Ken Harney — Leasebacks in spotlight

Here are two questions getting a lot of attention on Capitol Hill and from the Obama administration: When homeowners lose their houses to foreclosure, should they be able to stay in the property, leasing it back at fair market rent from the lender?

Should they also get an option to purchase the house from the bank at the end of the lease term, assuming they have the income to afford it?

Before leaving for their break last month, Democrats and Republicans in the House took a rare unanimous stand on both questions by passing the Neighborhood Preservation Act by voice vote. The bill was co-sponsored by Reps. Gary Miller, Republican of California, and Joe Donnelly, Democrat of Indiana.

The bill would remove legal impediments blocking federally regulated banks from entering into long-term leases — up to five years — with the former owners of foreclosed houses. It would also allow banks to negotiate option-to-purchase agreements permitting former owners to buy back their houses.

The idea, said Miller, is, “at no cost to the taxpayer,” to “reduce the number of houses coming into the housing inventory and preserve the physical condition of foreclosed properties,” which ultimately should help stabilize values in neighborhoods with large numbers of distressed sales and underwater real estate.

If the bill is approved by the Senate, participation by banks would be purely voluntary. But the legislation might encourage banks to calculate whether they would do better financially taking an immediate loss at foreclosure, or collecting rents and then selling the property at a higher price in four or five years.

Though it was not opposed by banking lobbies, the bill quickly attracted critics. The Center for Economic and Policy Research, a think tank based in Washington, said a key flaw is to leave decisions about leasebacks solely to banks themselves.

“If Congress does want to give homeowners the option to stay in their homes as renters,” said the group, “it will be necessary to pass legislation that explicitly gives them this right.”

Some private-industry proponents of short sales — where the bank negotiates a price that’s typically less than the owners owe on their note — say turning banks into landlords won’t work well, either for the banks or the foreclosed owners who want to stay in their house.

Al Hackman, a San Diego real estate broker with extensive experience in commercial transactions, argues that leasebacks with options to buy are the way to go — but not if banks run the show. Hackman and a partner, Troy Huerta, have recently begun putting together what they call “seamless short sales” as alternatives for banks and property owners. Their short sales and leasebacks are “seamless” because the financially distressed homeowners remain in their properties, before and after the settlement.

Here’s how they work: First, the bank agrees to a short sale to a private investor, just as they often do now. In the seamless version, however, the investor is contractually bound to lease back the house on a “triple net” basis — the tenants pay taxes, insurance and utilities — for two to three years.

The former owners only qualify if they have sufficient income to afford a fair market rent and can handle the other expenses, including maintaining the property. The deal comes with a preset buyout price after the leaseback period. That price is higher than the short-sale price paid by the investor, but lower than the original price of the house paid by the foreclosed owners.

Hackman and Huerta already are doing seamless short-sale transactions. Here is one that Hackman says is “real life” and moving toward escrow: A family purchased a house for $725,000 with 20 percent down in 2005, then made substantial improvements with the help of an equity line of $72,500. The house now is valued around $500,000, but is saddled with $625,000 in mortgage debts.

Enter the seamless short sale: Hackman has brought in a private investor who is willing to buy the house at current value, all cash. As part of the deal, the investor has agreed to lease back the house at $25,000 a year, triple net. In three years, assuming they’ve been good tenants, the original owners have the option to buy back the property for $550,000.

Hackman says the internal rate of return to investors can be raised or lowered based on rents and the buyback price, but typically are in the 8 to 10 percent range.

“It’s a win-win,” he says. “The owners stay in their houses. Private investors get a moderate return on what should be a safe investment.” Plus, the banks are out of the equation. TRD

Ken Harney is a real estate columnist with the Washington Post.