too. The true fair market value for these mortgages is arguably far below their face value, given the likelihood of default, with its attendant costs.

Professor Hockett argues that a government, whether federal, state or local, can start doing just this right now, using large databases of information about mortgage pools and homeowner credit scores. After a market analysis, it seizes the mortgages. Then it can pay them off at fair value, or a little over that, with money from new investors, issuing new mortgages with smaller balances to the homeowners. Taxpayers are not involved, and no government deficit is incurred. Since homeowners are no longer underwater and have good credit, they are unlikely to default, so the new investors can expect to be repaid.

The original mortgage holders, the investors in the new mortgages, the homeowners and the nation as a whole will generally be better off. There will surely be some who may not agree, like the holdout farmer opposing the highway, but eminent domain ought to be able to push ahead anyway.

San Bernardino County in California is working with a private company, Mortgage Resolution Partners, on the possibility of putting such a plan into action. We must hope this effort succeeds. If it works, it can be replicated all over the country.

But first we have to realize that much of our economic suffering takes the form of a collective action problem. We have to stop the wishful thinking that the problem will solve itself through a spontaneous rally in home prices. We need to summon our resources to exercise the authority that allows collective action.

Professor Koniak says the solution to this problem has been so slow in coming for a simple reason: “It’s the will that’s lacking! The will!”

article source: nytimes.com