The Urban Institute’s Laurie Goodman and Jun Zhu have posted Do Two- to Four-Unit Properties Have Higher Credit Risk? An Analysis of Default and Loss Experience to SSRN. The abstract reads,
Two- to four-family properties make up 19% of all rental housing but receive almost no attention. Using a unique dataset from Freddie Mac and Fannie Mae, we show that, for any given set of loan characteristics and compared with one-unit properties, two- to four-unit properties are more likely to default, its owner-occupied (investment) properties are less (more) likely to liquidate, and all two- to four-unit properties are more likely to have a higher loss severity upon liquidation. Historically, these patterns have led to higher losses on two- to four-unit loans. Current tighten credit results in loss rates much closer to those on one-unit owner-occupied properties, indicating that policymakers can relax the credit requirements of two-to-four properties to better serve affordable rental housing.
It is great that the authors are looking at the neglected, middle child of the rental housing market. Providing 19% of the rental housing stock is nothing to sneeze at, even if other segments of the housing stock provide more.
It is particularly interesting to me that owner-occupied 2-4s do better than investor-owned 2-4s in terms of liquidation, even while overall 2-4s are roughly on par with 1-unit owner occupied properties in that regard. There are a lot of other interesting tidbits about this housing stock in the paper, such as the fact that these properties are more likely to be owned by lower-income households and that 2-units have the highest default rates of 1-4 unit properties.
The authors make the case that
though predicted losses on two- to four-unit production are now on par with one-unit owner-occupied properties, the low volume suggests that many borrowers (who are disproportionately likely to be low and moderate income and minority) are getting squeezed out. In the interest of expanding credit to these underserved populations and expanding, or at least preserving, the supply of affordable rental housing, the government-sponsored enterprises (GSEs) could relax the current loan-to-value requirements. If this relaxing were coupled with counseling for landlords, we believe it would make financing more available for this critical part of the market, with little additional risk to the GSEs. (3)
This all sounds good, although I am somewhat skeptical of the claim that reduced financing costs for owners will be passed onto tenants in the form of lower rents or rent increases. There are a lot of factors that go into rent levels, and costs are just one of them. The local demand for housing as well as the competing supply cannot be ignored. Owners may be able to keep all of those reduced financing costs as additional profits, depending on those local conditions.
The main question I am left with after reading the paper is — why haven’t Fannie and Freddie, whose data the paper is based upon, already reached the same conclusion about loosening credit for this type of housing? Do they know something about it that the author’s don’t?
