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How Modern Land Banking Can Be Used to Solve REO Acquisition Problems

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How Modern Land Banking Can Be Used to Solve REO Acquisition Problems How Modern Land Banking Can Be Used to Solve REO Acquisition Problems by Thomas J. Fitzpatrick IV Federal Reserve Bank of Cleveland The foreclosure crisis has become a national Problematic, for sure. But these distressed REO issue over the past few years, affecting virtually properties can also represent opportunities for every region of the country. Problems of wide- local governments to help stabilize, or even spread vacancy and abandonment, however, revitalize, areas struggling with population loss have persisted primarily in older, shrinking cit- and an overhang of housing stock. To capitalize ies, many of which can be found in the Rust Belt, on these opportunities, local governments must where once-strong industries like manufactur- first overcome the challenges of acquiring REO ing and raw materials production have moved properties. Two commonly reported challenges overseas or otherwise reduced employment. As that local governments in and around shrinking these industries moved and evolved, the popu- cities face when trying to acquire REO property lations of their host cities and their inner-ring are bringing the owners to the table to nego- suburbs have fallen, while outer-ring suburbs tiate for the purchase of REO properties and 1 grew. Without steady or increasing population obtaining the financing necessary to acquire to occupy housing stock, vacancy and abandon- and remediate such properties. This article will ment occur organically. The recent foreclosure explore how modern land banking differs from crisis has aggravated this existing problem for traditional land banking, and how the newer shrinking cities. One of the natural results of land banks can be a useful tool to solve these foreclosures in such hard-hit areas is an increase two challenges. in real-estate-owned (REO) properties. Land Banking: Then and Now In shrinking cities, as home loans become delin- Land banking in one form or another has been quent and properties go into foreclosure and are around, in Ohio and other states, for more than auctioned off, it is unsurprising that ownership 40 years. For most of this time, only minor often reverts to the loan owner; there is sim- changes occurred in what land banks were ply too little demand to fill the housing stock. thought to be, how they were funded, and the Logic dictates a rather predictable cycle: the type of properties they acquired. Recent Ohio highest-quality properties will be filtered out of legislation dramatically overhauled land bank- the pool of properties before or after foreclosure ing in the state, reshaping the way land banks through short sales or at foreclosure auctions. can be funded and organized and augmenting This leaves lower-quality houses among those the powers they have to acquire, address, and that end up as REOs. Anecdotal reports and dispose of distressed properties. empirical research suggest that REO prop- erties in shrinking cities are more frequently Land banking was originally used as a munici- 2 distressed than they were even a few years ago. pal tool to acquire and hold large amounts of Private markets often find the REO properties property for redevelopment as a way to encour- in shrinking cities undesirable, as evidenced by age development consistent with municipalities’ the lack of interest in acquiring them. long-term plans.3 As land banking evolved, some have advocated its use as a tool to further Federal Reserve Banks of Boston and Cleveland and the Federal Reserve Board 145 Distressed REO specific goals, such as affordable housing or scope of that mission. In Ohio, such land banks properties represent acquiring and redeveloping tax-delinquent are organized as nonprofit corporations with a opportunities for properties.4 Traditional land banks shared statutorily defined public mission.6 local governments many limiting features; the most important to help stabilize or to this discussion is that they were local gov- Equally important to modern land banks’ flex- revitalize areas ernment programs that passively received ibility is having dedicated staff and a statutorily struggling with properties either not sold at tax-foreclosure defined revenue stream, both of which allow for population loss sales or acquired through donation. long-term planning. In addition, modern land banks are organized and funded on a broader and excess Structuring land banks as municipal govern- geographic scale, allowing them to take advan- housing stock. ment programs is limiting in two important tage of economies of scale when acquiring, ways. First, it means that land banks depend rehabilitating, or demolishing properties and on local governments for funding and staff sup- when funding their operations. These benefits port, which forces land banks to coordinate the allow modern land banks to make bulk pur- efforts of the multiple agencies that support it chases of REO properties directly from lenders without the ability to incentivize those agencies’ in situations where municipalities, acting on efforts. It can also cause land banks’ funding and their own, would be unable to do so. operations to be politicized, making it difficult to engage in long-term, optimum strategic Some Roadblocks on the Path planning. Second, the limited geographic scope to Acquiring REO Properties of municipal land banks’ operations prevents Modern land banks can be powerful tools to them from taking advantage of economies of acquire REO properties as a way to stabilize, scale that would be available if they were oper- and in some cases revitalize, at-risk neighbor- ating in a wider geography, and from better hoods. These newer land banks are designed to addressing problems along municipal borders. deal with the distressed property that is more frequently becoming REO in shrinking cit- Modern land banking has departed from these ies. Additionally, their structure allows them traditional land banking forms in several key to overcome the challenges municipalities face ways. For one, the purpose of land banks has when attempting to acquire REO properties. broadened considerably. While the seeds of In practice, these points are driven home by the modern land banking were planted in the success of Ohio’s modern land bank in over- Genesee County (Michigan) land bank model, coming these challenges. it is in Ohio that modern land banking has fur- 5 ther developed. The Ohio legislation illustrates The ownership of REO properties within a that modern land banks are no longer simple municipality is frequently extremely frag- tools to control future development patterns. mented. This may be a natural by-product of Rather, modern land banks assist public and securitization, which encouraged the aggrega- private redevelopment by actively identifying tion of a geographically diverse pool of loans and strategically acquiring parcels otherwise into a trust that sold securities to a diverse set unattractive or unobtainable by public or pri- of investors.7 Because geographic diversity was vate markets, clearing their titles, and, where an important factor to many investors during necessary, deciding how to remediate the prop- the securitization boom, only the largest REO erty to make it attractive for future investment. sellers will own more than a relatively small Another key difference between traditional and number of properties in the largest jurisdic- modern land banks is that the modern ones are tions. Even the largest mortgage owners—such not organized around narrow goals such as fur- as Fannie Mae and Freddie Mac—who may thering fair housing. Instead, they are given a own a significant number of REO properties in broad public mission and the flexibility to oper- a region will generally only own a small number ate as an independent private entity within the of properties in any one municipality. 146 REO and Vacant Properties: Strategies for Neighborhood Stabilization The fragmentation of ownership can be a large REO sellers against private market participants, problem for municipalities. Municipalities in part because private markets are not bound tend to only be interested in acquiring prop- by municipal borders.8 Thus, it is more likely erties within their borders, and fragmented that private market purchasers will be more ownership makes it very difficult for them to interested in making bulk REO purchases than negotiate with any one REO seller for a large municipalities will. If acting rationally, REO number of properties. Because modern land sellers—who want to be short-term property banks typically cover a much broader geogra- owners—should prefer to deal with private- phy than traditional land banks or any single market bulk buyers over municipal buyers municipality, fragmentation does not interfere interested in fewer properties, as it could help with bulk purchasing to the same extent. The reduce REO sellers’ transaction costs and time more the geographic scope of the land bank’s of REO ownership. jurisdiction expands, the more likely it is that the land bank will be able to engage in bulk Another challenge facing municipalities is purchases of properties from REO sellers. obtaining funding. Assuming municipalities can get REO sellers to the table, they often There is usually no shortage of REO properties have a hard time obtaining funding to acquire in shrinking cities or their surrounding suburbs. the properties in which they are interested. And it is not uncommon that the acquisition One reason is that shrinking cities have corre- of such property fits into a local government spondingly smaller tax bases to fund operations. or nonprofit plan to revitalize a neighborhood, Additionally, traditional land banks, and often suburb, or the central city itself. And yet, once the municipalities themselves, do not have a interested prospective buyers find the right peo- revenue stream earmarked for acquisition of ple to talk to, they often report having a hard REO property, and creating new earmarks may time getting to the negotiating table. Anecdotal be politically challenging. This limits the source reports suggest that this phenomenon is likely of funding for municipal REO acquisition aggravated by a few factors.
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