Duplex, triplex and fourplex units supply almost a fifth of the nation’s rental units and play a big role in affordable housing thanks to their prevalence in underserved, low-income communities and older cities.
Lenders treat mortgages on these small buildings like those on single-family homes, meaning borrowers don’t have to go through the more-complicated paperwork required for larger apartment buildings.
The bad news is loans on these units are extremely hard to get these days. Too hard. Why? Like with single-family homes, rules put in place after the housing bust have overcorrected for the loose lending that went on during the boom. Consequently, only borrowers with nearly pristine credit and a sizable downpayment stand a chance of obtaining a loan for a two- to four-unit building.
Lending for these units has plunged from 5 or 6 percent of all single-family lending to just 2 to 3 percent of the market since 2009. And our research shows that the riskiest borrowers aren’t necessarily who you might think.
We’re troubled by this credit tightening because these units play a disproportionately large role in addressing affordable rental housing. They’re prevalent in underserved, low-income communities and in older and larger cities and are consistently more affordable than single-unit properties and large multi-family rentals.
[redfin_table file=”https://redfin.com/blog/wp-content/uploads/2016/05/Goodman-Post-Table-A.csv” footnote=”Source: Authors’ calculations based on 2013 FHFA public use database for Fannie Mae and Freddie Mac.
Note: Rental affordability category is based on the ratio of annualized rent to area median family income.”][/redfin_table]
A look at the numbers
To shed light on why it’s so hard to get these important mortgages, we took a closer look at the potential losses lenders are likely to suffer.
Using newly available data, we analyzed defaults and foreclosures on 14 million mortgages taken on one-, two-, three- and four-unit properties and guaranteed by Fannie Mae or Freddie Mac. We divided the loans into six categories to identify their different risks.
We then compared the likely losses on loans made between 2000 and 2014 against likely losses for loans made just in 2014 to see if lending patterns had changed in this 15-year period. Here’s what we found:
[redfin_table file=”https://redfin.com/blog/wp-content/uploads/2016/05/Goodman-Post-Table-B.csv” footnote=”Source: Urban Institute”][/redfin_table]
Who are the risky borrowers?
The data shows a clear order of risk. Loans on single-unit, owner-occupied houses carried the lowest chance of default. Interestingly, investors in three- to four-unit buildings came in second, ahead of other owner-occupied properties. We attribute this to the additional cushion provided with the income from one or two more tenants.
Note also, however, that owner-occupied units are generally a better risk than their investment-only counterparts. We attribute this to the additional commitment an onsite owner has to maintaining the building that also serves as their home.
An investor who rents out a single house, townhome or condominium has a higher risk of default than a small-building owner. And loans on duplexes, or two-unit properties, showed the highest losses.
Two facts jump out that make it clear that standards are higher than they need to be for two- to four-unit properties.
First, we’re tolerating significantly lower losses on loans than we have historically. The predicted loss numbers for loans made in 2014 are much lower than the 15-year average. This means that higher losses were accepted historically, but increased downpayment and credit score requirements have been imposed to significantly reduce risk.
Second, current rules have brought the risk on two- to four-unit properties down to about the same level as on owner-occupied, single-unit homes. Historically, a typical loss on a failed small apartment loan would by our calculations range from about $5,800 to $10,900. On a single-unit house or condo, it would be closer to $4,600.
As of 2014, the losses lenders would tolerate for small rental buildings were between $1,200 and $1,800, which is remarkably similar to what they were tolerating for single-unit properties.
What should we do?
Borrowers should take time to get up to speed on what it takes to be a successful landlord. One of the most important issues to consider is whether to purchase a two-unit or a three- to four-unit property. As you can see, larger properties offer less risk simply because the additional apartment units help a landlord better ride out a vacancy.
Policymakers need to support counseling to ensure that borrowers on two- to four-unit properties, particularly owner-occupants, understand how to minimize and manage income variability and be a landlord.
Policymakers also need to ease downpayment requirements. Fannie Mae and Freddie Mac increased downpayment requirements for multi-unit loans because of concerns about higher default rates. Losses on those loans now are on par with one-unit, owner-occupied properties. The low volume of these loans suggests many borrowers, who are disproportionately likely to be minority or low and moderate income, are getting squeezed out.
In the interest of expanding credit to underserved populations and increasing, or at least preserving, the supply of affordable rental housing, Fannie and Freddie could relax the current requirements. If they coupled easier standards with counseling for landlords, their costs could be largely offset.
–With Jun Zhu
United States
Canada