In late September, a historic Ann Arbor building went up for sale. The listing highlighted the Alonzo Palmer House’s “beautiful details,” including original woodwork from the 1860s. What it didn’t mention was that the mortgage had gone unpaid for months.
Judging from the names on the mailboxes, some thirty students are paying rent in the orange-brick Gothic Revival house and matching carriage house at the corner of Division and Ann. Yet the complex remained unsold at an asking price of $1.45 million. As the tenants parked bicycles out back and drank beer from the wooden porches, planned parties, and handled homework, one of Ann Arbor’s most beautiful apartment houses was going into foreclosure.
On October 28, the Palmer House went up for sale at the weekly foreclosure auction held in Courtroom 7 in the Washtenaw County Courthouse on Main Street. A lender, the “Madison Class B Investors,” made the only bid–$1.2 million.
Through the fall and early winter, other foreclosed student rentals went up for sale at the courthouse every two or three weeks. Among the buildings auctioned by sheriff’s deputy James Damron were several smaller apartments in the Kerrytown area–including at least four within blocks of the Palmer House.
“It’s a great location,” says Bill Godfrey, who owned the property for fourteen years. He remembers students and their parents really liked the Palmer House, with its charming feel and high ceilings. When he and his partners decided to sell many of their student rentals in 2006 to diversify into Grand Rapids office properties, Godfrey says, “There was fierce competition and the most competition [was] for the Palmer House.”
Fast forward five years, and the housing market in Ann Arbor has gone from overheated and overpriced to chilly and depressed. According to the county Register of Deeds, the Palmer House was just one of 1,399 homes, apartments, vacant lots, and commercial properties sold at foreclosure auctions last year. That almost matched the record 1,439 foreclosures in 2008, and many expect this year’s total to be even higher.
Catherine McClary, the Washtenaw County treasurer, says the region is now in its third wave of foreclosures. The first was subprime mortgages and people who bought homes with nothing down, including some who didn’t have the earnings to repay their debts. Then came middle-class families who lost jobs or pensions in the Great Recession. The third wave is mostly “walk-aways”–borrowers who see no good reason to keep paying on a property that has lost so much of its value. This includes both homeowners and investors–“we’ve had a huge increase in commercial properties,” McClary says–and she believes it is just getting going.
“We’re early in the game–the third inning,” agrees Albert Berriz, McKinley’s chief executive. He expects foreclosures and liquidations of student housing to continue without real improvement until 2013 or 2014.
The foreclosure sales themselves are a simple, speedy affair. Damron reads off the address, the offering price, the lender, and the name of the person or company about to be foreclosed on. “Are there any other bids? Are there any other bids? Are there any other bids?” Damron says. When there are not, the property is “sold to the mortgage holder,” and on to the next home.
Jimmy Moore, the retired special deputy who ran the foreclosure sales before Damron, says he hardly ever saw campus-area apartments come up for auction. That changed, however, as the real estate bubble stretched, and finally popped. “What happened is a lot of people purchased rental units in areas during the good times and overpaid,” says Moore. “They bought at the top of the market.”
For decades, the city has made it hard to add new apartments in the neighborhoods around campus. Factor in the U-M’s growing enrollment, and many investors saw student rentals as a foolproof investment. But in the 2000s, rents got so high that developers started to build new high-rise apartments in the business districts around campus–and at the same time, the university built its first new dorm since the 1960s. With the richest students leaving for newer, more convenient buildings like the Corner House, North Quad, and Zaragon Place, older rentals farther from campus suddenly didn’t seem so desirable.
“There’s not an unlimited supply of renters here,” said Doug Spaly, a local real estate broker who owns a handful of student rentals. Investors and parents of U-M students, aware of the growth in housing options, are now more selective about where they are willing to buy.
McKinley’s Berriz adds that many landlords who bought at the height of the market have loans coming due that they can’t refinance. Some were “making money flipping the buildings,” Berriz says. “Now the music’s stopped,” and they cannot refinance or sell their properties for anything near what they paid.
McKinley owns 5,000 apartment units in the Ann Arbor-Ypsilanti area, but Berriz says that it’s cushioned from the downturn by its access to capital on Wall Street. The risks are greater, he says, for smaller companies without much cash cushion–“their margin for error is very thin,” and even a few unfilled apartments can put them in financial trouble.
One veteran real estate agent who asked not to be named says some student landlords appear to be making strategic decisions to let overpriced properties go into foreclosure. Several times in the last year, he’s seen landlords sell a building after foreclosure. By law, owners have at least six months to redeem their property. These landlords found buyers willing to pay more than the bank-set foreclosure price, redeemed the buildings, sold them to the buyers, and pocketed the difference.
Other rentals have different paths into foreclosure, but few are as intricate and involved as the Palmer House. Built in 1867 by U-M medical professor Alonzo Palmer for his second wife, Love, it remained a private residence until 1970, when it was converted to apartments.
Bill Godfrey, a real estate investor who has owned student rentals along Ann, Catherine, and Division for years, bought the property with partners in 1992. “The apartments were fun to manage and the kids loved it,” he recalls. When he and his partners decided to sell, he says, they got many offers. They chose local buyers with extensive experience in Ann Arbor real estate: Jeffrey Starman, an attorney and investor, and Francis Clark, whose Arch Realty is one of the city’s largest managers of student rentals. Clark says he’d tried to buy the Palmer House the last time it was on the market. “I’ve always loved it,” says Clark, noting that he and his wife, Wendy Chapman, briefly considered living there.
Asked what the historic property sold for, both Godfrey and Starman say they don’t recall. But a year after buying the Palmer House, Starman and Clark took out a $2 million mortgage on 205-207 N. Division and one other property with LaSalle Bank, outside Chicago. Their monthly payment was $12,562.55, plus a smaller amount owed to Ann Arbor Commerce Bank on a line of credit they inherited from Godfrey’s group.
Starman stresses that the Palmer House never lacked for tenants. The building, he says, “is 100 percent full. It has been almost continuously.” But in what Starman calls a “strange twist,” the house ended up with two primary mortgages on it–the $2 million one and a second one with Madison Class B Investors (MCBI). The latter was used as collateral when Starman and Clark bought the Hidden Valley Club apartments. (That complex had its own brush with foreclosure last spring, but now is restored, Starman says.)
Starman calls the double mortgage “a freak case of a title company disaster–we still don’t understand how it happened.” But it did, and soon afterward, real estate headed south and property values started falling “dramatically.”
Starman also serves as chief executive of Madison Properties, managing rental properties from an office above Martin Bouma’s on Main Street. “Student housing was considered immune to the economy,” he recalls. “This time [the recession] was big enough and bad enough that it penetrated.” Hardest hit were properties purchased at the peak of the bubble in 2005-2007; those buyers paid the highest multiples on rents and took out the biggest loans.
According to court documents, Starman and Clark first missed a mortgage payment on the Palmer House in August 2009. That November, the bank sent them a notice of default. Though they made two partial payments in April and May 2010, the “defaults are continuing,” the bank reported. Unpaid interest continued to accrue, and by last July the mortgage balance had increased to $2.177 million.
In August, the bank filed suit, requesting that the court appoint a receiver to oversee the buildings and asking for an injunction to safeguard the premises. A flurry of filings followed, including one in which the owners charged that the bank had never sought a judgment against them, voiding the “due process” required under the law. Then the case got more complicated still. The other mortgage holder, MCBI, requested to intervene. The judge agreed, and in October, it was MCBI that foreclosed.
“I deeply regret not being able to work it out,” Clark says of the foreclosure. But, he notes, they had borrowed the money under a “non-recourse financing” clause, which meant the bank couldn’t easily pursue them for any deficit. Between the two mortgages and the property’s reduced value, he says, it didn’t make sense to try to prevent the foreclosure. And so they walked away.
Starman is now helping some landlords arrange “short sales,” in which properties are sold for less than the mortgage balance. Some owners “have to do deals, even if they lose money,” he says.
Both Starman and Clark believe that the rental market is now on the upswing, with rents inching up for the 2011-2012 year. “We’re seeing real improvement,” says Clark, noting that three-quarters of Arch’s 1,100 rental units already are pre-leased for fall.
The main problem, Starman and others say, is that many banks cannot or will not make new loans on commercial properties, or are demanding huge down payments.
While students continue to study and party at the Palmer House, it is once again up for sale. “We’ve been getting offers,” says Jim Chaconas of Colliers International, but “they’ve been too low to deal with” on a historic property marketed at $1.4 million.
Lately, though, the offers have been getting better. Chaconas thinks a sale could go through in coming weeks for more than $1 million. While that would be far less than lenders valued it at just a few years ago, it could be a bargain for the buyer, who will own a historic property that draws students aplenty.
“It’s one of the coolest properties,” says Chaconas. “It’s got those big vaulted ceilings” and murals on the walls. Unfortunately, those features are no longer as valuable as they were before the third wave of foreclosures hit campus.