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Unless you live on the moon, you've heard about the issues facing American homeowners with respect to mortgages.  You've heard it on TV, in the papers, and on blogs. 

The good news is that relief is on the way (somewhat).  Momentum to "help the homeowner" started with the states (Ohio), moved into Congress (FHASecure), and is now heading onto mortgage servicers (Countrywide).

The bad news is that not all homeowners are going to be relieved equally. 

The least protected class of homeowners in America right now are real estate investors that bought homes from 2001-2007.  There's not a line of legislation that will come to the rescue of any member of the over-extended-real-estate-investor class.

One television pundit was overheard saying this:

"They bought their tickets, they knew what they were getting into.  I say, let 'em crash."

Now, with respect to real estate investors, it's important to differentiate between the two types who may have bought from 2001-2006.

1. The buy-and-hold investor who makes money off rent, tax write-offs, and long-term property gains.  This is a long-term strategy.
2. The buy-and-sell investor who makes money off selling a property for more than its purchase price within a short period of time.  This is a short-term strategy.

For Type #1, the current market conditions are a stress, but nothing major.  Because their real estate strategy is a long-term one, the home was likely financed with a long-term fixed mortgage, and excellent rent prospects for the unit(s).

For Type #2, however, the financing tends to be much different.  Because their strategy was a short-term one, the home was likely financed with a short-term sub-prime ARM, and in an area that was designated as "hot", or "likely to appreciate".  Rent prospects were not necessarily a factor when the purchase was made.

Now, both investor types likely bought with very little downpayment.  Lenders didn't require it, so the investors didn't give it.  Real estate investment is about leverage, after all.  In a rising market, buying one property with 20% down generates a dramatically lower ROI versus buying four properties with five percent down.

But now the market is changing. 

As we mentioned, the long-term investor basically shrugs it off.  He knows that weak markets come and go and -- long-term -- real estate is a winning investment. 

By constrast, the short-term investor is facing some very real problems. 

First, sub-prime loans are no longer available for real estate investors.  And second, real estate property values are declining in many of the areas that attracted investment between 2001-2006.  The short-term investor hadn't expected the market to change while they were still in the midst of their "flip".

To impress upon how big of a deal this is, let's look at a "Sunny Skies" scenario for a short-term real estate investor.  We know that most investors have "Stormy Skies", but this is meant to show how all short-term investors are feeling a pinch:

In 2004, a person buys an investment condo in Chicago for $300,000, and mortgages $285,000 with a 3-year ARM that includes principal + interest.

The condo appreciates 4.000% annually and is now worth $338,000.  The mortgage balance is now $275,000.

Today, the home's LTV is 81% and the loan is about to adjust. 

So, for the "Sunny Skies" guy, it looks like everything's coming up roses.  But is it really?

For one, nearly every investment property home loan over 80 percent loan-to-value is going to be considered sub-prime, and the market for those loans vanished months ago.  In order to get out of sub-prime territory, it's necessary to pay down the loan to at least 80 percent.  75 percent is ideal.

Plus, if the investor decides to sell the investment property, he's competing for sales with every other investor nearby that also wants to divest.  The extra supply means lower prices for everyone.  It should also equate to more time on the market.

Meanwhile, the clock on all of those ARMs is still ticking so if an investor has a fire sale just to cut his losses, it's going to drop the value of every other unit nearby.  Ouch.

In other words:

• To remortgage will cost money as a paydown
• To not remortgage will cost money as a mortgage rate hike
• To sell the home will cost money in the form of depreciation
• To not sell the home will cost money in the form of lower home values

Ouch again. 

But, it's not all bad!  Many short-term investors can readily convert their short-term strategy into a long-term strategy by re-assessing their real estate portfolios.  And it starts with the mortgages.

See, in the current market, the biggest risk to a highly-leveraged investor is that there are no highly-leveraged mortgage products available for refinancing.  When the mortgage begins to adjust, therefore, the investor has no choice but to absorb the adjustment.  This impairs cash flow and usually leads to financial distress. 

Probability of Foreclosure: Very High.

This is why the first step to convert a short-term real estate strategy into a long-term strategy is to convert to long-term mortgages.  And, in order to do this in our current market, the home has to become un-highly-leveraged.  This requires the principal balance to be paid down to at least 80 percent, and preferably 75.  With less leverage, the loan is considered less risky and the mortgage moves from sub-prime territory into the conforming world.  Backed by Fannie and Freddie, the home loan programs are plentiful and relatively cheap.

Once the capital is ready, the next step is to remortgage the investment property into a long-term home loan with a lower LTV.  The new mortgage doesn't have to be a 30-year fixed, but it should be long enough to match your long- and short-term investment goals.  Your mortgage planner can help you formulate a plan.

Now, with a long-term mortgage locked in, the long-term payment is locked in, too.  By knowing the payment, you can set a monthly rental price and know exactly how much cash will be required to cover the monthly nut on the home.  Having a fixed cost also helps to build a predictable monthly budget.

Probability of Foreclosure: Very Low.

Yes, the hardest part about converting from a short-term real estate strategy to a long-term one is finding cash for a principal paydown; most people don't have access to that sort of capital at a moment's notice, nor do they know where to find it. 

Surprisingly, most investors ignore the most likely source because -- despite investors' tendency to leverage non-owner-occupied properties -- they don't always take the same approach on the homes in which they live.  The primary residence is an excellent source of capital and the equity existing on paper can be accessed and redeployed somewhere else. 

The same applies for second homes and vacation homes -- the equity is there and is sitting idle. 

So, let's come full circle on this. 

Remember that states, Congress, and mortgage servicers are trying to help homeowners, but not investors.  Therefore, there are loads of mortgage programs available for primary and secondary residences.  Plus, cash out transactions are still be approved to high LTVs.   This means that the equity required to go long on your real estate investments may be waiting there in your own home(s).

Buy-and-hold strategies works in real estate -- we've seen it historically.  In fact, other than baseball, long-term increases in real estate prices has been the one constant in America.  It's this short-term flipping that is causing problems. 

The good news is that with available equity, a real estate investor can change his tune, thereby protecting his assets, his credit, and his investments.

In mortgage planning circles, we call this process "equity repositioning" -- removing home equity from properties in order to meet financial goals.  There are risks inherent in strategies like this and it's not something to undertake on your own.  If you don't have an experienced mortgage planner with whom you work, email me and I'll walk you through it.

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Dan Green is an active loan officer. Email or call 513-443-2020. Dan is on Twitter at @mortgagereports.