Last week John Koskinen, Chairman and Chief Executive of Freddie Mac, made the bold statement that the worst of the housing market is “clearly” behind us. This must be some kind of “exit” statement as he’s heading for the door next month. He sees the uptick in housing numbers and lull in foreclosures as basis for renewed enthusiasm and optimism. But is it time to break out the party hats? Not just yet. According to recent studies by Deutsche Bank and Credit Suisse, we may be in for a renewed cycle of loan defaults equal or in my opinion, greater than we experienced in 2007-2008.

A recent research report by Deutsche Bank, as reported on MSNBC, estimates that roughly half of all U.S. homeowners will be under water by 2011. Credit Suisse recently reported that we may be in for a renewed cycle of loan defaults equal, or in my opinion, greater than we experienced in 2007-2008. Credit Suisse estimates that during June 2009 mortgage defaults reached a two year low and are now one third the number that occurred during the fourth quarter 2008 peak. The next great wave will be in resetting teaser rates in Alt-A and Option loans.

We should see Alt-A and Option adjustable defaults begin to swell later this year, peaking in 2011 with a slow decline into 2012-2015. During that next peak in resetting teaser loans, the number of loan defaults and foreclosures will in all likelihood be higher than in fourth quarter 2008, and more than three times what we are experiencing this year.

Alt-A and Option teaser loans were not limited to one or another economic class. They helped the poor and well heeled buy up on property they couldn’t otherwise afford. The bigger problem with this next wave in resets is that it begins in a world where millions of jobs have already been lost along with billions in home equity, unlike the world of 2007-2008 when we kicked off this great recession we’re in today. That means that folks close to the edge will fall off even faster than before unless there are effective programs in place to refinance and stem the flood tides of default and foreclosure.

With the next great wave of resets on the horizon, I’m not ready to start celebrating the turning of the tide just yet. Lenders and government officials must put effective programs in place to take out the teaser loans that could pull our economy and housing market out to sea in the greatest riptide we’ve seen in our housing history.

On August 1, 2009, the FTC began enforcing its so called “Red Flag Rules,” which requires certain businesses, including franchisors, to develop effective programs to identify the warning signs of identity thief.

Franchisors that regularly extend “credit” to their franchisees or arrange financing are subject to the rule. A franchisee may be regarded as a creditor if it defers payments from its franchisees or extents credit or if a franchisor bills a franchisee after providing goods or services. The other way a franchisor would fall under the rule is if it suspects that it may be subject to risk of identity thief. With such broad coverage, most national and regional franchise systems would appear to be subject to this new rule.

If a franchise system is subject to the rule, then it is responsible to develop and put an effective identity theft program into place. The program must be approved by the corporate board of directors or senior management. Failure to comply could result in a franchisor being fined civil penalties.

Although burdensome on franchisors, hopefully this new rule will help curb identity thief, a growing international concern. For more information about the Red Flag Rules, the FTC has published a free plain-language handbook, Fighting Fraud with the Red Flags Rule: A How-To Guide for Business. For a free copy of the guidebook, or for more information about compliance, visit the FTC’s website.

Postscript: With news today of Federal prosecutors charging a Miami man of trying to gain access to 130 million credit and debit card accounts, mostly though hacking into retail networks, it’s difficult to argue against the logic of the Red Flag Rule, despite the obvious burden it places on certain business and franchise enterprises.

Hope you’re enjoying the heat. Certain lenders may not be enjoying the heat caused by the new changes to RCW 64.24.

On July 26, 2009, legislative changes to the Washington Deed of Trust Act went into effect. The Act amends RCW 61.24.005, 61.24.010, 61.24.040, and 61.24.060; reenacting and amending RCW 61.24.030; adding new sections to RCW 61.24; adding a new section to RCW 59.12.

The principal amendments require coaching of delinquent borrowers for deeds of trust made from January 1, 2003, to December 31, 2007. Prior to sending a notice of default, the trustee, beneficiary, or authorized agent must contact the borrower by letter and by telephone in order to assess the borrower’s financial ability to pay the debt secured by the deed of trust and explore options for the borrower to avoid foreclosure.

According to the legislative record, a 30-day extension is made to the current timeline for foreclosure, measured from the time the lender contacts the borrower by letter and telephone to attempt a work out to avoid foreclosure.

During the initial contact, the beneficiary or authorized agent must advise the borrower that he or she has the right to request a subsequent meeting and, if requested, the beneficiary or authorized agent shall schedule the meeting to occur within fourteen days of the request. The assessment of the borrower’s financial ability to repay the debt and a discussion of options may occur during the initial contact or at a subsequent meeting scheduled for that purpose. During the initial contact, the borrower must be provided the toll-free telephone number made available by the department to find a department-certified housing counseling agency and the toll-free numbers for the department of financial institutions and the statewide civil legal aid hotline for possible assistance and referrals.

The new law does not apply to deeds of trust securing: commercial loans, obligations of a grantor who is not the borrower or a guarantor, or a purchaser’s obligations under a seller-financed sale.

After the initial contact is made, if the lender is to proceed with a notice of default, then the notice must contain the following:

You should take care to protect your interest in your home. This notice of default (your failure to pay) is the first step in a process that could result in you losing your home. You should carefully review your options. For example:

You may feel you need help understanding what to do. There are a number of professional resources available, including home loan counselors and attorneys, who may assist you. Many legal services are lower-cost or even free, depending on your ability to pay. If you desire legal help in understanding your options or handling this default, you may obtain a referral (at no charge) by contacting the county bar association in the county where your home is located. These legal referral services also provide information about lower-cost or free legal services for those who qualify.

That’s just some of the highlights. For full detail see http://apps.leg.wa.gov/billinfo/summary.aspx?bill=5810&year=2009#documents.

Because these new requirements only apply to institutional loans, it is hard to determine if they will actually assist in preventing foreclosures. Lenders must be willing to actually modify loans and work with borrowers for the new law to have any actual benefit. Otherwise it’s little more than window-dressing. While all institutional lenders have loan modification programs, few if any really work for consumers facing declining home values, along with job loss, reduced hours and pay, or loss of spousal income. The barriers are substantial and most borrowers don’t qualify under present standards. Without a willingness to modify loans on a broader basis, the new laws simply forestall the inevitable, causing a brief reprieve from foreclosure at a greater administrative expense, which will ultimately be borne by all borrowers. The new Act expires December 31, 2012. If it were open-ended, I suspect we’d all be in for a lot more heat when shopping for new loans.

On July 26, 2009 amendments to the Seller Disclosure Act (RCW 64.06) go into effect. The amendments impact mandatory seller disclosures in both improved and unimproved residential real estate transactions. According to an analysis by a non-partisan legislative staff for the use of legislative members in their deliberations, the changes include:

The definition of “unimproved residential real property” is modified to exclude timber land.

A seller must amend the disclosure statement if the seller learns from a source other than the buyer of additional information or an adverse change that makes the disclosure inaccurate.

Unimproved Residential Real Property Disclosure Statement.
Several questions on the disclosure statement are modified in the title, flooding, soil stability, and environmental sections.

Title.
• The question regarding rights-of-way, easements, or access limitations is modified to ask whether they affect the buyer’s use of the property rather than “may” affect the buyer’s use of the property.
• The question relating to zoning violations, nonconforming uses, or any unusual restrictions on the property is modified to ask whether they affect future construction or remodeling rather than “would” affect future construction or remodeling.
• Rather than asking whether there are any covenants, conditions, or restrictions which affect the property, the question asks whether there are any recorded against the title.

Flooding, Soil Stability, and Environmental.
• Questions related to flooding, standing water, or drainage problems and fill dirt, waste, or other fill material are moved to the “Environmental” section.
• The question related to transmission poles is changed to ask whether there are transmission poles or other electrical utility equipment installed, maintained, or buried on the property that do not provide utility service to the structures on the property.
• The question related to radio towers is modified to ask for information about those that cause interference with cellular telephone reception.

Improved Residential Real Property Disclosure Statement.
Several questions on the disclosure statement are modified in the title, water, structural, systems and fixtures, and environmental sections.

Title, Water, Structural, Systems and Fixtures.
• Rather than asking whether there are any covenants, conditions, or restrictions which affect the property, the question asks whether there are any recorded against the title.
• A question is added about defects in the operation of the water system.
• Rather than asking whether the roof has ever leaked, the question asks whether the roof has leaked within the last five years.
• A question is added about whether the property has a wood stove, fireplace insert, pellet stove, or fireplace and whether the wood stove or fireplace inserts are certified as clean burning appliances to improve air quality and public health by the U.S. Environmental Protection Agency.

Environmental.
• A question is modified to ask whether there is any flooding, standing water, or drainage problems that affect the property or access to the property.
• A question is modified to ask about dirt, waste, or other fill material on the property.
• The question related to transmission poles is changed to ask whether there are transmission poles or other electrical utility equipment installed, maintained, or buried on the property that do not provide utility service to the structures on the property.
• The question related to radio towers is modified to ask for information about those that cause interference with cellular telephone reception.

See Final Bill Report SHB 1420 (http://apps.leg.wa.gov/documents/billdocs/2009-10/Pdf/Bill%20Reports/House%20Final/1420-S%20HBR%20FBR%2009.pdf).

In reviewing the changes, it seems that many of the questions that arguably drew upon ambiguous personal interpretation, belief, or state of mind have been simplified and call for fact answers. For example, the question “are there any rights-of-way, easements, or access limitations that may affect the buyer’s use of the property…” has been changed by deleting the word “may.” This makes a lot of sense. After all, who other than the buyer can really say if a right-of-way may affect his or her use of the property? The disclosure concerning covenants, conditions, or restrictions has been updated to simply ask if there are any CC&Rs recorded against title, with the words “that effect title” removed. How is a lay person to determine if a covenant effects title or not? Overall the amendments add clarity and precision to the seller’s disclosure obligations. More clarity should result in fewer lawsuits.

Sellers are supposed to furnish a disclosure document to buyers in compliance with RCW 64.06 within five days of presenting an offer. Buyer’s have three days to accept or rescind their offer. However, according to RCW 64.06.07, other than the right of recision prior to closing, RCW 64.06 provides no other remedy to a buyer if a seller fails to deliver a disclosure statement in a residential sale transaction.

The NWMLS has updated Form 17 for the sale of improved residential real property, Form 17C for the sale of unimproved real property, and Form 35, the inspection addendum. Any disclosure in a residential real estate sale after July 26, 2009 should be on the new NWMLS forms or derived directly from RCW 64.06 to comply with the new law.

On April 7, 2009 the Washington Legislature passed House Bill 1856, amending RCW 59.18.570. The new law is designed to provide greater protection to victims of domestic violence, sexual assault, unlawful harassment, or stalking. The statute provides a means for victims of these crimes to flee an abusive situation, and more important, break a residential lease after meeting certain qualifications.

In brief, if a tenant or household member is victim of one of these crimes, has a valid protective order, reports the act to a qualified third party and furnishes this information to the landlord, then the tenant or household member may terminate the rental agreement and quit the premises without further obligation. The request to terminate must be made within ninety days of the reported act. If the rental is terminated under this section, then the tenant is discharged from payment of rent for any period following the last day of the month of the quitting date. Further, the tenant or household member is entitled to return of its deposit, even if the agreement has a forfeiture clause.

If the harassment is from the landlord, then the tenant may terminate the rental agreement and quit the premises prior to making a copy of the protective order or written record of the report, provided that a copy of the order and record are furnished in seven days.

The revisions to RCW 59.18.570 also address adding or changing locks, engagement of law enforcement, and procedures for vacating the dwelling unit.

The forgoing is only a brief explanation of the new law. The full House Bill may be found at http://apps.leg.wa.gov/documents/billdocs/2009-10/Pdf/Bills/House%20Passed%20Legislature/1856-S.PL.pdf. If you are a renter and victim of domestic violence, sexual assault, unlawful harassment, or stalking, then you may wish to consult with an attorney for detail on the law and breaking your lease.

The amendment to RCW 59.18.570 are sensible clarifications to existing law designed to protect a vulnerable class of Washington citizens. The effective date of the new law is July 26, 2009.

The condo market continues to degenerate. Development deals are catering left and right. Many buyers are no longer qualified to close on their presales. Consequently, creative buyers and sellers are looking to the courts to read into their presale agreements what they argue are implied covenants. So far Western Washington courts are not agreeing with creative interpretation of those presale agreements.

Some time has passed since the limo driver’s case against Bellevue Towers was filed and discussed in the press and this BLOG. Recall that the plaintiffs sued Bellevue Tower’s developers and lender for fraud in the inducement, breach of contract, mistake, conspiracy, and violations of the Washington Consumer Protection Act with respect to the presale agreement for their condos. Prior to filing their answer to the complaint, defendants filed a motion to compel mediation and arbitration. In their opposition, the plaintiffs argued that the arbitration clause was unconscionable and should be rejected; that the purchase contract was an unconscionable adhesion (“take it or leave it”) contract; and that the “loser pays” attorney fee clause was unconscionable. In their reply the defendants pointed out that none of the terms were hidden and significantly, that plaintiff’s counsel was told on more than one occasion that ADR is required under the terms of the agreement. King County Superior Court agreed with Bellevue Towers and stayed the proceedings and granted the motion to compel mediation and arbitration. The defendants were also awarded attorney fees. No big surprises there. The court simply upheld the real estate purchase agreement as written, including the alternative dispute resolution and attorney free clauses.

The understandably hard part to swallow for many is losing one’s earnest money when one can’t close a purchase because the developer’s preferred lender that promised you that sweetheart loan, well, maybe just short of promised, advises that you’re no longer qualified to borrow, the promised rate and terms have vaporized, and that you’ll need more down payment money you don’t have because the condo you prequalified for is worth less then when you put down your $50,000 or more that you’re now going to kiss off along with attorney fees. (Run on sentences are allowed in blogs.)

In a similar but different case, on June 25, 2009 the Supremes filed an En Blac Opinion in the matter of Torgerson v. One Lincoln Tower LLC, another Bellevue high rise condo purchase dispute. In this case the development stalled and the developer rescinded its purchase agreements offering to return deposits. The Buyers sued for specific performance and damages. King County Superior Court and Division I upheld the purchase agreement and found for the defendant developer.

Supreme Court Justice Sanders framed the issue as to whether or not a real estate contract can limit a buyer’s remedies for breach to return of deposits and certain monies spent improving the property. The plaintiffs argued that the limitation is unconscionable. The contract contained a standard clause, in all caps, stating that if the buyer fails to close without excuse, the seller can keep the deposit and terminate the agreement.

The Court found that: (1) the contract provisions limiting remedies enforceable (“It is black letter law of contracts that the partes to a contract shall be bound by its terms” Alder v. Fred Lind Manner (2004)); (2) the remedy limitations do not fail their essential purpose; (3) that limitation on remedies is not void for public policy reasons; and (4) that the sellers are entitled to attorney fees by contract as the prevailing party.

In this case, the Court concluded that the buyers, real estate agents, were “sophisticated buyers.” The Court found the buyers were given the opportunity to provide input into their agreements. I’m not convinced of that. Few high rise developers, even in this market, are going to renegotiate seller default provisions under any circumstance. But I suppose knowing that is in itself an opportunity to better understand your position in a transaction.

For now I think it’s safe to conclude that Washington Courts, at least in Western Washington, are going to continue to firmly uphold the limitation of remedy clauses in standard real estate purchase and sale agreements. As Justice Sanders’ stated, “… remedies limitations can cause … Buyers or Sellers to bear the risk of the other party’s breach, depending on changes in the housing market.”

HUD dropped the following news release last Friday. Headlined “Donovan Announces Recovery Act’s Homebuyer Tax Credit Can Immediately Help Thousands of First-Time Homebuyers To Buy a Home.”

WASHINGTON – Speaking to the National Association of Home Builders Spring Board of Directors Meeting, U.S. Housing and Urban Development Secretary Shaun Donovan today announced that the Federal Housing Administration (FHA) will allow homebuyers to apply the Obama Administration’s new $8,000 first-time homebuyer tax credit toward the purchase costs of a FHA-insured home. Donovan said that today’s action will help stabilize the nation’s housing market by stimulating home sales across the country.

For every FHA borrower who is assisted through the tax credit program, FHA will collect the name and employer identification number of the organization providing the service as well as associated fees and charges. FHA will use this information to track the business closely and will refer any questionable practices to the appropriate regulatory agencies, as necessary.

Good news for first-timers. Hay, how about the rest of us? If you want to stimulate the market through a tax credit program, why not open it up? There are a number of ways it could be done such as percentage of sale price or income limits to name just two. It’s good news, but more needs to be done to move the home market into positive territory.

Today’s Seattle Times’ Retail Report featured a story on dwindling occupancy in the downtown retail core. Vacancies are up 3.4% and so are rents – from $31.50 to $31.80. Who would increase rents – even thirty cents a square foot – when vacancies are increasing at the same time with no end in sight? Owners and managers who want to offset the negative impact of rising cap rates (a income multiplier used to value commercial real estate) on pro forma operating statements for valuing real estate investments for one. There are other reasons too. But that is an incentive. At $31.80 PSF, a independent retailer needs to generate sales of $636.00 PSF to “make it” according to conventional wisdom and published statistics (ICSC) as a 5% rent load factor is optimal for most retailers. I said most. Food operators – double that. So, a typical 1,000 square foot boutique needs to generate $636,000 annual sales. In this business environment, that’s a tall order. Get out to your suburban strip center and mini-strip center, the numbers are a little less harsh as rent is quite a bit lower, however, same math applies. And foot traffic is lower, or non-existent, with sales much lower as well. In my client mix, I represent small retailers, the “moms and pops.” I’ve put them in business, and helped them shut ‘em down. It’s painful to watch years of savings and hard work, go down the drain in an economy like this. I’ve also helped many save themselves from themselves, by pointing out the flaws in their business plans, and advising to hold off for another day. I only digress to save my reader from thought that I may have been dishing on small business last week. I wasn’t. As to the recession benefitting “big retailers,” from the onslaught of bankruptcies this past year, I think the jury is still out on that one. Please support your neighborhood mom and pop stores. They stepped out and took the risk. Independent retailers need and deserve our business. Have a great Memorial Day Weekend. Enjoy the sunny Seattle weather.

This morning NPR featured a piece on the National Association of Realtors’ annual convention in Washington DC. The upshot is that the ever-optimistic Realtor group sees a ray of sunshine in the otherwise gloomy real estate market. Thanks to government programs, first time home buyers may qualify for products that may help the battered market. Not so lucky are the commercial real estate brokers, or investors for that matter, as the lending market continues its deep freeze. That with today’s report of lower than expected retail sales, I thought I’d revisit commercial real estate investment grade cap rates and sales.

Ouch… Deals that were going out a few years ago at 5% cap rates are now in the mid-sevens. What does this mean? If you had purchased a commercial property, say a Walgreens Drug Store with $300,000 net operating income (“NOI”) at a 5% cap rate, back around 2004, 2005, you would have paid around $6MM. A conventional take out loan at 75% loan-to-value would require $1.2MM equity investment. That same credit tenant lease and NOI today at a 7.5% cap rate is worth a mere $4MM. In other words, that brilliant 2005 addition to the portfolio is now upside down to the tune of two million bucks, rounded. You’ve not only lost all your equity, but your loan is upside down too. Worse for the rest of us, your lender is south in security in the neighborhood of $1.5MM (the difference between the $4.5MM he or she could have underwritten then, versus the $3MM that could otherwise be underwritten today). If you bought a little strip center to go along with your mini-anchor, filled or partially filled with zero-credit tenants (mom and pop coffee shops, dry cleaners, hair, nail and tanning salons, struggling franchised five buck sandwich shops, etc.), then that part of the portfolio is in even worse shape, if that’s possible. It certainly is on paper if you’re being honest. There are tons of those deals out there too. And I don’t think their impact has really hit public consciousness or pocketbooks yet. No question, however, that cap rate increases have hit the valuation of REITS, and private retirement portfolios; and increased illiquidity in capital markets, hence the freeze.

There is a title wave of commercial real estate foreclosures ready to hit. It is being held off in some measure, but who knows for how much longer. There is anecdotal evidence in the market that many developers and investors, particularly local and regional mom and pops, are still living in dreamland, grossly overvaluing their portfolios. Lender complicity in these dreams only postpones the pain. Will it turn around some day? Maybe. It always seems to, eventually, but that sunny day is not on the horizon just yet.

Last month the Department of Financial Institutions released an Interpretative Statement related to the Mortgage Broker Practices Act (“MBPA”) and the Consumer Loan Act (“CLA”). The statement was in response to inquiries as to whether or not loan modification service providers must be licensed in Washington State to offer services to Washington residents involving their Washington real property. Anyone exploring Craigslist, the Pennysaver or other compilations of classified ads knows that the sharks run thick in those waters trolling for the unwary looking for shelter from bad loans. Interestingly enough, companies from California and Florida seem to lead the pack. Some are looking for lawyers and former real estate agents to partner in the loan modification business.

The short answer is yes. In order to offer loan modification services in Washington State requires licensing under the Mortgage Broker Practices Act RCW 19.146, or Consumer Loan Act RCW31.04, unless a specific exemption applies. Significant excerpts from discussion section of the Interpretative Statement follows and makes for good reading for anyone seeking services from a loan modification specialist:

The Division has received many inquiries regarding the regulation of loan modification services. According to callers, individuals are communicating directly with borrowers and brokers offering to provide loan modifications services. Many callers inquire about what restrictions are applicable to loan modification services.

In addition to any applicable licensing requirements under either the MBPA or CLA, all individuals who offer or negotiate loan terms for borrowers are prohibited from directly or indirectly employing any scheme, device, or artifice to defraud or mislead borrowers or lenders or to defraud any person; engaging in any unfair or deceptive practice toward any person; obtaining property by fraud or misrepresentation; soliciting or entering into a contract with a borrower that provides in substance that the mortgage broker or loan originator may earn a fee or commission through “best efforts” to obtain a loan modification even though no loan modification is actually obtained for the borrower.

There seem to be new companies coming into, or forming in Washington State, on a weekly basis, offering loan modification services. Many are legitimate; however, many are simply out for a quick buck. And that buck quickly heads south and out of state. We’ve seen too much carnage in this area already. This interpretative has been circulated by the NWMLS and the WSBA Real Property Listserv to advise brokers and lawyers practicing in this area as to what the guidelines are for compliance. Consumers need the same information to make informed choices. As always, it makes sense to shop around before committing. Before you shop, make sure you know the rules of the road.