Homeowners facing foreclosure will soon be able to rent their homes from the government controlled Fannie Mae. Called Deed to Lease^TM,  the program lets homeowners transfer ownership of their home to Fannie Mae. They then sign a one-year lease, with the option of month-to-month extensions available.  Fannie Mae will try to sell the homes during the year-long rental period.

In the first half of 2009 Fannie Mae took about 57,000 homes into foreclosures which became REO. In the same period they did about 1200 deed-in-lieu of foreclosures but those borrowers didn’t rent the homes back. It is likely that a significant percentage of potential foreclosures which cannot enter loan modification will be eligible for the D4L program as the requirements on credit quality are quite lenient.

According to Jay Ryan, Fannie Mae vice president, “The Deed to Lease Program provides an additional option for qualifying homeowners who are facing foreclosure and are not eligible for modifications.  This new program helps eliminate some of the uncertainty of foreclosure, keeps families and tenants in their homes during a transitional period, and helps to stabilize neighborhoods and communities.”

Deed to Lease serves borrowers who are unable to qualify for a loan modification, but still want to remain in their homes.  To qualify for the program, the owners must live in the home and offer proof that they can afford the market rent, which is determined by a third-party company hired to manage the properties.  The rent must be less than 31 percent of the resident’s pretax income.

This program is a major step towards acceptance of rentals as a solution to the overhang of potential foreclosures in US single family residences. It recognizes that keeping families in homes that they had chosen to live in and own in the recent past is healthy for the family, the neighborhood and the house itself.

A few things about D4L are worth noting:

• D4L is offered for mortgages that are part of securitized pools not whole loans unless serviced by Fannie Mae so it is likely that many banks with whole loans will not be able to use the program. However, it provides banks a positive signal about a business model that turns homeowners into renters if loan modifications cannot be done. Banks should thus be more amenable to creative solutions to the looming foreclosure waves on single family residences.

• Participation in either the D4L program or an internally run analogous program does not provide the bank with any incremental new capital. The bank may or may not have or want to take a hit to capital depending on whether they believe they can sell the house for its mortgage value in the future.

• There is no borrower upside in the medium term or long term — Fannie Mae reserves the right to market the property for sale while the lease is in force but the only incentive for the occupant to maintain the house is the threat of eviction.

• Since the transaction is a Deed-in-Lieu transaction, the bank retains the right to come after the former homeowner for a deficiency judgment in the future if the bank cannot get its mortgage value on the future sale of the house.

• Fannie Mae will become a landlord and will need property managers. They are unlikely to build that capability in-house to the extent they don’t already have it. This is a positive development for private physical property management services as single family residential property managers will be critical to the success of the D4L program.

The broad implication is positive as the program validates our company, Lifeline’s, rental and property management model as well as the social desirability of keeping homes occupied, ideally with its former owners.

S. Jafer Hasnain is a Managing Partner of Lifeline Assets, a Chicago-based real-estate private equity firm which he co-founded in 2008. Mr. Hasnain was previously a portfolio manager and analyst at AllianceBernstein for 14 years with stints at Merrill Lynch, Citibank and Goldman Sachs prior to that.