Obama Foreclosure to Rental Plan Being Readied: Report (Update 1)

Foreclosure story updated with recent commentary from Goldman Sachs.

NEW YORK ( TheStreet) -- The Obama Administration is close to announcing a pilot program to sell government-owned foreclosures in bulk to investors as rentals, CNBC reported citing unnamed administration officials.

The Federal Reserve, Treasury, HUD, Fannie Mae ( FNMA) and Freddie Mac ( FMCC) are working out details of the plan, including what the pricing for such a sale would be, the government's role in the plan and identifying those with the operational experience to manage such properties, according to the report.

The policy aims at reducing the foreclosure supply in the market, which has been depressing housing prices, while capitalizing on increasing demand for rental homes.

Banks repossessed fewer homes in 2011, but much of the slowdown was because of foreclosure processing delays. The recent spike in "default filings" points to a fresh wave in foreclosures in 2012, according to RealtyTrac, which could hold prices down further. The number of properties in the foreclosure pipeline is more than four times the number of REO -- or real estate owned properties -- for which foreclosure processing has been completed, according to the Fed.

Meanwhile, rents have risen in the past year, with the vacancy rates of multi-family units dropping, as families who are unable or unwilling to purchase homes have chosen to rent instead.

Families who have lost their homes to foreclosure also tend to move to single-family rentals, so a proposal to convert foreclosures to rentals will also make sense.

The Fed has been pushing for a foreclosure to rental conversion plan. "Reducing some of the barriers to converting foreclosed properties to rental units will help redeploy the existing stock of houses in a more efficient way. Such conversions might also increase lenders' eventual recoveries on foreclosed and surrendered properties," the Fed noted in a white paper released last week.

The Federal Housing Finance Agency, the conservator of Fannie Mae and Freddie Mac, released a request for information on August 10, 2011, to collect information from market participants on possible ways to convert foreclosed property to rentals and received more than 4,000 responses.

The Fed has said it is working on designing the foreclosure-to-rental plan, but as no program currently exists, it expects "ongoing experimentation and analysis" is key to the program.

A government program could take many forms, the Fed said in its white paper. "The REO holder could rent the properties directly, sell the properties to a third-party investor who would rent the properties, or enter into a joint venture with such an investor. In making this decision, policymakers should consider what program design will provide for the best loss recoveries and the best outcomes for communities," the paper said.

Investors have been snapping up foreclosed properties at bargain prices and converting them into rental units, but large-scale conversions have not taken place.

For one, investors are willing to buy bulk properties only at significant large discounts, partly because they are unable to get debt financing for such transactions. Mortgages are available for individual one-to-four family homes and multi-family units but not for a portfolio of single-family homes.

Owners of foreclosed properties worry that selling in bulk will affect their recoveries.

The Fed expects that providing investors with some sort of debt financing will improve the prices investors are willing to offer for the bulk properties and is debating whether such financing should be subsidized.

While Fannie Mae and Freddie Mac hold a significant amount of the REO inventory, banks owned as much as $10 billion in residential REO properties on their balance sheets, not including serviced-for-others foreclosure properties.

Bank of America ( BAC), JPMorgan Chase ( JPM) and Wells Fargo ( WFC) originate the most mortgages in the country.

Banks are generally not allowed to engage in real estate property ownership or management and guidelines call for disposal of properties as soon as possible. Still, recognizing the realities of the current market, banks have been allowed to rent properties directly or through third party vendors so long as they show good -faith efforts to sell the property.

The Federal Reserve is contemplating issuing guidance to banking organizations and examiners to clarify supervisory expectations regarding rental of residential REO properties by such organizations, according its white paper.

The market has been anticipating a major government program to boost the housing market, which has acted as a drag on the economy. Last week, rumors that the administration would announce a $1 trillion mortgage refinancing plan pushed up bank stocks, although the White House later denied that it had a refinancing plan in the works.

Still, there appears to be a broad push to revive the housing market, with political analysts also seeing another stimulus as a possible way to seal President Obama's re-election in 2012.

Analysts at Goldman Sachs said a foreclosure-to-rental plan appears to be the most likely to be implemented. Still, it expects such a program to have a modest impact on the housing market.

Responding to the Fed's white paper, analysts Alec Phillips and Hui Shan anticipate that shifting all Fannie Mae and Freddie Mac-owned foreclosed properties to the rental market will have the effect of improving housing prices by 0.5% in the first year of the program and 1% in the second year. It will also reduce rent inflation proportionately.

But the actual response could in fact be lower according to the analysts. Some investors buying out foreclosed property may already be renting it out, which means that rental vacancies may not necessarily increase, although homeowner vacancies might drop.

Secondly, homes that are being held off the market for temporary reasons will find their way back into the for-sale market as vacancy rates drop. So "market forces could partly offset policy intentions," the analysts note.

Finally, as the Fed itself acknowledges, not all foreclosed homes are suitable for rent because of their condition, their location or because rental cash flow might not provide adequate compensation for the cost of the property.

Still, compared to a tax credit, which has only a temporary impact, an REO-to-rental program might have a more "lasting effect" and could alleviate concerns about the effect of "shadow inventory" on the housing market over the next couple of years, the analysts said.

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--Written by Shanthi Bharatwaj in New York

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