“While the single-family/real estate-owned rentals could grow in the short term — absorbing excess inventory through shadow inventory pipeline — the long-term outlook remains cloudy.” That assessment by HousingWire’s Christina Mylinski may be the understatement of the year.
In fact, a lot of experienced investors I know see their world changing quickly. It’s a change that’s being accelerated by dozens of the hedge funds that continue to gobble up every distress sale in sight despite the fact that their insatiable appetites are only hastening their own demise, especially now that it’s clear securitization of SFRs isn’t going to happen any time soon, if at all. The fact that the future is cloudy only spurs them on to “get while the gettin’ is good.”
In my first post for BiggerPockets over a year ago (Twilight of the Foreclosure Time), I wrote that “Someday the Foreclosure Time will indeed end, though most likely not within the next two years. Its end, however, is inevitable and the forces that will bring about its twilight are already hard are work.” Well, the forces have been hard at work.
The critical focus currently is foreclosure inventories and discount. On inventories, I have nothing to add to what most of the readers of BP already know: unless you live in Midwestern or Northeastern judicial states (which few of you do) or Florida, inventories hardly exist and they supply is not going to get any better. As my friend Harrison Stowe so accurately points out, the shadow inventory is shrinking.
As far as discounts go, recently I had the chance to review some extraordinary third quarter data from Pro Teck and was shocked to see that in Las Vegas and Phoenix the REO discount barely exists. Last week, the national director of distressed sales for one of the top three banks told me that the foreclosure discount no longer exists. He wasn’t kidding, nor was he boasting. How incredible it must be for a huge lender sitting on hundreds of thousands of foreclosures to see the overheated foreclosure marketplace wipe out billions of dollars of losses in just a few months. Every day that passes their inventory is worth more, not less.
Tighter Mortgage Underwriting Standards
The thousand pound gorilla in the room is the new, tightened mortgage underwriting standards, codified last week by the QM Rule. The rule makes it virtually impossible to get a mortgage unless you have the ability to pay for it. Since the 2006 meltdown, lenders have turned down the screws and the vintages of mortgages closed since then are light years lower in risk. The average American moves every eight years, which means that in just a few years homeowners who bought in the bad old days will be a minority. That’s why foreclosure starts have been falling steadily for two years and will continue to do so.
On the income side of the equation, the verdict is in on securitization: it will take years to establish track records necessary for ratings agencies to assess risk. Ten days ago Moody’s shot down the latest idea, an “equity” structure that would expose investors to risks that are not typically present in residential mortgage-backed securitizations and commercial mortgage-backed securitizations.
Rental Demand: Single Family Vs. Multifamily
Finally there is the question of rental demand. Here the latest trends have been surprising, as single family rentals are keeping up multifamily rents and vacancy rates, even though single family rentals typically cost more than apartments. Will demand for SFRs continue to be strong, even as more and more come on stream? Or will selling off properties into a recovering national housing economy provide a profitable exit strategy for hedge funds that can’t meet their financial goals?
A Modern Day Gold Rush?
Sometimes I think the REO-to-Rental business is like the California Gold Rush. First came the lucky locals and the nearby pioneers who discovered the gold fields and grabbed the placer gold in creeks and rivers. Many got rich and word spread. Soon fortune hunters from the East, China and Europe arrived, only to find the easy pickings gone. Most didn’t make a dime. Years later, technology helped a new generation of miners return to the gold fields. Earthmoving equipment and sophisticated machines to wash the ore allow them make a profit from small bits of gold in large volumes of gravel and dirt. However, small prospectors and mining operations survived and many thrive alongside the big guys because they have lower costs and know where to find gold.
The placer gold in the REO-to-rental business is getting scarcer. Organized like real estate factories with property buyers, renovators, management companies and investment bankers all under one roof, the REO-to-rental hedge funds are like modern day gold miners. They were attracted by the nuggets harvested by the pioneers but they might be able to flourish for a while on large volumes of lower returns until the ore plays out. Whether the large operators stay or go time will tell but the small operators, like the small prospectors, know their local markets and they’ll figure out a way to make a profit, just as they did long before the Foreclosure Flood.
Yes, I think we can all agree the outlook is cloudy.
Photo: Alberto Carrasco Casado