Legal/Legislative Update – January, 2013

Published on: January 10, 2013


Although surveys show that young adults, sidelined by the economic downturn and rattled by the housing market collapse, appear to be regaining their appetite for home ownership, builders are not curbing their appetite for constructing multi-family housing.

Increasing demand for apartments has pushed rents and property values higher, while low interest rates have created a favorable construction climate. As a result, multifamily construction activity has been increasing steadily for the past two years. Starts increased by 54 percent in 2011 and have been averaging more than 35 percent ahead of the 2011 pace this year. Real Estate Analytics is predicting that multifamily sales for last year will reach $75 billion — 40 percent above the 2011 total.

But even as industry executives have welcomed the multifamily recovery, they have begun to worry that a new bubble could be forming, threatening to produce a glut of vacant, and over-valued rental buildings as home ownership rates begin to rise.

Historically low interest rates have reduced the ratios between annual revenue and market value, pushing property values higher. But industry executives worry about what will happen when interest rates begin to rise.

“Don’t get complacent,” Patrick Simons, an analyst at Strategic Property Economics, warned in a recent client newsletter, noting, “these levels are not the historical norm.”

Some analysts think the norm may be changing, as policy makers and consumers rethink traditional assumptions about home ownership in the wake of the subprime debacle that contributed to the housing market’s collapse. “It is entirely possible that some people aren’t supposed to rent a home – that some people are supposed to rent,” Stephen Gordon, chairman and chief executive officer of Opus Bank, told American Banker.



The skin-of-their-teeth Congressional action that avoided a national plunge over the fiscal cliff also rescued a measure that allows homeowners who participate in a short sale (selling their homes for less than they owe on the outstanding mortgage) or restructure their mortgages, to avoid tax liability on the debt forgiven under those transactions.

In addition to resolving (albeit temporarily) the rancorous debate over spending and tax policies, the fiscal cliff agreement, embodied in the American Taxpayer Relief Act of 2012, also extends for a year the Mortgage Forgiveness Debt Relief Act of 2007, which was scheduled to expire on December 31. That law exempted from taxation up to $2 million in mortgage debt forgiven on homeowners’ primary residence. Realty Trac estimates that the average debt forgiven on a short sale is $95,000, which, the company estimates, could trigger a tax bill of as much as $33,250, depending on the individual’s tax rate.

Housing industry executives and consumer advocates had argued frantically that eliminating this tax break would jeopardize the expanding, though still fragile, housing recovery.

“Our tax policy should not result in bad housing policy that will prolong a foreclosure crisis that has already gone on for too long,” the Center for Responsible Lending and the Financial Services Roundtable argued in a joint letter to lawmakers in early December

The cliff legislation also renews a law that expired a year ago, allowing homeowners to deduct the premiums on private mortgage insurance as well as on government-backed FHA, VA and Rural Housing Service loans. More than 3.5 million homeowners claimed that deduction in 2009, according to Compass Point Research & Trading.



FHA officials have acknowledged that the agency is facing serious financial pressures, but the problems may be even more serious than reports to date have indicated. An analysis of loans approved in 2009 and 2010 found that the foreclosure risks are well above average, threatening losses that could exceed $20 billion. That projected loss would be in addition to the $13.5 billion deficit identified in an agency audit citing exposure related to the collapse of the housing market.

The recent study, by Edward Pinto, a recent fellow at the American Enterprise Institute, focuses on loans originated after the housing implosion, which makes the conclusions “particularly disturbing,” industry observers say. Pinto analyzed 2.4 million FHA-insured loans, looking at their location and borrower characteristics. He found that the agency does not accurately assess the repayment prospects of borrowers, approving high-risk loans and failing to set premium prices that accurately reflect those risks.

Although FHA underwriting standards generally set a maximum housing debt-to-income ratio of around 30 percent, exceptions allowed by the rules pushed that ratio much higher. More than 40 percent of the loans approved in 2010 went to borrowers with debt ratios exceeding 50 percent or with credit scores lower than 660 – borrowers who, Pinto said, were “just a car repair away from failure.”

“The FHA’s underwriting policies encourage low- and moderate-income families with low credit scores to make a risky financing decision,” he said, “one combining a low score with a 30-year loan term and a low down payment. This sets up for failure the very families and communities it is the F.H.A.’s mission to help.”

Equally problematic, he noted, the agency doesn’t adjust the guarantee fees charged to reflect the risks, charging the same amount regardless of their credit scores or size of the down payments they make. He also found a high concentration of loans in low-income zip codes, where foreclosure rates will likely reach 15 percent – above the average of 9.6 percent the FHA’s recent audit is projecting for the two years Pinto analyzes.

The problem is not the agency’s commitment to providing mortgages to low- and moderate-income borrowers, Pinto emphasizes; it is the failure to underwrite those loans prudently and control the risks. He suggested specifically that loan terms should be shorter (20 years rather than 30) and maximum debt loads lower.

“The [agency] should set loan terms that help homeowners establish meaningful equity in their homes with the goal of ending their dependence on F.H.A. lending,” he said.

FHA officials disputed Pinto’s conclusions, particularly the suggestion that long-term loans increase the risks to borrowers and the agency. “The assertion that FHA is setting up potential homeowners for failure by insuring a 30-year, fixed, rate , fully documented loans for underserved borrower is not supported by the information presented, George Gonzalez, an FHA spokesman, told the New York Times. He added that “selective use of FHA data ignores that the [agency] has successfully provided access to mortgage financing for millions of creditworthy borrowers for almost 80 years.”



You probably won’t find many Massachusetts residents who would prefer to live in Michigan, and (not to dis Michigan residents), the reverse may also be true. But when it comes to defending slip-and-fall claims, Massachusetts landlords and community associations have some cause to envy their Michigan counterparts. While Massachusetts courts have made it more difficult for property owners to prevail in those suits, Michigan courts have moved in the opposite direction.

The Michigan Supreme Court ruled last year that Michigan residents should be aware that snow and ice makes walkways slippery, have an obligation to exercise due care and can’t automatically blame property owners if they are injured in a fall.

The case at issue involved a woman who suffered serious injuries in a fall outside a (don’t overlook the irony) health club. The court ruled that she knew the ground was slippery and had no compelling reason to enter the club at that time.

Citing that decision, a Michigan Appeals Court ruled that a supermarket was not liable for the injuries a man received when he slipped in the icy parking lot, because, the court pointed out, he could have shopped elsewhere.

“Michigan being above the 42nd parallel of north latitude is prone to winter. And with winter comes snow and ice accumulations on sidewalks, parking lots, roads, and other outdoor surface,” the majority held in the Supreme Court’s decision, adding, “Landowners are not charged with a duty of ensuring absolutely the safety of each person who comes onto their land, even when that person is an invitee.”

The Massachusetts courts held a similarly unsympathetic view of slip-and-fall complaints until three years ago, when the state Supreme Judicial Court (SJC) eliminated the distinction courts had recognized between “natural” and “unnatural” accumulations of snow – the former resulting from the inevitable falling and freezing of the white stuff, the latter from efforts owners undertook to deal with it.

Under the old legal framework, the courts had regularly rejected slip-and fall claims when the accumulation was deemed natural, providing a sturdy defense for landlords and community associations. But in “Papadopoulos vs. Target Corporation, the SJC eliminated that long-standing distinction, and the exception it had provided to “the general rule of premises liability, that a property owner owes a duty to all lawful visitors to use reasonable care to maintain its property in a reasonably safe condition in view of all the circumstances.”

That ruling leaves property owners more exposed to slip-and-fall liability in Massachusetts than they might be in Michigan, which probably isn’t enough in itself to spur a mass migration from Boston to Detroit. On the other hand, the Tigers did make it to the World Series last year, while the Red Sox….well, never mind about that.


WORTH QUOTING: “It might not be quite as fluid for a period of time, change will come slow, but the private sector will, over time, be able to make up the slack…. When the markets froze up, the GSEs were the only answer just because we hadn’t developed any other model. But the next time it happens, the private sector could be there.” — Walt Smith, CEO of Riverstone Residential, predicting, that private sector lenders will be able to fill the financing gap for multifamily construction created by the restructuring and down-sizing of Fannie Mae and Freddie Mac.