FEATURE ARTICLE, MARCH 2009

THE 35 PERCENT SOLUTION FOR THE HOME MORTGAGE MESS
Reducing defaulting loans by 35 percent may be the solution for shoring up troubled mortgages.
Steven J. Waldman and W. Carter Gremp

Of all of the financial and fiscal stimuli in the federal government’s tool box, using land sales to reduce bad home loans by 35 percent may be the solution for shoring up troubled mortgages. Based on average prices for commercial land sales, it is reasonable to assign 35 percent of total property value to the land component, with improvements making up the remaining 65 percent. The government should establish a program to buy the land underlying homes with defaulting mortgages and use the proceeds to pay down that mortgage.

Mortgage Mess

Estimates of the actual size of defaulting residential mortgages are not readily available. In 2008, total outstanding loans in the U.S. totaled $27 trillion. If one-third makes up residential mortgages, with approximately 7 percent forecast to be in default by the end of 2009, the country has a $630 billion problem related to residential mortgages, which is close in size to the government sponsored bailout.

The Solution

As part of the bailout, the federal government writes a check to the lender for 35 percent of the troubled mortgages, or $210 billion covering the purchase of the underlying land. Unlike debt forgiveness, the government is not giving “something for nothing.” Rather, the government exchanges the land under homes for proceeds to reduce troubled loans. The government would then set up a long-term land lease of 99 years, with the homeowner as tenant, and charge the homeowner 4 percent of investment as rent per year.

How It Would Work

Homeowners and lenders would submit a request on a government website for the U.S. Treasury to make an offer on the underlying land. If the property qualifies, the Treasury will respond with an appraised value. The homeowner may then accept price and terms of the offer, with proceeds from the sale going to pay down principle and arrearages on the property’s mortgage. Banks must accept that they will no longer have as collateral underlying land on the residual loan. A land lease is put in place. The title company distributes new title documents to homeowner and government.

The land lease must include an option for the homeowner to buy back the land at an amount equal to government’s purchase price, so that the homeowner retains the ability to sell the whole property to a new owner.

The federal government is able to offer homeowners a lower rental rate than the cost of their previous mortgage payment, firstly because the transaction is subsidized by the federal government, and secondly because the land lease payments are backed by both the homeowner and the first mortgage on the home — if homeowner ceases making payments, lender at the leasehold level must do so.

The Plan’s Advantages

In most cases this strategy would save the homeowner from foreclosure and eviction.

It will reduce homeowner’s monthly payments by 15 percent to 20 percent, to bring them in line with what the homeowner can afford to pay.

It is a solution for banks’ troubled loans, by reducing exposure by 35 percent and shoring up bank balance sheets.

With this plan, the government does not give away taxpayer money for nothing in return. The government receives a 4 percent yield on investment, and when markets stabilize, it will have assets that can be pooled and sold as a security at a profit.

It injects liquidity into the residential real estate market, helping to spur further lending from banks and other capital sources.

By setting up an appraisal system and commitment to invest at a certain level, the government sets a benchmark that helps shore up falling real estate values.

Further Details About The Plan

This structure is already common with commercial real estate and condominiums, especially in urban centers. Battery Park City located on the southwestern tip of Manhattan in New York City was created by New York State in the late 1970s out of landfill. It remains owned by a state entity, the Battery Park City Authority. Numerous condominiums have since been built in Battery Park City on parcels controlled with land leases.

The homeowner retains full use of the land and ownership of all improvements. The lease terms are very long in duration with 99 years or longer common. Property expenses flow 100 percent to the homeowner, including taxes, utilities and any capital improvements. In the event of casualty or condemnation, the methods of reimbursement via insurance or government payment are spelled out in the land lease to carefully match the respective party’s interest in the property.

Rent increases in later years could make land leases more desirable for resale, as well as give homeowners with underlying land leases an incentive to exercise their buyout option. Another strategy is to amortize rent payments over the life of the lease, to incrementally pay off government’s investment.

Steven J. Waldman and W. Carter Gremp are presidents of Spectrum Realty Services, LLC. Waldman, who specializes in 1031 exchanges, has developed a program to separate leasehold interest from fee simple interest in real estate to maximize value to the owners. Gremp, has closed more than  7 million square feet of commercial real estate nationwide.

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