Private Equity Has Too Much Money to Spend on HomesJohn Gittelsohn
Funds planning to invest more than $6 billion to buy and rent foreclosed homes are finding it easy to raise money. The difficulty is spending it.
The number of low-cost foreclosed homes coming to market has dropped, bulk sales have been slow to materialize and prices are recovering in markets such as Phoenix, making it hard for private-equity firms, hedge funds and pension systems to buy as many homes as they need.
“The folks that raised capital are worried about under-accumulating properties and how to get capital out in an efficient way,” Richard Ford, a managing director in the real estate investment banking group at Jefferies Group Inc., said in a telephone interview. “A lot’s being raised. Less than $2 billion of institutional capital has been spent.”
Investors are trying to spend at least $6.4 billion on single-family rentals, including from funds such as Colony Capital LLC, GTIS Partners, KKR & Co., Oaktree Capital Group LLC, Och-Ziff Capital Management Group LLC and the Alaska Permanent Fund Corp. They want to take advantage of U.S. home prices that are 35 percent below the 2006 peak and growing demand for rentals as the homeownership rate sits at the lowest level since 1997.
The largest pending bulk sale is a portfolio of 2,490 properties by Fannie Mae, the Washington-based mortgage-finance company controlled by the U.S. government. Final bids, announced in February, are still being reviewed.
The Federal Housing Administration, which manages about 35,000 repossessed homes whose mortgages it insured, plans to sell loans on about 5,000 properties with delinquent loans beginning in September for possible conversion to rentals, Secretary of Housing and Urban Development Shaun Donovan said June 8.
Future bulk sales by Fannie Mae and McLean, Virginia-based Freddie Mac, also government-controlled, may be delayed by political pressure to monitor the properties in the pilot project, making it harder for investors to accumulate real estate owned -- or REO -- homes that were repossessed, according to a June 7 note by Jaret Seiberg, a policy analyst with Guggenheim Securities LLC in Washington.
“This could be a disappointment to many investors who expected Fannie and Freddie to unload thousands of properties through the REO-to-rental program,” Seiberg wrote.
Bank of America Corp., which had more than $40 billion of losses related to mortgages and foreclosures, has conducted only two bulk auctions of a “few hundred” properties, according to Rick Simon, a spokesman for the Charlotte, North Carolina-based bank.
“That isn’t a large part of our strategy,” Simon said in a telephone interview from his office in Calabasas, California. Rather than selling in bulk, the bank is agreeing to short sales, in which homeowners sell their properties for less than they owe; selling foreclosures through real estate brokers; and auctioning off properties one at a time, Simon said.
PropertyAccess, a unit of FirstService Corp. that manages about 10,000 single-family rentals a year for banks and institutional investors, is starting an “acquisition platform” to help large funds find properties, said Jim Warren, senior vice president of the Austin, Texas-based division. By the fourth quarter, PropertyAccess will be able to procure 500 to 1,000 homes a month for investors, he said in a telephone interview.
“You’ve got Warren Buffett saying he’d buy 200,000 homes if he could find the operational ability to do so,” Warren said. “The reverse of the conversation is, Where the hell do you think you’re getting 200,000 properties? The operations exist.”
Colony Capital, the private-equity firm founded by Tom Barrack, is building an in-house staff to realize its plans to acquire $1.5 billion of rental homes by April of next year, said Justin Chang, acting president of the firm’s Colony American Homes unit. Colony, based in Scottsdale, Arizona, has acquired 1,200 homes and hired 125 people to buy and maintain properties in Arizona, California and Nevada, with plans to add at least three other states this year, Chang said.
“Our view is there’s tons to buy, and tons to buy attractively,” he said in a telephone interview. “Once you own the homes, it’s fixing them up, leasing them up and managing them on a go-forward basis which is challenging.”
An exception is Nevada, the U.S. leader for delinquent mortgages for more than five years, according to RealtyTrac Inc. Foreclosures in the state slowed after a law that took effect in October raised the burden of proof on lenders seeking to repossess property, making it “a less attractive part of our business,” Chang said.
Tom Shapiro, chairman of New York-based GTIS Partners, expects to invest $1 billion by 2016, in what he estimates is a $1 trillion market for single-family rentals. He said he’s buying properties one at a time, like “a sharpshooter,” rather than purchasing them in bulk because houses aren’t a commodity like oil or gold.
“If you buy by the pound, I think you’ll underperform,” Shapiro said in a telephone interview from New York. “If a firm that wants to put in $500 million today at $100,000 a house, that’s 5,000 houses, and they’re not doing the level of work they need to. They’re not going to every house and looking at the Google street map.”
The homes in the Fannie Mae bulk sale will be sold in regional pools in Atlanta, Chicago, three regions of Florida, Las Vegas, Southern California and Phoenix, according to a summary prepared by Credit Suisse Group AG, the financial adviser for the sale.
Andrew Wilson, a Fannie Mae spokesman, and Steven Vames, a spokesman for Credit Suisse, both declined to comment because the transaction is a private placement.
The pools will be either sold outright to investors or used for joint ventures with Fannie Mae, according to six people who reviewed the offering and asked not to be identified because of a nondisclosure agreement. Buyers of the homes, 85 percent of which come with rental tenants, will face sales restrictions to prevent flipping or flooding the market with distressed properties, the people said.
About 8 percent of the 114,157 homes in Fannie Mae’s inventory of foreclosed properties had tenants as of March 31, according to a regulatory filing.
Carrington Capital Management LLC, based in Santa Ana, California, announced a $450 million commitment in January from Los Angeles-based opportunity investment fund Oaktree to buy single-family rentals.
“We’re finding the hardest thing is deploying funds,” Carrington Executive Vice President Rick Sharga said in a telephone interview. “It’s hard to find investments in any volume.”
Real estate brokers oppose bulk sales to large funds, arguing there’s enough demand by small investors and individual buyers planning to live in the homes to absorb the inventory coming to market.
Large-scale foreclosure sales “would put further downward pressure on home prices, take away local investment opportunities and enrich Wall Street investment funds,” Richard Smith, chairman of Realogy Corp., said in a telephone interview. “It’s a solution in search of a problem.”
Realogy, based in Parsippany, New Jersey, handled about a quarter of all U.S. listed home sales last year through such brands as Coldwell Banker and Sotheby’s International Realty. Its parent, Domus Holdings Corp., on June 8 filed papers for an initial public offering that would raise as much as $1 billion. Brokers wouldn’t receive commissions from bulk sales.
Opposition to bulk sales isn’t deterring potential investors. Oliver Chang, who estimated last year that 7.5 million homes with a market value of $1 trillion would be lost to foreclosure by 2016, left his job as an analyst with Morgan Stanley in May to start a fund investing in rental homes.
“We are seeing tremendous interest in our fund from investors, and expect to close on a significant allocation shortly,” Chang said in a departure note to his colleagues. He declined to comment for this story.
Treehouse Group LLC, a Tempe, Arizona-based real estate company, and London-based property investor Regis Group Plc formed a partnership to buy and manage $1.5 billion of single-family homes, Treehouse Chief Executive Officer Dallas Tanner said at a Jefferies conference last month in Falls Church, Virginia, according to three people at the gathering, who asked not to be identified because they weren’t authorized to speak for the company and the conference was closed to the media.
“Treehouse Group and Regis Plc have formed a strategic partnership and are creating a national platform,” Tanner said in an e-mail, declining to comment further.
The flow of discounted foreclosures has slowed since late 2010, when some of the largest mortgage servicers, including Bank of America, imposed a temporary moratorium on home seizures amid allegations they used faulty or forged paperwork to seize properties from delinquent borrowers. Even after a $25 billion settlement in February between the five largest loan servicers and attorneys general from 49 states, foreclosure processing hasn’t recovered.
Banks repossessed 185,451 homes in the first quarter, a 14 percent decline from a year earlier, RealtyTrac data show. The number of REOs bought by third parties in the first quarter was 123,778, down 15 percent from a year earlier, according to the Irvine, California-based company.
Rather than seize properties from delinquent borrowers, banks have stepped up the number of short sales, which rose to their highest level in three years during the first quarter and are expected to surpass the number of REO sales this quarter, according to a May 31 RealtyTrac report.
About 1.6 million homes were in the so-called shadow inventory -- meaning they’re more than 90 days delinquent or already held by banks and not listed for sale -- according to a March 21 report by CoreLogic Inc. The total balance of loans on homes in the first quarter’s shadow inventory was $1.13 trillion, Standard & Poor’s said in a May 8 report.
About 6 million borrowers will lose their homes in the next five years because of inability to pay their mortgages, creating demand for as many as 4 million new rental households, according to Scott Simon, head of mortgage bonds at Pacific Investment Management Co. in Newport Beach, California. If funds spend $6 billion on foreclosures, that buys only about 40,000 homes at $150,000 apiece, leaving plenty more for investors of all size to buy rental housing, he said.
“There will be millions of new foreclosures,” Simon said in an e-mail. “Renting is now more expensive than owning in most areas. However, if you can’t get a loan, housing is in practice infinitely expensive.”
While there’s a foreclosure supply surplus nationwide, Phoenix, one of areas hardest-hit by the housing crisis, is running dry, according to Simon. Investors are competing to buy a shrinking pool of distressed homes, helping home values find a floor, he said. Prices there jumped more than 11 percent from a year earlier in April, the biggest increase among the 10 largest U.S. metropolitan areas, according to CoreLogic.
That’s prompting some single-family investors to look elsewhere. Landsmith LP, a San Francisco-based firm with about $100 million to invest in single-family rentals, sold 75 of its 250 homes in Phoenix, said Chief Executive Officer James Breitenstein. The deal, announced yesterday, was for $7.5 million, about $2.2 million more than Landsmith paid for the properties.
“We’ve attained key investment objectives in Phoenix, and are now entering other U.S. markets exhibiting the traits we first identified in Arizona,” Breitenstein said in a statement. “There are a select number of other cities and sub-markets that offer the right combination of currently distressed housing prices, a stable if not rising employment rate, and investment fundamentals that fit our model.”
American Residential Properties Inc. raised $225 million in a private real estate investment trust offering that was completed on May 11, President Laurie Hawkes said. She expects the REIT, now limited to institutional investors, to go public next year. The Scottsdale, Arizona-based investment firm previously committed about $85 million for more than 650 single-family rental homes in Arizona and Nevada through a separate fund.
“There’s no question the Phoenix market has become more competitive,” Hawkes said in a telephone interview. “But we’re still finding a lot of opportunity in Phoenix as well as our other target markets.”
Prices have also begun to recover in Miami as the supply of foreclosed homes dwindles. Home values were up 2.8 percent through March from a post-peak low in April 2011, according to an S&P/Case-Shiller price index for the area.
A $25 million fund raised by Delavaco Properties Inc., a Fort Lauderdale, Florida-based owner of about 450 single-family properties, was “more than two times over-subscribed” with investors drawn to the 7.5 percent interest on the debt plus options to buy shares of the company, said Chief Executive Officer Andy DeFrancesco. The firm plans to go public, with a listing on the Toronto Stock Exchange, late this year, he said.
Delavaco, which buys homes costing an average of $70,000 that rent for $1,500 a month, will grow by accumulating properties with steady returns, not by purchasing in bulk, DeFrancesco said in a telephone interview.
“I don’t know how you can put $1 billion to work and maximize your profit,” he said. “To spend $1 billion in short order, you’d need to buy 10 homes a day or more. You’d have to take a lot of junk.”
The Alaska Permanent Fund tentatively agreed on May 27 to invest as much as $400 million in single-family rentals through American Homes 4 Rent, a property-management company owned by Wayne Hughes, the retired chairman of Public Storage. Hughes didn’t respond to telephone messages seeking comment.
“Nobody’s ever done this on a scale before,” Michael Burns, chief executive officer of the Alaska Permanent Fund, which had $41.5 billion under management at the end of the first quarter, said in a telephone interview from Juneau, Alaska. “These people’s background is in public storage, which is about as close as we could find.”
The Alaska fund expects unlevered returns on its investment of 6 percent to 7 percent a year, Burns said. The expected yield, while better than Treasury bonds, is an indication that the single-family rental market’s risk is lower -- and so are potential rewards -- than the usual draw for opportunistic investors, said Steve Duffy, managing director of real estate investment banking at accounting firm Moss Adams Capital LLC.
“It’s logical that early capital had the view to get a higher return from their investments,” Duffy said in a telephone interview from his office in Irvine, California. “That’s no longer the case. The risk is down because the economy is recovering and there’s stabilization in housing.”
While the market for single-family rentals is experiencing growing pains, there’s still a lot of opportunity as investors gain a better view of cash-flow potential and financing becomes easier to get, said Ford of Jefferies.
“You’re still talking millions of homes,” he said. “Real companies are being built.”
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