Wall Street “Gold Rush” in Foreclosed Homes

I received an interesting article from one of our investors, Steve Lemke. The article is via Reuters and reported by Matthew Goldstein and Jennifer Ablan (Editing by Claudia Parsons). In the article, it is reported that there is tremendous interest from large institutional investors, including some of the biggest names in the investment community, in purchasing large packages of single family homes. In most cases these homes are looked upon as rentals and in some as “flips”.

This great “Gold Rush” may seem threatening to us investors. After all, doesn’t it stand to lower inventories, create price wars and get prices soaring? Quite possibly. However on the way there, there is still plenty of buying opportunities. Many institutions will need time (possibly quite a bit of time) to “digest” such large blocks of houses. Unlike ICG, many of these entities have little experience managing and holding a multitude of homes. This will delay the “closing of the window of opportunity”. By the time all these large buyers get going, organize and get their management set up, we will most likely be able to grab quite a few great deals.

Needless to say, the big picture is, if this truly materializes, prices will go up (and not necessarily steadily), which will help millions of underwater homeowners. this will also create profits for the savvy investors who had already purchased houses. In general, as prices go up and there is a sense of improvement, MORE buyers flock to the market rather than less, as is always the case historically. We may see a “mini boomlet” fueled by all this, but I don’t believe this will manifest (if at all) before the second part of 2013.

Another very beneficial effect on the economy at large is, as prices go up, the gap between the foreclosed home pricing and builders’ pricing will narrow, prompting more and more builders to jump back in. This, of course, creates jobs and stimulates the economy. When the volume of purchases increases, banks are likely to jump back in and lend (especially since the trend will be appreciation which makes the loans more secure by the year), since they will not want to miss on making a large number of loans. If loans become easier to get (not as easy as during the peak but certainly much easier than now), this will further speed up the housing recovery.

For the smart investor, buying in 2012 and into 2013 is likely going to be not only profitable, but potentially profitable in a relatively short time, if indeed the “Big Boys” start buying en mass.

Here is the article:

INSIGHT:  The Wall Street Gold Rush In Foreclosed Homes.

NEW YORK (Reuters) - Dan Magder recently gave up a top job with private equity firm Lone Star Funds to strike out on his own and become a landlord.

He’s joining a growing list of big and small investors who see fat profits to be made in renting out foreclosed homes, especially now the U.S. government is moving ahead with a trial project to sell big pools of single-family homes that Fannie Mae currently owns in some of the hardest-hit housing markets.

Investors seeking higher yields are drawn to foreclosures because the rental market is red hot. But the heated competition for foreclosed homes is reminiscent of the frothy expectations that seem to accompany each new Wall Street investing craze.

Even proponents of buying foreclosed homes are advising caution about the kind of returns that investors can expect to reap and the potential negative headlines that can come with being a landlord.

Critics, meanwhile, contend the federal government is fostering a transfer of wealth of sorts by selling big pools of foreclosed homes to big fund investors and high-net-worth individuals. There’s also concern that some of the players who helped create the housing crisis will now benefit by buying foreclosed homes at a steep discount.

Between them, Fannie and Freddie Mac own more than 200,000 foreclosed homes. The nation’s banks own more than 600,000 single-family homes, according to RealtyTrac, a housing tracking service.

Housing experts expect the foreclosure machinery to crank up again now that regulators and banks have agreed to a $25 billion settlement to deal with earlier foreclosure abuses.

Some of the high-profile institutional investors who are committing money to buying foreclosed homes - or seriously considering jumping in - include private equity firm TPG Capital, investment firm Oaktree Capital Management, Warren Buffett’s Berkshire Hathaway Inc., Starwood Capital, Och-Ziff Capital Management and bond fund manager TCW, say people familiar with the fast-growing market.

PILOT PROJECT

The Federal Housing Finance Agency, which regulates Fannie and Freddie Mac, expects it will receive a considerable number of bids in April for the initial round of 2,500 Fannie-owned homes in cities like Atlanta, Chicago, Los Angeles and Phoenix.

“This is really a test and we don’t know what the results will be,” says Meg Burns, senior associate director for housing and regulatory policy for the FHFA. “But the beauty of this pilot is we are going out with properties that are largely rented already, so people know what the cash flows look like and we know it is far preferable to have people living in the homes rather than the properties sitting vacant.”

In August, when the FHFA first announced its intention to conduct bulk sales for Fannie and Freddie properties, it received expressions of interest from more than 4,000 investor groups, not-for-profits and other organizations.

If the pilot is successful, the FHFA is also considering selling off pools of distressed mortgages held by Fannie and Freddie, according to people familiar with discussions about that.

On the Internet, the gold rush mentality clearly has taken hold with some small investment firms. Wong Diversified International Investments of Austin, Texas, for example, offers a fund to invest in foreclosed homes, boasting on its website that it is pursuing the Fannie bulk sale.

“It is clearly over-hyped, but I think this is real and it’s going to happen,” said Magder, who about a week ago left Lone Star, where he had focused on distressed banks and financial services firms. “There is definitely room for people who have a well-thought-out operational plan and are careful about putting the pieces together.”

Magder has formed Rock Creek Capital Group, based in Washington, D.C., and intends to raise money from investors and submit a bid for some of the foreclosed homes Fannie is selling in Los Angeles and Phoenix and across Florida.

RETURN ON INVESTMENT

One of the most bullish investors is Carrington Capital Management, which has teamed up with Los Angeles-based OakTree Capital. They have created a $450 million fund to buy foreclosed homes in bulk and rent them out.

In a marketing document for one of its funds, Carrington claims that without using leverage or borrowed money it can generate an annual yield of 7 percent from rental income alone. Its long-term strategy is to package the fund into a publicly traded real estate investment trust. If that strategy is successful, Carrington projects investors can see an internal rate of return of 25 percent over three years.

Rick Sharga, an executive vice president with Carrington, says the firm is optimistic that if the Fannie auction attracts a lot of bidders, then banks will begin holding their own bulk sales of foreclosed homes.

Other investors looking at the foreclosed home market say Carrington’s projections seem too rosy and they are projecting a return on investment of between 8 percent and 15 percent. That said, in an environment where U.S. Treasuries are yielding less than 2.5 percent on a 10-year Treasury note, those kind of returns are piquing the interest of wealthy individuals.

Miami-based Carlos Guajardo, who is considering bidding for some of the Fannie properties being sold in bulk in Florida, says he is seeking to raise about $50 million, largely from wealthy individuals and small family offices. To date, his firm Maynada Capital Advisors has acquired about 70 foreclosed homes in southeast Florida, which he has fixed up and is in the process of renting out.

In Las Vegas, Laus Abdo is doing something similar and he’s trying to expand his potential reach by partnering with a hedge fund or private equity firm to back him.

“I think the majority of your return in this portfolio comes in the form of cash flow from renting, not capital appreciation, unless you buy properties at a huge discount,” says Abdo, executive director at TriArchic Advisors, a Las Vegas-based real estate advisory and management firm.

Even as some investors are getting into the market, others are looking at getting out because they fear the presence of big institutional players will drive up prices.

New York hedge fund manager Jason Ader says he and a business partner in Phoenix are looking at selling some of the more than 100 homes they acquired at foreclosure auctions over the past year. Ader, founder of Ader Investment Management, said the market in Phoenix for foreclosed homes began getting more competitive this year. He expects institutional money will start to crowd out smaller investors bidding for the Fannie properties.

PR NIGHTMARE

Some hedge fund managers say they’re staying out of the market largely for fear of getting vilified as being a bad landlord if the need comes to evict a tenant. One manager who did not want to be identified said while there’s a lot of money to be made from investing in foreclosed homes, “it is a potential PR nightmare.”

In February, Phil Angelides, the former chairman of a federal commission set up to look into the causes of the financial crisis, stepped down as executive chairman of Mortgage Resolution Partners one month after Reuters reported on his involvement in the company which aimed to turn a profit from buying distressed mortgages. Angelides’ involvement had drawn scrutiny on Capitol Hill, where one congressman sent a letter warning about potential political influence peddling.

Already, some liberal economists are questioning the wisdom of the federal government pushing to sell homes owned by Fannie and Freddie to institutional investors at a potential 20-30 percent discount to prevailing market price.

“This is actually moving the underlying physical assets, or homes, to the top 1 percent,” says L. Randall Wray, a professor of economics at the University of Missouri-Kansas City and a senior scholar with Bard College’s Levy Economics Institute.

Laus, the Las Vegas housing entrepreneur, says there could be a “potential backlash” if some of the buyers are subsidiaries of the big banks that got bailed out by the federal government.

But many more public policy experts say the bulk sales by the government are worth trying, given the huge stockpile of foreclosed homes controlled by Fannie and Freddie.

“We have a shortage of rental housing already and I think this is a win-win situation,” says Kenneth Rosen, chairman of Rosen Consulting Group, which advises on urban planning and real estate management.

In February, Rosen co-authored a report with mortgage-backed securities guru Lewis Ranieri, which advocated the need for a private sector solution to the foreclosure crisis. A Ranieri-backed hedge fund, Selene Finance, has been investing in distressed mortgages for the past few years and is now eyeing foreclosed homes.

“I don’t think the money to do this is the problem,” says Rosen. “It’s the execution.”