Sherley Bretous-Carré and Edenswear Carré still believe in the American dream. Starting in 2002, the Carrés began investing in real estate as a way to build wealth. Over the years, they purchased two homes and two plots of land, amassing a tiny real estate empire that spans three states–their home state of Massachusetts, plus Florida and Texas. The Carrés carefully plotted their road to prosperity, and it was all going smoothly until the real estate boom came to a sudden halt. Now, confronted with declining home values and an economic meltdown, owning multiple properties feels, to the Carrés, more like a stranglehold than a savvy wealth-building strategy.
The Carrés are hardly unique. Through most of this decade, millions of Americans were drawn into the housing market. They came not simply looking to be homeowners, but with visions of becoming landlords and market speculators who could buy homes at low prices and flip them for profit. In those years, U.S. economic activity was powered by home building, home buying, the financing of real estate purchases, and consumers’ own desires to fill new homes with the furnishings of middle-class life.
The Carrés were no different. In 2002, they purchased their primary residence, a four-bedroom, two-bath, $220,000 house, in Lawrence, Massachusetts. In 2006, they bought a $292,000, three-bedroom, two-bath rental home in Cape Coral, Florida. Then there’s the two acres of land in Coral Spring, Texas, they bought for $57,000, and the 35 acres in Marianna, Florida, purchased for $60,000 the same year.
The housing market’s collapse has stripped wealth from millions of American households. Since the height of the boom in 2006, home values across the U.S. have fallen dramatically. By the end of 2008, more than 8.3 million homeowners nationwide owed more on their mortgages than their property was worth, according to a survey by mortgage market analysis firm First American CoreLogic.
The Carrés were no frenzied real estate speculators. There was logic behind each of their purchases. They bought land in Texas thinking the warm climate would make it an ideal place for Sherley’s New York-based parents to retire. The Florida rental property was supposed to pay for itself, but given the economy and the resulting glut of houses on the market, they haven’t been able to make a sale. They also haven’t been able to get much in rent. The most they’ve been able to charge is $1,000, but the monthly mortgage payment is $2,000. And the other plot in Florida? “I was supposed to flip that land quickly but it didn’t happen because of the market,†says Edenswear, 35.
As if declining assets weren’t enough, the Carrés, who have three children, are enduring another hallmark of the current economy: job loss. Last summer, Edenswear lost his job in sales, making $30,000 a year. That blow has made living on Sherley’s annual salary of $105,000 (which she earns as an assistant principal at a charter school) more difficult. In addition, the couple’s 2-year-old daughter Ilyana, recently started daycare, which costs $215 per week. The couple’s two other children are 10 and 8 years old. “The economy has had a major effect on our plans,†says Sherley, 36.
The couple, married for 11 years, owes about $600,000 on the two homes, for which they pay approximately $3,000 in monthly mortgage payments. As for the two plots of land, they own them outright. Sherley’s undergraduate and graduate school loans, however, total $50,000 and deferment ends later this year, when they’ll have to begin chipping away at that bill.
On the plus side, Sherley has $74,000 in her 401(k) at work. They each have $2,500 in individual stocks, a total of $7,000 in a mutual fund, and $4,000 in their savings and checking accounts. “It’s not enough,†says Sherley, who is becoming increasingly
anxious. Says Edenswear, “If we could just sell the land or house in Florida, the profits would do a lot to change our situation.†Meanwhile, Sherley and Edenswear want to begin saving, not only for emergencies, but for retirement and their children’s college education. Sherley and Edenswear have learned the hard lesson that sometimes things don’t go according to plan. The reality check has inspired them to think twice about purchases and cut back as much as they can.Despite everything, they’re optimistic. “We’re proud of the homes and the land we’ve purchased,†says Sherley. And they haven’t given up on real estate, as they hope their investments will eventually help them retire early.
The Advice
What is most encouraging about the Carrés’ situation is the optimism that the couple holds for the future. They are clearly thinking in the right way to prosper in the long term (i.e., plan for retirement, save for a rainy day, thinking twice about purchases large and small.) However, remedying their current situation will require them to rationalize some of their personal goals with the hard realities of the market. Never forget that for us to get to the long term we must always first go through the short term. So let’s start there.
The Carrés’ greatest short-term need is to increase cash flow. Because of the loss of Edenswear’s position, the family has experienced a 25% reduction in its gross income. Assuming a 25% marginal tax rate at the federal level, and a 5.3% marginal tax rate in Massachusetts, the after-tax value of Edenswear’s salary was approximately $24,400. Assuming he is currently still unemployed, an immediate way to recoup 46% of his after-tax salary, or approximately $11,200 per year, is to remove their youngest child from daycare until he finds permanent employment. Hiring a babysitter on the days when Edenswear has to leave the home for an interview will be much less expensive than their current situation.
A second measure to improve not just short-term, but long-term cash flow is to refinance the mortgage on the family’s primary residence. Without specific information on the credit situation of the Carré family, I am assuming this is still possible, especially given Sherley’s employment in a high-paying job. With respect to their primary residence, the Carrés are suffering from a situation similar to some 20% of all American homeowners–negative equity. The Carrés are hurt to a much greater degree, however.
At current market prices, their primary residence has a loan-to-value ratio of 149%. Lenders prefer this ratio not to exceed 95%, and the lower the better. Still, there’s hope. Part of the Obama administration’s Housing Affordability and Stability Plan is directly aimed at homeowners like the Carrés who are not currently in default but are likely to default on their mortgages due to their high level of negative equity.
There are many ways the Carrés could have their mortgage modified. The simplest method would be an interest rate reduction. Assume that they were able to achieve a modification that reduced their interest rate by 2% annually. This would save them approximately $400 per month, or $4,800 a year. If they were able to negotiate a modification that extends their mortgage’s term from 30 to 40 years, in addition to a reduction of their interest rate by 2%, this would save them approximately $600 per month, or $7,200 a year. Finally, if they were able to have their mortgage amount reduced to 105% of current value (difficult, but not impossible), maintain the term at 30 years, and receive a 2% interest rate reduction, they could save approximately $900 per month, or $10,800 per year. Let’s assume they achieved the middle option, extending the term with a rate reduction, and temporarily removed their youngest child from daycare until Edenswear found permanent employment, on a pretax basis, they could effectively replace 85%, or $20,800, of Edenswear’s lost after-tax salary.
n My final piece of advice will likely be the hardest to accept. The land that the Carrés bought to retire their parents on in Texas–sell it. Don’t get me wrong, loyalty to one’s parents is a laudable value. However, economic responsibility is also a laudable goal. By the Carrés’ own admission, they did not purchase the property with an eye to making it an income-producing piece of land. They currently receive no cash flow from it, and are unlikely in the near future to be able to build a home on it to house their parents. While it’s true that they are currently underwater on the property by approximately $46,000, they may be able to recoup some of this loss through capital gains reductions on their taxes. This could reduce their taxes by as much as $750 in the year of the loss (capital losses are limited to $3,000 against ordinary income), not to mention the approximately $11,000 in increased liquidity that they would receive from the proceeds of the sale.
Additionally, they could carry forward the remaining losses to future years for further tax savings. Collectively, all of these recommended cash flow improvements in the first year would increase their cash flow to $32,550 (or 133% of Edenswear’s after-tax salary). Note that this solution does not have to leave the Carrés’ parents out in the cold. Instead of moving them to Texas, give them the rental property in Florida.
If they just replace the current amount of rent received, $1,000, then there is no loss. If they receive the property free and clear, then the foregone monthly rent will be a minor portion of the salary Edenswear receives from a new job.
This story originally appeared in the May 2009 issue of Black Enterprise magazine.