Under the new Neighborhood Stabilization Program (NSP), the U.S. Department of Housing & Urban Development (HUD) has allocated a total of $3.92 billion to all of the states and particularly hard-hit areas in an effort to help stabilize towns, cities and neighborhoods.
The NSP appropriation comes under the Housing and Economic Recovery Act of 2008, which was enacted in an effort to ameliorate the foreclosure crisis and revitalize the depressed housing market. The program's funds are allocated to state and local governmental units under a formula created by HUD and based upon various factors, including foreclosure rates, prevalence of subprime loans and default rates.
These funds will be distributed in early 2009 in accordance with HUD's formula, and they must be obligated by local governmental entities within 18 months after receipt of the funds. The various local governments will then use the funds to acquire, rehab or demolish foreclosed or abandoned properties.
Given the scope of the problem nationwide, $3.92 billion is not very much money. The vehicle by which the program funds will be utilized is a strategic plan developed at the local governmental level, either directly or in partnership with local community development corporations (CDCs) or other nonprofit organizations.
It cannot be overemphasized that the utilization of the NSP funds by local government must be strategic and not transactional, given the limited resources available under the program. This mind-set may be new for many of the local players. Demolition or acquisition and rehabilitation of one vacant real estate owned (REO) property may have the effect of stabilizing an entire block or neighborhood.
This could result in stabilization and, ultimately, a rebound in housing prices. Successful, strategic use of the money can put a local community on the road to recovery and increase the potential opportunity for further grants in the future to build on initial successes.
If successful, revitalization of troubled communities will occur, increasing housing values in key areas nationwide, which will be good for both homeowners and our industry by stabilizing the value of the family home and the assets collateralizing the mortgage loans that underpin our financial system.
For the industry, the NSP represents the opportunity to dispose of many of its more problematic REO properties, which would otherwise be difficult to sell and are probably the subject of various code violations and housing court proceedings. The administrative cost of dealing with these more problematic assets (or liabilities, depending on how one looks at them) can and should be factored into the analysis of any purchase offers.
If stabilization of local real estate values results from participation in NSP transactions, the positive effects on value could benefit REO assets more broadly, not to mention stimulate and accelerate the overall recovery.
The challenges faced by both local stakeholders and the mortgage banking industry in fulfilling the goals of the NSP are significant, both individually and collectively.
At the local level, engineering the best strategic use of the NSP funds will be difficult. Some specific areas that will challenge local government, CDCs and nonprofits include:
- fundamentally poor strategic decisions;
- politicization of the process and allocation of funds based upon non-strategic reasons;
- lack of experience relative to the activities for which the funds will be used (e.g., managing projects on scattered sites);
- limited infrastructure to execute the local strategic plan, reflected primarily in construction and property management functions;
- absence of a holistic approach in leveraging debt and philanthropic, Community Development Block Grant or other available funds to enhance the efficacy of the program;
- inability to effectively communicate and interface with the mortgage banking industry;
- duty under the NSP to purchase assets at a discount below value; and
- disagreement with the mortgage banking industry on valuation methodology.
The mortgage banking industry, meanwhile, will have its own share of challenges, which include the following:
- a lack of resources to interact with the numerous and disparate local entities attempting to execute their strategic plans,
- fiduciary and contractual duties to the government-sponsored enterprises and investors to realize highest and best value on disposition of REO assets, and
- disagreement with local entities as to valuation methodology.
As can be seen, some of the challenges described above are mutual. In some instances, the mortgage banking industry and local interests are at odds with one another on issues such as the price point at which assets can be acquired and the valuation methodology used to reach that price point. Add to this the impediments to effective communication and negotiation between the industry and local entities, and the outlook for attainment of the NSP begins to look a bit challenging.
Bridging the gap
While there are challenges that our industry and local stakeholders will face as execution under the NSP begins, there are also possible solutions to remove these impediments. The National Community Stabilization Trust (NCST) represents a viable bridge between the industry and local entities. The NCST was created to connect servicers and investors with local entities in efforts to address the decline of communities with high concentrations of vacant and abandoned foreclosed properties.
The purpose of the NCST has become increasingly relevant in the context of the NSP. The NCST engages in four primary activities. In the transfer of foreclosed properties to local entities, the NCST essentially serves as a single point of contact to negotiate bulk sales.
The trust also serves a role in providing financing to support local efforts. The NCST will have the stature to rally governmental, private philanthropic and other financial resources and make those more readily available to local entities.
The trust organizes and facilitates local collaboration and is working to build frameworks for management, rehabilitation and transfer of REO assets that are reusable to help local entities overcome some of the challenges mentioned above so that resources are not expended locally, reinventing the wheel.
Last, the NCST advocates for programs, policies and resources, serving as a unified voice for the sponsors of the trust and a platform to address issues and facilitate collaboration at the national level.
The NCST will commence operations in early 2009, coinciding with the availability of the NSP funds from HUD. It is currently operational in a small number of test locations and has developed relationships with many of the largest financial institutions.
Valuation will be a focal issue under the NSP. The mortgage industry is accustomed to valuations consistent with Financial Institutions Reform Recovery and Enforcement Act of 1989 standards, uniform appraisal standards and fiduciary obligations to investors. The difficulty is that traditional valuation models result in high error rates with vacant properties in heavily impacted neighborhoods.
In today's economic climate, traditional valuation models are often not sufficient, as they tend to be retrospective rather than contemporaneous or prospective (making market comps unreliable). The inventory of unsold homes is on the rise, and housing prices are experiencing a rapid and ongoing devolution. Moreover, there's a lack of available credit to qualified buyers, resulting in a reduced demand or ability to purchase.
In addition to the intrinsic and contextual problems with traditional valuation models, there are conflicting legal standards and fiduciary duties surrounding the current process of selling REO assets vis-a-vis the valuation parameters required under the NSP that require discounted pricing.
The policy objectives reflected in the NSP will require a shift in how the industry looks at valuation of REO assets and an adjustment of expectations. Otherwise, valuation will be an insurmountable hurdle to the realization of the NSP program goals and the benefits it can bring to the industry and to local communities.
Our industry will have to examine the definition of market value, keeping in mind the context and considering perspectives on valuations such as disposition value, liquidation value, highest and best value, and restricted-use value.
Many are looking at net realizable value (NRV) as an appropriate valuation methodology in the current environment, particularly if the NSP is going to succeed. NRV would be a selling price in the ordinary course of business, less costs of repair, holding and disposition. NRV is a recognized valuation approach consistent with Financial Accounting Standards Board principles.
Although the ways in which the industry and the local governmental entities may look at value come from different perspectives, it is clear that there is an area where these perspectives are likely to overlap, and an agreement regarding value and opportunity may exist. The fundamental challenge on this issue will be in how quickly and efficiently this area of overlap in perceptions of value can be reached.
Wes Kozeny is managing partner of Kozeny & McCubbin LC and board chairman of the American Legal & Financial Network. He can be reached at (314)744-5680 or firstname.lastname@example.org.