Real Estate

The case for and against REO to rental

REO to rental is trending — maybe not on Twitter but certainly in mortgage finance circles where it’s all the rage.

Rick Sharga, executive vice president with Carrington Mortgage Holdings, presented a reasoned, balanced case of the pros and cons of the concept Thursday during a SourceMedia mortgage servicing conference in Dallas-Fort Worth.

Carrington and Oaktree Capital Management formed a partnership earlier this year to buy up to $450 million in foreclosed homes with a plan to rent them out. The partnership says its REO investment could reach $1 billion if all goes as planned. Obviously, the companies favor the concept in a big way.

Sharga offers plenty of smart arguments to support it but also throws in a few caveats.

He even took a slight jab at the country’s largest real estate trade group, the National Association of Realtors, contending the math doesn’t support NAR’s argument that REO to rental is “largely unnecessary.” He even calls NAR’s argument a “dog-bites-man news story” from a group whose members sell homes for a living.

I call it a slight jab because at some point in his talk, Sharga made a point to say Carrington is pro-Realtor and owns a real estate brokerage. Sharga said some of those agents might even be able to make the transition from property sellers to property managers if this whole REO-to-rental thing actually takes off.

In 28 of last 29 quarters, the nation has created more inventory in REOs than it has sold off, according to RealtyTrac data. And the so-called high price obtained by real estate agents in selling REO (supposedly about 94% of broker price opinions) is skewed because the best properties have been cherry-picked for sale, Sharga contends.

In arguing his case for REO to rental, Sharga said home prices are at or near the bottom; multiple sources exist for acquisition of REO in bulk (banks and the government-sponsored enterprises being the main sources); and rental demand and monthly rents are soaring, offering opportunities for investors to make some money.

The concept also jives with public policy efforts to reduce inventory and reconstitute housing stock.

Sharga contends there’s no need for governmental financing (there’s plenty of capital available) and deep discounts won’t be needed to get investors involved. As testament to its popularity, thousands responded to the Federal Housing Finance Agency‘s request for information.

Yet he isn’t one to sidestep the challenges of the concept.

It’s been much easier to buy nonperforming loans than it has been to buy actual REOs, several investors noted during the conference

And the FHFA’s pilot represents a mere 1% of the agency’s REO inventory. And it’s been painfully slow to develop. HousingWire recently reported on a delay in the rollout.

Nor is the pilot optimized to boost local economies as 85% of homes in the pilot are already occupied so investors won’t have any incentive to inject capital (jobs) into communities via home renovation work.

Initial bulk portfolios put out by lenders, meanwhile, have been small, unfocused affairs.

The inability for investors to be selective in what goes into the bulk offering also minimizes effectiveness and could require discounts to get investors to accept unwanted properties. At least one investor at the conference told me that was a key reason why his company declined to participate in the FHFA pilot.

Carrington, for its part, doesn’t want swimming pools with any properties. It also ruled out the very low end and the very high end of the market. Other investors have specialties as well. Some, for example, are looking specifically for government-supported Section 8 affordable housing stock.

“Your inability to be selective hampers your ability to be successful in this (REO-to-rental) marketplace,” he said.

The positive energy remains palpable. Can these bulk sales be organized in such a way to work for the large, institutional investor and stabilize the housing market?

“We have a chance to reduce the number of vacant properties, stabilize local marketplaces, provide homes for displaced borrowers,” Sharga says. “It provides liquidity and reduces risk … injects capital into the market that is sitting on the sidelines,” he adds, wrapping up on a positive note.

Here’s hoping someone can figure out how to make it work.

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