Recycling At Risk PUDs with SSA Bonds through use of Eminent Domain

 

There has been significant publicity recently about a plan being considered in San Bernardino County, Ca. to condemn “under water” mortgages on single family homes and refinance the mortgagors into non-under water loans, thus bailing out the affected home owners (the “Mortgage Condemnation Plan”).  The Mortgage Condemnation Plan is also being considered by the Chicago city council’s finance committee which is planning to hold hearings on the plan as well as other possible plans starting in mid-August. 

 

Much of the reaction to the Mortgage Condemnation Plan has been negative. I believe that the plan has merit, albeit in a modified form than that which is being proposed in California.  The purpose of this paper is to briefly discuss the reasoning behind the Mortgage Condemnation Plan and then explore variations on the plan that may work in the Chicago area.  

 

The Mortgage Condemnation Plan was first proposed in a paper by Professor Robert Hockett of Cornell University, Breaking the Mortgage Debt Impasse: Municipal Condemnation Proceedings and Public/Private Partnerships for Mortgage Loan Modification, Value Preservation, and Local Economic Recovery, Robert Hockett, 2010.   The basic problem is the fact that a significant number of homes throughout the Country are “under water” in that the value of the home is less than what is owed on the mortgages on the home, often significantly less.  Home values have fallen so low since the housing crash that it is unlikely that values will recover enough in the foreseeable future to bring them above water.  This situation is having a severe negative impact on the economy in general, as well as the under water owners and the communities in which they live.

 

Professor Hockett asserts that short of reinflating the housing bubble, the most logical way to deal with this serious issue would be for mortgagees to agree to principal reductions on under water mortgages.  Professor Hockett explains, however, that even if the mortgagees wanted to write down principal on loans, they can’t because of how the loans were packaged and sold in mortgage backed securities and the restrictions on the  legal authority of the servicers of the mortgage backed securities to write down or sell loans.  In order to accomplish the goal of writing down loans, Hockett suggests that action needs to be taken by a third party that essentially forces the desired result.  The suggested action is the use of eminent domain, a legal proceeding whereby the Municipality takes title to the mortgage loan and pays its current value, as determined by the court, to the mortgagee.  Eminent domain is an established tool that has always been available to municipalities. Getting a mortgagee before the court and forcing ownership of the mortgage to go to the municipality, for just compensation as determined by the court, cuts through all the legal and systemic impediments to getting to the goal of principal reduction. The funds for acquiring the under water mortgage at a discount from its face value would come from an investor who would then refinance the home owner into a new loan at a reduced principal amount, using the new loan proceeds to pay off the condemned mortgage at a discount that would approximate the amount paid by the municipality to acquire the mortgage.

 

The use of eminent domain to acquire title to a mortgage is a departure from the more common use of eminent domain to acquire land for public use, such as to build a highway.  However, a mortgage is an interest in real estate and, as such, can be condemned.  Indeed, Hockett points out that eminent domain can apply to personal property, even intangible personal property.

 

Much of the resistance to the Mortgage Condemnation Plan comes down to several arguments:

 

  1. Taking a mortgage in order to essentially refinance it is not a good enough “public purpose” because it only benefits the home owner, who will no longer be under water, and the investor, who will make a profit.
  2. The plan as currently proposed will target under water, but not delinquent, loans.
  3. This wholesale approach will have an adverse effect on future mortgage lending because of concerns that performing loans will be cherry picked and refinanced,  leaving the lower quality loans in the mortgage backed security from which the performing loan was taken.
  4. There are also several constitutional and jurisdictional arguments that are beyond the scope of this paper.

 

I believe that the Mortgage Condemnation Plan is legally and constitutionally defensible. However, I am troubled by the strategy of taking only under water loans that are not in default.  I am also troubled by the public purpose argument in this context.

 

This leads me to a discussion of how this concept underlying the Mortgage Plan can be applied in a modified form in Illinois.  There is a significant difference between California law, which applies to the San Bernardino situation, and Illinois law.  In California, owner occupied residential property cannot be condemned for private use. Cal. Const. Art I, Sec 19(b).  In Illinois, residential property can be condemned for private use, as long as 20% of the homes are made available for low income housing for at least 15 years. 735 ILCS 30/5.  

 

The Chicago area has a significant number of housing developments that stalled before they could be completed and are currently at risk of failing and bringing down the surrounding community.  A number of planned unit developments (“PUD”)  in the Chicago suburbs have the additional burden of being part of an “Infrastructure Special Service Area” or “SSA”.  An SSA is a special taxing district that levies taxes (“SSA Tax”) on a distinct area, generally an entire PUD, to repay bonds (“SSA Bonds”)  issued by a municipality at the request of a builder/developer.  The funds generated by the sale of the SSA Bonds were used to pay for infrastructure improvements that historically had been made by the builder/developer, where a portion of the cost of the improvements attributable to each lot was built into the price charged for home on the lot in the PUD.  In theory the portion of the cost of the infrastructure improvements which were paid for through SSA Bonds to be repaid out of SSA Taxes attributable by each home would have reduced the price of the home, but this did not always occur. In any event, the SSA tax burden on the homes and the vacant lots in a stalled PUD pushes the values of the homes further under water and, in many cases, makes the vacant lots worthless or worse.

 

I believe that a modified version of the Mortgage Condemnation Plan can work in Illinois with respect to stalled PUDs with SSA Bonds (“At Risk PUD”) without many of the shortcomings and limitations of the Mortgage Condemnation Plan being proposed in California.  I propose the following (“At Risk PUD Plan”):

 

  1. The municipality in which the At Risk PUD is located would use its eminent domain powers to obtain title to all homes and vacant lots in the At Risk PUD by paying an amount equal to the current fair market value of each home and lot, as determined by a court.  The amount paid for each home or vacant lot would go first go to pay off the liens on the home or vacant lot, with the balance, if any, going to the former owner of the home or vacant lot. This process would be essentially a forced short sale (“Forced Short Sale”) of each home in the At Risk PUD.[i]
  2. The municipality would use eminent domain to acquire title to the SSA Bonds at a cost that would be substantially below their face value. 
  3. The municipality would cancel the SSA bonds
  4. The cost of acquiring the homes and vacant lots in the At Risk PUD and the SSA Bonds would be paid by way of a loan from a financial institution or an investor in an amount necessary to pay the cost of the acquisition of the home, vacant lots and SSA Bonds and any additional costs necessary carry out the balance of the plan to reposition and return the At Risk PUD to the community as a viable source of housing (“Recycled PUD”).   The repayment of the loan would be secured by a mortgage on the homes in the Recycled PUD (“Blanket Mortgage”). The Blanket Mortgage would be non-recourse to the owners and would have a home by home release price.  
  5. Homes in the Recycled PUD could then be conveyed to those owner/occupants who desire to continue to own their home, subject to the Blanket Mortgage, for a nominal price. Alternatively, a home could be “sold” to a former owner/occupant by way of an installment sale contract, under which the owner pays the assessments, real estate taxes and share of the Blanket Mortgage service attributable to the home and gets title to the home when the owner sells or refinances the home and obtains a release from the lien of the Blanket Mortgage. Other homes could be rented to former owner/occupants and/or current tenants. To comply with the requirements of the Equity in Eminent Domain Act, 20% of the homes would be sold or conveyed (subject to the Blanket Mortgage) to an investor (which may be a not for profit entity) to be rented to low income tenants.[ii]   
  6. The vacant lots would be sold to an investor or builder free of the SSA or the Blanket Mortgage, with the proceeds being used to pay part of the cost of implementing the plan.

 

To illustrate how the At Risk PUD Plan would work, assume the following:

 

  1. The At Risk PUD consists of 200 lots.
  2. 100 of the lots are improved with homes and have been sold to owner/occupants, most of which have under water mortgages.
  3. 100 lots are vacant and are owned by the original developer, a lender who foreclosed on the lots or an investor.
  4. An Infrastructure SSA was created to install certain subdivision improvements and float bonds to pay for the cost of the improvements, with proceeds from an SSA Tax on each lot (usually $2,000+ per year) in the PUD being used to repay the bonds.
  5. The homes were originally sold for $150,000 each, but are now worth about $100,000 each or less.
  6. A typical home has a mortgage or mortgages totaling $140,000 and, therefore, is under water.
  7. The outstanding face value of the SSA bonds is $3 Million, or about $15,000 per lot (improved or vacant).

 

The At Risk PUD Plan would work as follows:

 

  1. The municipality would condemn the entire PUD, thus transferring to the municipality clear title to all homes and vacant lots in the At Risk PUD.
  2. The municipality would also condemn the SSA Bonds, using the approach and legal basis suggested by Prof Hockett in the Mortgage Condemnation Plan.
  3. Because of the drag of the under water mortgages and the burden of the SSA tax, the value of the PUD as a whole would be significantly depressed.   For purposes of this example, assume the value of the PUD (and thus the total condemnation award) would be in the area of $12 Million, determined as follows: 100 homes valued at about $100,000 each ($10 Million), plus 100 vacant lots at about $5,000 each ($500,000), plus the SSA Bonds at 50% of face value ($1,500,000).
  4. The municipality would cancel the SSA Bonds.
  5. The municipality would put a Blanket Mortgage on all of the homes in the PUD, with release prices of about $100,000 per home, thus supporting a Blanket Mortgage of about $10 Million. 
  6. The municipality would sell the vacant lots (free of the SSA tax burden and not subject to the Blanket Mortgage) to a builder or investor for $20,000 per lot or a total of $2 Million.
  7. The proceeds of the Blanket Mortgage and sale price for the vacant lots would fund the condemnation cost of $12 Million.
  8. Owner/occupants who can afford to pay the carry on their home (which will be reduced from what they were paying prior to the condemnation) will be conveyed title to their home, free of the SSA tax burden and subject only to the Blanket Mortgage with a release price of $100,000. Alternatively, a home could be “sold” to a former owner/occupant by way of an installment sale contract, under which the owner pays the assessments, real estate taxes and share of the Blanket Mortgage service attributable to the home and gets title to the home when the owner sells or refinances the home and obtains a release of the home from the lien of the Blanket Mortgage.
  9. To comply with the Illinois Equity in Eminent Domain Act, 20% of the homes will need to be used for occupancy by low income tenants for at least 15 years. These homes could come from abandoned homes or homes where the former owner chooses not to return to ownership or cannot afford the carry. These homes would be sold or master leased to a NFP who will populate the homes with low income tenants.

10.  The balance of the homes would be sold to an investor, subject to the Blanket Mortgage, to be leased or sold to owner occupants, as determined by the market.

 

I submit that the At Risk PUD plan would clearly satisfy the public purpose by recycling the entire PUD and putting it back on its feet, bailing out under water and delinquent owners (not just those that are not in default), and making it possible for a builder to resume the construction of affordable homes without the burden of the SSA tax.

 

     

 

 

 

 

 

 

           


[i] Following are excerpts from relevant Illinois laws that form the legal basis for the use of eminent domain in this situation

 

  1. Eminent Domain.  735 ILCS 30/5 (Illinois Equity in Eminent Domain Act) (2006) deals with the power of eminent domain.  Section 5-5-5 (e), which deals with the use of eminent domain to acquire property for private ownership, reads, in part, as follows:

 

“(e) If the exercise of eminent domain authority is to acquire property for private ownership or control and if the primary purpose of the acquisition is one of the purposes specified in item (iii) of this subsection and the condemning authority elects to proceed under this subsection, then the condemning authority must prove by a preponderance of the evidence that: (i) the acquisition of the property is necessary for a public purpose; (ii) an enforceable written agreement, deed restriction, or similar encumbrance has been or will be executed and recorded against the acquired property to assure that the project and the use of the property remain consistent with the applicable purpose specified in item (iii) of this subsection for a period of at least 40 years, which execution and recording shall be included as a requirement in any final order entered in the condemnation proceeding; and (iii) the acquired property will be one of the following:


        (1) included in the project site for a residential project, or a mixed-use project including residential units, where not less than 20% of the residential units in the project are made available, for at least 15 years, by deed restriction, long-term lease, regulatory agreement, extended use agreement, or a comparable recorded encumbrance, to low-income households and very low-income households, as defined in Section 3 of the Illinois Affordable Housing Act…”

                               

B. Low Income Households and Very Low Income Households.  Section 3 of the Illinois Affordable Housing Act (310 ILCS 65) defines Low Income Household, Very Low Income Household, and Affordable Housing as follows:

 

“(c) "Low-income household" means a single person, family or unrelated persons living together whose adjusted income is more than 50%, but less than 80%, of the median income of the area of residence, adjusted for family size, as such adjusted income and median income for the area are determined from time to time by the United States Department of Housing and Urban Development for purposes of Section 8 of the United States Housing Act of 1937.


(d) "Very low-income household" means a single person, family or unrelated persons living together whose adjusted income is not more than 50% of the median income of the area of residence, adjusted for family size, as such adjusted income and median income for the area are determined from time to time by the United States Department of Housing and Urban Development for purposes of Section 8 of the United States Housing Act of 1937.


(e) "Affordable housing" means residential housing that, so long as the same is occupied by low-income households or very low-income households, requires payment of monthly housing costs, including utilities other than telephone, of no more than 30% of the maximum allowable income as stated for such households as defined in this Section.”

 

[ii] The Equity in Eminent Domain Act was passed in Illinois in 2006 in response to the U.S. Supreme Court opinion in the case of Kelo v City of New London, 545 U.S. 469 (2005).  The court in Kelo dealt with the constitutionality of the use of eminent domain to take private land (homes) to convey to another private owner in order to facilitate a redevelopment project. The court upheld the taking in Kelo as a legitimate exercise of eminent domain for a “public purpose”.  In Kelo the justification for the taking was that the redevelopment project would generate more tax revenue and, thus, would serve a public purpose.  The Kelo decision was met with a public outcry from private property owners who feared that their homes or businesses would be taken without their consent for a different private use that would generate more tax revenue.  Many states quickly passed legislation to limit the power of local governments to make such takings.  Illinois passed the Equity in Eminent Domain Act in 2006.  The Act allows the taking of private property for private use as housing or mixed use as long as 20% of the units are made available for at least 15 years for occupancy by low income households. The legislature may have had in mind the demolition of existing improvements and the construction of new residential or mixed use buildings.  However, the law, as written, does not preclude the recycling of an At Risk Condo without demolition and construction.  Thus, I believe that the recycling of an At Risk Condo as suggested in this proposal falls within the ambit of the Equity in Eminent Domain Act in Illinois and would likely be permitted in other states whether or not they have passed legislation similar to the Equity in Eminent Domain Act.

 

Thank you for your interest in MPSLaw. Please fill in the forms below.
Thank you again for your interest. We will be in touch soon.
Close