Category Archives: Money Matters

Loans Getting Even Harder For Townhouses

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I was talking to our mortgage guy at Wells Fargo the other day, and on top of the rehab loan amounts going down over $100K on September 30, there are now restrictions on using rental income to qualify for a mortgage.

We qualified for our mortgage by taking our incomes and adding 75% of the expected rental income. Only with that rental income were we able to qualify for our mortgage. Now people getting loans have to prove that they can pay the mortgage payment out of their own pockets with no help from rental income. That’s a huge barrier.

Take us for an example… We’re not rich, we just invested well when we bought our coop back in ’98 and walked away with (barely) enough to buy a shell nearly “all cash” when we sold our coop in ’09. We were pushing the debt-to-income ratios as it is. Come October the $930K loan we got would drop to $800K, and then the $1,500/mo (75% of $2,000) that we calculated in as rental income wouldn’t count. That would drop the loan we would qualify for by almost another $300,000. We just couldn’t do any sort of renovation for $500K. It would have stopped us dead in our tracks.

There are exceptions to the rules. You can count the rental income if 1) you can show that you’ve managed rental property before, and 2) if you’re a first time home buyer. You can also ask for an exemption if there is an established rent roll for the building and the tenants are staying put. But of course, that’s never the case with shells undergoing major renovation.

All of this is because the banks are worried about the borrowers covering the first few months of mortgage payments. So I asked if an escrow could be set up to cover those months – the answer was ‘no’…

The thing is, even in a case like ours (which pushes the limits) the numbers really do work once a tenant is in place. We’ll be paying slightly more for 3,000 sq. ft. in a townhouse than we used to pay for our 1,350 sq. ft. coop – and rental income is a big part of the reason why the numbers work as well as they do.

What this means for Harlem townhouses is fewer of them will get renovated and the renovations that are done will be lower end “rental grade” renovations. It also means more investors doing renovations and fewer owner occupied townhouses. All of those factors have a direct negative impact on the community.

As always, if you’re affected by the new changes – talk to one or more mortgage experts to see if there are loopholes you can qualify for to get around the rules. There may be factors I’m not familiar with that will affect whether you qualify for the mortgage you need.

Good Overview Of Real Estate Market

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I thought this interview with Richard LeFrak had a lot of truth in it…

The take-aways are:

  • There’s a glut of single-family homes across the nation. Values are still 10 to 15% higher than they should be and are likely to continue to decline.
  • Rental properties are doing very well right now since people are afraid of being trapped in a bad investment if they buy, so they’re renting.
  • A lot depends on the City. If the City has job growth its real estate market is fine (e.g. Washington D.C.)
  • Commercial real may be going back into a bubble. Low interest rates are what’s spurring the investment.
  • New York City is doing pretty well.

Lower Mortgage Limits Coming September 30

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MAJOR CORRECTION: I’m going to sticky this post for a few days. Max loans aren’t going down nearly as much as I thought they were. So the situation isn’t all that dire. It’s worse, but not all that much worse… Essentially the limits on conforming loans are going down just 15% after September 30. I’ve stricken the parts that were wrong, and put corrections in italics.

The big news today was that it seems there’s bipartisan support for lowering the loan limits for Fannie and Freddie in high cost areas like New York. Assuming it happens, it could have a rather profound effect on places like New York – and it will particularly affect Harlem townhouse shells where many of us depend on the higher loan limits to make the numbers work and the banks avoid the risk of renovation loans.

Right now in NYC, you can borrow up to $729,750 for a 1 family home without having to get a “jumbo” mortgage – that will drop to $417,000 $625,500. For a 2 family you can currently borrow up to $934,200 – that will drop to $533,850 $800,775. For a 3 family you can currently borrow $1,129,250, but that will drop to $645,300 $967,950. (And so on…)

What that means is that fewer people will be able to buy townhouses since they won’t be able to qualify for federally insured mortgages that cover enough of the costs. They will have to try to get mortgages from banks that will require much larger down payments, higher incomes, and overall much less risk for the banks. There already is no such thing as a jumbo renovation loan – so renovation loans will really dry up are less likely to cover the cost of renovation come this fall. Somewhat less demand means real estate prices will could drop slightly (because of this). Properties like shells that are particularly risky will probably see the biggest drops are the most likely to be affected.

This is major will have real effects on Harlem townhouses…

Those of us who have already bought will could see the prices of our homes drop in value since there will be less competition among buyers slightly fewer buyers will be able to get the size of loans they need.

People who are buying will find it somewhat harder to get mortgages that cover all the expenses. A lot of people just won’t qualify. We wouldn’t qualify be able to do the renovation we want to do under the new rules. It doesn’t mean the buyers can’t afford the homes. Our place will actually be quite affordable once it’s all done. It’s just that the renovation process is a risk no bank wants to take on.

My advice to people who own shells that are on the market is SELL NOW! realize after September 30 the value of your place may go down even further. If you’re holding that property after September 30, you’re probably going to hold it for quite a while into the future and it will sell for substantially less money. Now is not the time to be greedy.

If you own a shell and haven’t closed on your rehab mortgage – do everything what you can to close the mortgage before September 30 - otherwise you may not be able to do as nice of a renovation.

If you’re in the market for a shell – that’s a tough one… After September 30 you may not be able to afford a townhouse at all. But closing on a rehab mortgage takes time. You need approved plans (which can take months to get), you need a contractor who’s ready to start, etc. And on top of it all it’s possible the place you buy could drop in value shortly after you buy it.

The same goes for renovated townhouses, but to a lesser degree – the situation won’t be quite as dire for livable places Renovated townhouse may not feel the hit much at all since jumbo mortgages will be available for them (just a little harder to get).

After September 30 cash will continue to be king (even more than it is now). You’ll need a large down payment PLUS pretty substantial income. It’s sorta sad really. The current crop of homeowners who are buying and renovating shells are often pretty regular Joes… A lot of them will just be priced out of the market.

I feel fortunate that we bought when we did and got our loan closed when we did. Yes, our place will most likely go down in value, but renovated places will fair better than shells since banks will be still be lending on regular, non-rehab mortgages. We’ve always taken a long-range view of the townhouse purchase. It will still be affordable for us after we get done. And I’m not sure any of this will matter in 15 or 20 years and we have every intention of living in our place for that long…

Hopefully something will happen to derail the support for these changes. It’s being implemented all wrong… They should take everyone down slowly. They way they’re proposing will hurt places like California and New York and not change anything for middle America. Hopefully common sense will prevail and none of this will come to reality. But from the sounds of it, it’s a done deal.

 

Harlem Townhouse Shells, Rehab Loans & Fannie/Freddy

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At our mortgage closing the other day our loan officer made an interesting comment – “there are no jumbo rehab loans”. Jumbo loans are really big mortgages that are bigger than Fannie Mae or Freddy Mac are willing to insure. They’re purely a bank product. People can still get regular jumbo mortgages, but jumbo rehab loans simply don’t exist – the banks think they’re too risky. The line between “conforming” and “jumbo” is determined by Fannie Mae and Freddy Mac. Currently conforming loans in New York max out at $729,75o for a one family, $934,200 for a two family, and $1,129,250 for a three family. Where this comes into play vis-à-vis Harlem townhouse shells is that it limits who can buy and renovate shells and how the townhouses are configured. Let’s take a few examples and see how this plays out…

Harlem’s little townhouses – 12.5′ x 53 x 4 stories

Dotted all around Harlem are 12 1/2 foot townhouses where the original developer fit two homes on one 25 foot lot. These have 2,650 sq. ft. including the walls, 2,350 sq. ft. inside the walls (586 per floor).

If we assume $165/sq. ft. for an average shell, that puts the purchase price around $450K. Then add $530K ($200/sq. ft.) for a nice renovation and the total cost will be just under $1M.

Owners are probably going to want the entire house for themselves – 2,350 sq. ft. isn’t that much when you subtract the space taken by the staircases, etc. Since only $730K can be financed with a conforming mortgage that means the potential buyer needs nearly $300K in cash to make it work.

If the buyer converts it to two family then only about $100,000 of cash is needed, but then the buyer gets a pretty small space and won’t get much rental income since the unit will be pretty small.

The standard “smaller” Harlem townhouse – 16′ x 50′ x 4 stories

All over Harlem you see 16 footers that are roughly 16′ x 50′ x 4 stories (3200 sq. ft. total, 2880 sq. ft. internal sq. ft. internal, 720 sq. ft. per floor). These will probably cost $525K to purchase (plus or minus depending on condition and location), and cost $650K to renovate – so $1.175M in total investment.

Chances are the buyer will want to configure it as a two family – so they’ll need about $250,000 in cash to put down (minimum).

If they configure it as 3 family their unit will be less than 1,500 sq. ft. and they’ll lose the back yard and only have a roof deck (much less desirable for the owner). But then they only need about $50K down and they can go with low-money down FHA-backed 203(k) loan.

The popular 18 footers – 18′ x 55′ x 4 stories

18 footers are popular because they’re wide enough to have floor through rentals which are popular with developers. But putting developers into the equation ups the prices. They have about 3,950 sq. ft. (3,600 interior, 900 per floor). With developers in the picture I’d expect the cost to be around $710K for the building and $790K for the renovation – so $1.5M total investment.

Configured as a two family the owner would get 2,700 sq. ft. but would need $575K in cash to make it happen.

Configured as three family the owner gets 1,800 sq. ft., but loses the back yard and still needs $375K in cash to pull it off.

While a developer might make it 4 family, there’s really no point. The increased taxes on 4 family (compared to 3 family) and having just a small apartment make it not worth while to the owner.

The coveted 25 footers – 25′ x 52′ x 4 stories

25 footers are just elegant. The space in them is incredible – 5,200 sq. ft. total (4,800 internal, 1,200 per floor). Typically 25 footers have 12+ foot ceilings on the parlor floor so they just feel cavernous. They’re wonderful houses. But with that space comes higher cost… Probably $900K for the building, plus $1M for renovation for a total cost of about $1.9M.

The most spectacular configuration is an owner’s triplex over a ground floor rental. That would give the owner a 3,600 sq. ft., 6 bedroom house with substantial rental income from a legal two bedroom apartment. But they would need $1M in cash since the 2 family rehab loan maxes out at $935K.

The other configuration is two floor-thru tenants over an owner’s duplex. But with that configuration the owner still needs to come up with $775K in cash.

5 story townhouses

In each of the scenarios above it’s possible you could buy a 5 story townhouse instead of the more common 4 story. In some cases it makes adding a unit easier and more desirable since the owner’s unit will have an additional floor. But it ups purchase and renovation costs.

The bottom line

The bottom line is that the lack of jumbo rehab mortgages means that potential buyers either need a lot of cash or they need to be OK with not having a very big owner’s unit. That severely limits the pool of people who realistically are suited for rehabbing buildings. The other thing to note is that this is a bigger problem for bigger townhouses since the costs go up and there aren’t jumbo mortgages to offset the increased costs. Even the little townhouses can easily exceed the max amounts for conforming mortgages.

If you look at some of the posts I’ve had on what things are selling for you’ll notice the gap between shells and livable townhouses is bigger than you might think. I think part of that spread is due to what I just described above – the potential buyers for shells are limited because the loan amounts for rehab mortgages are limited.

But it gets worse…

The problem looming on the horizon is that politicians want to scale back Fannie Mae and Freddy Mac. If that happens it means no more Fannie and Freddy mortgages. There are proposals to make this happen over the next two to ten years. NYC already has increased loan amounts because we’re in a high cost area. As Fannie and Freddie get scaled back all of that will just go away. In fact people think 30 year fixed rate mortgages will go away if Fannie and Freddie are eliminated or severely scaled back.

The politicians who are advocating getting rid of Fannie and Freddie aren’t thinking about what it will mean to neighborhoods with blighted buildings – but it will have a huge effect. They understandably want to  stop the federal government from taking on such big risks, but rehabbing blighted neighborhoods is a risk I think it’s appropriate for governments to take on since even if the mortgages default the community benefits. If Fanny and Freddy go away it’s possible next to nothing will get rehabbed in Harlem – or the rehabs will only be done by developers – not by homeowners who are investing themselves in the community. I’m not saying Fannie and Freddie are perfect, but very few Harlem townhouse shells would get rehabbed without them.

Limited Supply of Manhattan Townhouses

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I was looking through The Real Deal the other day and they have an article on Manhattan townhouses…

Recession notwithstanding, the median sales price of a Manhattan townhouse jumped 13.2 percent between 2009 and 2010 … One reason for the jump is that, unlike condos, very few newly built townhouses have been added to the housing stock …

If you’re trying to choose between a condo and a townhouse the supply of each should be one of the things you take into consideration. Think twice about the fact that 1) it’s easy to find a condo or coop, but 2) difficult to find a townhouse. Limited supply = scarcity = higher prices. This will only become more true in the next 10 to 20 years as far more condos are built than townhouses.

The article goes on to explore why Manhattanites prefer new construction for their condos and old historic buildings for their townhouses…

In Manhattan, “new construction [townhouses are] not well received,” Miller concurred. “Gut rehabs are fine, but it’s got to have the bones and the façade.”

Failure to heed this preference can damage a house’s value.

“I’ve seen houses that had contemporary interiors linger on the market,” Desmond said. “One of the reasons people like houses is because they like the way they were built originally, with all the different kinds of woods for the floors and that kind of thing.”

When advising Manhattan homeowners who are renovating, he said, “I always tell people that you should keep as much of the original detail as you can … because that is what will sell the house.”

Well, we’re doing a contemporary interior inside a historic exterior – so not exactly following their advice. Then again we don’t have any original details and we don’t have the budget to recreate a high quality “original”(ish) look. I’d love to ask “Desmond” more details about his statement. Was the level of finish equivalent on the contemporary interiors? Were the contemporary interiors taste specific or dated in anyway?

One of my mantras in the design of our place was that the space not feel particularly dated in 10 years. We saw some (nice) townhouses on our search that were already feeling dated just 5 years after they were completed. There was on on 130th Street that had an “infinity” bathtub where the water came from the ceiling. A more classic bathtub with contemporary details wouldn’t have felt so dated.

There’s a difference between “dated” and “classic”. If you can manage to hit on something that becomes “classic” it won’t ever really feel “dated” – at least not in a negative way. Take Poliform / Varenna as an example. If you saw a kitchen they did 10 years ago, I’m guessing it would be difficult to tell it wasn’t done last year – they understand how to do a “classic minimalist” aesthetic.

The other way we looked at it was whether it’s easy to “freshen” up the space to make it more current. We wanted fixed elements to be classic and we’re OK with more replaceable elements being a bit more “on trend”. For example, I was worried about the design of our staircase until our architect proposed a staircase with removable panels. If the shape or materials we use become dated, we (or the new owner) can always replace them with something else without replacing the entire staircase. If the new owner doesn’t like the fact that we have open risers, they can fill in the space and have closed risers, etc. If the new owner doesn’t like our flush baseboards and lack of crown mouldings, they can add baseboards and crown mouldings over what we’ve done.

But I digress… The point of the article is that Manhattan is only so big and as the space in Manhattan becomes more valuable “extravagances” like townhouses will be come more and more rare. On top of that there’s a limited supply of historic townhouses in Manhattan and that leads to the prices of those townhouses increasing faster than other types of properties – especially when the interior feels historic as well as the exterior. Ergo, Manhattan townhouses are a good investment. I really do think Harlem will be the Manhattan neighborhood with the highest price increases over the next 20 years and I think the best investment within Harlem right now are townhouse shells. But that’s just my opinion – I’m a bit biased :)