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Investments

Here's why investors are flooding into REO-to-rental

Makes good dollars and sense

March 14, 2014
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In less than two years the REO-to-rental concept on a large scale has grown from what many real estate professionals and mortgage servicing industry experts believed would be at best a flash-in-the-pan fad or worse a crash-and-burn exercise in futility, to become a growing new asset class.

For many decades wealthy individuals invested in real estate as long-term rental properties. That tried and true model has morphed into a similar opportunity for institutional investors.

On Jan. 29 of this year, for example, HousingWire reported that the second major REO-to-rental deal would raise millions. The first such deal was put together by the investment giant Blackstone Group, which spent $7.5 billion to acquire 40,000 homes. But, although there is much to flush out about this new market sector, it is clear that it is here to stay, at least for a while.

In fact, the amount of interest and even excitement being generated via media reports and at a growing number of REO-to-rental conferences, seminars and symposiums across the country is nothing short of explosive.

At one such conference, The 2014 Clayton-Green River Capital Real Estate Symposium held recently in Salt Lake City, the REO-to-rental market took center stage. Incredible numbers were reported by speakers at the symposium in terms of how much private equity money is out in the marketplace ready to finance this new asset class – as much as $500 billion – with a “B”.

And this is not just reserved for mega-investors. This new sector is becoming a true “Wall Street to Main Street” phenomenon.

Where this was once thought to be the future domain of only major public entities, such as REITs and large investors the likes of Blackstone, Goldman Sachs, and other institutional investors, today there are countless smaller investor groups and even individual investors who are diving headfirst into this growing pool.

The housing crash created a tsunami of foreclosures, which in turn foretold of a matching torrent of bank-owned properties flooding the marketplace. While there is not space, nor need, to rehash the causes of the crash, it is important to understand why REO-to-rental has become such a huge market, and why the ‘torrent” of REO’s never became more than the steady drip of a faucet – a really big faucet, but nothing more.

Many note that with so much government intervention over the past several years with programs such as foreclosure moratoria, HAMP, HAFA, and others purportedly created to help struggling homeowners avoid foreclosure, the for sale REO market began drying up in late 2009.

Short sales soon became the fastest growing disposition method for selling off non-performing real estate assets. Adding to this situation was the “robo-signing” debacle that again stalled the foreclosure process, further keeping REO properties from hitting local real estate markets. 

The subsequent creation of the now infamous “shadow inventory” gave birth to an artificial housing recovery, not the “real” one that so many people have been touting. Because interest rates remained historically low, demand for housing continued to grow.

This demand was not just fueled by those individuals and families seeking to own a home, but also investors who were buying up bank-owned properties in bulk. As inventory of all housing classes decreased, home prices were driven up beyond which a “normal” market would have created.

Today, it is not unusual to have multiple offers on properties. This too drives up real estate values. Investors, with cash on hand, will pay more for properties than most individual owner-occupants would or could. Investors will because as long as they pay no more than the replacement value of a given property or properties they believe they have made a sound investment.

This is true, of course, provided there is no major downturn in housing prices that could be caused by, let’s say, a major stock market crash or other major financial fiasco. Even the recasting of interest rates on loans made through HAFA could increase foreclosures significantly. However, this volatility could still spell opportunity for investors in the REO-to-rental market.

To be sure, some analysts are not sold – to these analysts, margins are what is most important to investors. Still, there seems to be no shortage of people who are bullish on this market sector.

While many owner-occupants have been squeezed out of the home-buying process, individual investors are still buying and then renting to a growing number of tenants who have been priced out of purchasing a home, or who do not have sufficient funds to make the required down payment in order to own. The recent tightening of underwriting standards is also a factor.

This has driven up demand for rental properties. Many people would rather rent a single-family home than live in a cramped, noisy apartment complex.

This, naturally, has attracted numerous investors to the REO-to-Rental space. It makes good sense and is a good use of investor dollars.

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