Photo Credit:Â Wikipedia
By:Â Morgan Brennan, Forbes Staff
Investors have been snapping up homes. Lots of homes. The National Association of Realtorsâ€™ Investment and Vacation Home Buyers Survey reports that investment-home sales soared a whopping 64.5% in 2011, with investors purchasing 1.23 million homes compared to 749,000 in 2010.
With foreclosures continuing to flood marketplaces and home prices down nationally about 35% over the past five years (and down more than 50% in the hardest hit areas), investors believe housing is a promising place to park cash. Even the Oracle of Omaha, billionaire Warren Buffett, told CNBC that distressed single-family homes were one of the best investment opportunities around, asserting, â€œâ€¦Itâ€™s a leveraged way of owning a very cheap asset now and I think thatâ€™s probably as an attractive an investment as you can make.â€
So perhaps itâ€™s not surprising to see a concept that has been kicked around real estate circles for the past several years begin to materialize into reality: the bulk buying of distressed homes by large scale investors. This emerging real estate strategy has graced the pages of many a media outlet in recent weeks, the latest story harking from the New York Times.
What exactly is REO bulk buying? Itâ€™s when investors, usually institutional, usually hedge funds and private equity firms, negotiate to buy dozens, hundreds, even thousands of distressed homes at deeply discounted prices. Rather than flip these properties, though, they fix them up and rent them out. A large-scale buy and hold investment play, if you will.
As the Times notes:
â€œNobody has ever tried this on such a large scale, and critics worry these new investors could face big challenges managing large portfolios of dispersed rental houses.â€
Investors-turned-landlords have typically been individual mom-and-pop outfits and small firms.Â But with rental prices on the rise in local markets across the U.S.,Â the concept is catching fire on Wall Street as well as Main Street. And with good reason:Â While a 10-year Treasury note yields little more than 2%, economists at Goldman Sachs calculate that rental property investments yield more than 6% on average, nationwide.
ZillowÂ saysÂ median rents rose 3% nationally in 2011, whereas home prices dropped 4.6%. Â TheÂ U.S. Census estimatesÂ that the homeownership rate was 66% at the end of 2011, down from 69% in 2006, during the heights of the housing bubble. Nearly 650,000 bank-owned properties sit on lendersâ€™ books and 710,000 more are pushing through the foreclosure process,Â according to RealtyTrac. Meanwhile, housing affordability is at 20-year highs, according toÂ National Association of Home Builders/Wells Fargo Housing Opportunity Index. Â All of these market indicators conspire to help make REO bulk buying an attractive investment opportunity for investors with ample amounts of cold hard cash or fancy financing in place that allows them to bypass the ever-tightening process of qualifying for mortgages.
The largest holders of distressed assets are the Government-Sponsored Enterprises Fannie Mae and Fredie Mac. Together the two mortgage giants own roughly 180,000Â foreclosed homes. In February, Federal Housing Finance Agency announced the launching of a pilot program that would put 2,500 of Fannie Maeâ€™s homes, valued at $320 million, up for sale. Potential bidders, who have until mid-April to submit bids, include mortgage-backed securities traders Amherst Securities Group, hedge fund manager Paulson & Co, private equity investors Colony Capital LLC, and a fund run by Lewis Ranieri, the co-inventor of the mortgage-backed security,according to the WSJ.
Fannie Mae will sell the properties, comprised of single-family homes and condos, on the condition that the winning bidder(s) rent them out. The homes are located in six foreclosure-riddled areas:Â Southern California, Las Vegas, Chicago, Phoenix, Atlanta, and parts of Florida.
In March, Bank of America said it would test its own pilot program, allowing approximately 1,000 homeowners facing foreclosure in New York, Nevada and Arizona the option to remain in their distressed homes and pay rent. They could stay in these abodes for up to three years, shelling out rent payments set at or below market rates that will be lower than current monthly mortgage payments. After three years, the bank aspires to sell the properties to investors.
Many economists and real estate experts have been eager to see programs like these rolled out, asserting that investors could help stabilize prices in many markets. Â As the NY Times reports:
â€œIf you have a lot of foreclosures in one community you will improve everybodyâ€™s home values if you take them off the market,â€ said Diane Swonk, the chief economist at Mesirow Financial. â€œIf those homes are renovated and even rented, it is a lot better than having them stand empty.â€
However, large-scale conversion of foreclosures ato rentals brings with it some challenges, particularly the issue of how to effectively scale up property management.Â As my colleague Steve Schaefer recently noted:
â€œFor the Warren Buffettâ€™s of the world, management is one of the biggest challenges to scaling up a housing investment that could impact a portfolio in the billions, and why an idea akin to a single-family home real estate investment trust is such a difficult proposition.
As these programs roll out and more investors flock to housing, we will see how bulk buying turns out. I suspect we will see an increased number of property management companies emerge in major markets across the country. I also suspect rent prices will peak either later this year or in early 2013, as more rental inventory comes to market, thanks to both foreclosure conversion programs and new multifamily housing developments, for which building permits began rising last year.