Cash-Paying Vultures Pick Bones of U.S. Housing Market as Mortgages Dry Up

Delavaco Properties LP plans to spend as much as $30 million this year and $40 million in 2012 to buy bank-owned houses and condominiums in foreclosure-ridden South Florida. The private-equity fund will pay cash.

As lenders tighten mortgage standards and consumers stay on the sidelines amid a five-year slide in home prices, all-cash purchases are surging. The deals are done mostly by investors who can get properties for less than buyers needing loans, fix them up and resell or rent them.

“If there weren’t vultures out there, you’d have a city of dead carcasses,” Robert Theocles, an independent consultant for Fort Lauderdale, Florida-based Delavaco, said in a telephone interview. “It’s like the circle of life.”

A record 33 percent of existing-home sales were made to cash buyers in February, when an annualized 4.88 million properties changed hands, the National Association of Realtors reported March 21. That compares with 15 percent of the 4.82 million annualized sales when the Chicago-based trade group started monthly tracking of such purchases in October 2008.

In Florida’s Broward County, where Theocles is based, deals with no mortgages made up 69 percent of sales in February, according to Southeast Florida Multiple Listing Service data.

The national sales data don’t count homes bought in foreclosure auctions on courthouse steps, which are almost all cash-only transactions. The “lion’s share” of all-cash purchases are by investors, according to Walter Molony, a spokesman for the Realtors association, though the group doesn’t keep specific numbers.

Big Cash Cities

About half of all purchases were done with cash in the Miami, Las Vegas and Phoenix areas, where prices have plunged and bank-owned properties abound because of high foreclosure rates, said Oliver Chang, a housing-market analyst with Morgan Stanley (MS), the New York-based investment bank.

Cash sales in those cities -- as well as in Chicago, Cleveland, Los Angeles, New York, Seattle, San Francisco and Washington -- rose to 199,557 homes last year compared with 138,888 in 2004, according to a March 21 report co-written by Chang. Short sales, where the bank accepts less than the principal on a loan, and foreclosures accounted for 59 percent of last year’s cash sales, up from 10 percent in 2004, Morgan Stanley reported.

Cash buyers paid an average $81.83 per square foot for foreclosed properties in the 10 cities last year, 36 percent less than distressed properties bought with a mortgage, the report said.

Flippers’ Advantage

“It’s almost like an arbitrage,” Chang said in a telephone interview from San Francisco, referring to the investment strategy that seeks to exploit price differences between related securities. “You buy the house at a discount with cash. Then you flip it almost immediately to the first-time homebuyer who’s using a mortgage, simply because they were not able to buy at the foreclosure sale.”

Lenders reject mortgage applications for foreclosed properties because the homes lack utilities, appraisals are below agreed-upon prices or deals take too long to close, said Thomas Popik, research director for Campbell Communications Inc. in Washington, which conducts national monthly surveys of 3,000 real estate brokers.

“The proportion of cash deals could hit 40 percent by the end of this year,” Popik said in a telephone interview from his office in Nashua, New Hampshire.

Turnkey Deals

One emerging trend is turnkey transactions, where cash buyers repair foreclosed homes and manage them as rental properties for other investors, said Elmer Diaz, former president of the National Real Estate Investors Association in Covington, Kentucky. Diaz said he works with four groups raising money to acquire properties in Fort Collins, Colorado; Sarasota, Florida; South Bend, Indiana; and Houston. The groups manage a combined 200 housing units, adding about 10 a month, he said.

“We find the deal, do the rehab, find a tenant and manage the property for the turnkey investor,” Diaz said in a telephone interview from Sarasota. “Most of our investing is for the cash flow, not appreciation.”

Not all cash deals are done by property flippers. About 55 percent of international buyers paid cash for their U.S. homes, according to an April 2010 report by the Realtors group. International buyers, including recent immigrants and temporary visa holders, accounted for about 7 percent of $907 billion in U.S. home sales for the 12-month period ended last March 31.

Empty Nesters

Empty nesters, or couples with children who have gone out on their own, often pay cash when they move to a smaller house, said Sam Khater, chief economist for CoreLogic Inc. (CLGX), a real estate information company based in Santa Ana, California. Vacation-home buyers use cash because it’s hard to get a mortgage on a second home, while wealthy buyers often don’t need a loan, he said.

“You’re seeing an increase in cash deals at both ends of the price distribution curve,” Khater said in a telephone interview from Vienna, Virginia. “You’re seeing it in the hardest hit areas, where investors are coming in and picking up low-priced properties. And you’re seeing higher cash activity at the upper end as well.”

New-home sales fell to an annual pace of 250,000 in February, an all-time low in records dating to 1963, the Commerce Department reported March 23. Existing-home sales dropped to a 4.88 million annualized pace in February, down 2.8 percent from a year earlier, the National Association of Realtors said March 21, while the median price of existing homes fell to $156,100, the lowest since February 2002.

Record Affordability

Housing affordability is at an all-time high, according to records dating to 1970 from the Realtors group. Average monthly payments, based on home prices and mortgage interest rates, dropped to 13.1 percent of the median family income in January, the most recent month available, from 23.2 percent in 2006 at the peak of the housing bubble.

Lenders, who fueled the housing bubble with lax mortgage underwriting, are now too restrictive, said Molony, the Realtors spokesman.

“Lenders have only been willing to lend to the cream of the crop in terms of credit scores,” he said in a telephone interview from Washington. “As a result you’re seeing a depressed level of traditional buyers.”

FICO credit scores for loans insured by the Federal Housing Administration, a government program that extends credit to borrowers with down payments as small as 3.5 percent, rose to an average of 703 in February, up 10 points from a year earlier, on the scale of 300 to 850. FICO scores, developed by Fair Isaac Corp. (FICO), for FHA loans averaged 647 in February 2008. They climbed after the FHA imposed minimum scores for the first time in October and banks added stricter credit overlays.

Mortgage Bankers’ View

The weighted average FICO score for a home purchased with a Fannie Mae mortgage was 762 last year, up from 716 in 2006, the Washington-based mortgage finance company reported Feb. 24. Fannie Mae loans, which usually require a 20 percent down payment, had an average 68 percent loan-to-value at origination.

“It’s not surprising that the cash share has gone up if you couple both the number of distressed sales that are going on and the fact that, even outside of a foreclosure auction, mortgage credit is tightening,” said Michael Fratantoni, vice president of research at the Mortgage Bankers Association, a Washington-based trade group.

Rental Demand

The growth in all-cash deals occurs amid rising demand for rental housing as more homeowners go into foreclosure, Fratantoni said. The U.S. homeownership rate fell to 66.5 percent at the end of last year from a high of 69.2 percent in December 2004, according to a Jan. 31 Census Bureau report.

Mortgage financing to buy homes to rent is also shrinking, Fratantoni said. Residential-mortgage originations are expected to fall to $1.03 trillion this year from $1.57 trillion in 2010, his association said in a March 15 forecast. Investors submitted 6 percent of mortgage purchase applications in February, down from a 2007 average of about 10 percent, Fratantoni said. That’s a drop to about $6 billion in February from a monthly average of about $20 billion in 2007.

“What financing options will be available to investors in single-family properties who intend to rent them out?” Fratantoni said in a telephone interview. “That really has been cut back substantially.”

Delavaco, which hired Theocles as a consultant, financed about $400 million in deals last year, mostly in international oil and energy projects, said Andrew DeFrancesco, founder and chairman of the fund. Delavaco raises money from institutional and high net-worth investors in Canada and the U.S.

Delavaco Deals

The fund started buying homes in January 2010, acquiring about 70 foreclosed properties in Broward, Dade and Palm Beach counties with cash offers to get discounts, DeFrancesco said. While there’s still risk in Florida real estate, the downside is less than drilling for oil in the Ukraine or other places Delavaco has invested in energy projects, he said.

“Every time I drive by that house I know it’s there,” DeFrancesco said in a telephone interview. “I know the property and I know what county it’s in and I know it has a tangible value to it.”

The plan is to hold the properties between five and seven years, enough time for the market to absorb the glut of foreclosures and for resale values to rise, said Dallas Wharton, Delavaco’s chief operating officer.

In January, Delavaco paid about $32,000 for a bank-owned four-bedroom home in Pompano Beach, Florida, that had sold at the top of the market in 2006 for $285,000, Theocles said. Delavaco spent $11,000 to replace the interior sheetrock, plumbing and appliances. The house rents for $1,250 a month, and annual property taxes and insurance cost about $2,500, he said.

“We are the people that are going in, cleaning things up, renting the properties out to make nice homes for people,” Theocles said. “At the end of the day they’re worth a lot more.”

To contact the reporter on this story: John Gittelsohn in New York at johngitt@bloomberg.net

To contact the editor responsible for this story: Kara Wetzel at kwetzel@bloomberg.net

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