Straight Talk on Investing Today : A Conversation with Rick Sharga

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Perhaps no one is as closely identified with the Foreclosure Era as Rick Sharga. From 2004 to 2011 no one did more to forewarn Americans about the greatest floods of foreclosures since the Great Depression and to help them understand how their local housing markets would be affected. In the process, he made RealtyTrac a household name .

Now Rick is playing a similar role on behalf of Carrington Mortgage Holdings, the powerhouse mortgage servicer, asset management, property management and real estate services firm. He shared with us his thoughts about the future of residential real estate investing and related issues.

Let’s start by taking a look at the bigger picture in the foreclosure markets. There are some 1.2 million properties in the foreclosure pipelines, and they are just as likely to be in places like New Jersey, New York or Illinois than the traditional “sand states”. Foreclosure starts and completions have been down 20 percent in each of the past two years and that will continue barring an economic crisis. When do you see the Foreclosure Era ending?

I think we have two to three more years of unusually high levels of foreclosure activity. And then I think that it will fall back rapidly to normal levels. The only reason I see it going into the third year, candidly, is because of the time it takes to process foreclosures in the judicial states.

We’ve now seen a significant entry of hedge funds into the REO-to-rental business. Yesterday Bloomberg reported that the largest fund alone has spent $2.7 billion to date buying up single family homes. In light of the fact that foreclosures prices are strong and rising in many markets, are most funds still buying today?

Let’s take a giant step back just for a minute. Let’s assume that all $2.7 billion was spent. Let’s assume, just for sake of argument, that the average purchase price was $100,000. That means that 27,000 houses were bought in a year when about 4.6 million properties were sold. So, while this is trendy and fascinating, I think a little bit of this is the tail wagging the dog.

So you don’t see that these purchases are having a significant impact on the tight inventories of foreclosures?

I think they are in two ways. I think they are on a localized basis. We’ve seen it happen in Phoenix and we are starting to see glimmers of it happening in Atlanta. My guess is that Las Vegas will probably be next. You’re seeing the investors coming in and looking at distressed property pricing in hard hit markets where there appears to be inventory and the opportunity for rental transactions, and then bidding each other up.

We got to a point in Phoenix where we said these prices don’t make any sense. It’s mind boggling to hear an institutional investor say that their model is based on buying a property, holding it and then flipping it as prices appreciate and then buying a property for 25 percent over list price. It makes no sense. But that’s not our model so we’ll let everyone else do what they want.

I see institutional investors affecting foreclosure markets a second way. Last year there was not the anticipated supply of REO, partly because of the delays in foreclosure procedures, partly because we saw a huge lift in proprietary loan modifications and in short sales as the major servicers tried to comply with the Attorneys General agreement , and I think that wiped out a lot of potential REOs. So A) we never had the bulk sales that were anticipated and B) we saw over a million short sales last year, which was a record. REO sales actually dropped a bit from 2011. My guess is that we are going to see more of the same in 2013.

So you have people who are bidding and competing for pretty limited assets, and they’re competing with local investors and local home buyers. What that’s doing is raising the pricing on the bottom of the market, which makes the median value go up. To a certain extent you could say, perhaps, that it’s casting an artificial light on some of these home prices. Now, the fact that those prices tend to stick suggests that even if they started out as artificial, they look pretty real right now.

What if any impacts have you seen from the delay in the development of a secondary market in single family rentals? Any slowdown in hedge fund investments?

No, because the secondary market is really more about financing and most of the major players have cash at this point. Some have decided to do a REIT as a way to gain leverage to invest more. But, candidly, there’s been more capital raised than there is inventory available to buy.

Let’s look down the road three or four years. Do you see a significant percentage of single family rentals being owned by large companies and an overall market of one to two million single family rentals? Another scenario is that future demand for these rentals won’t be there and these large investors will simply sell off their properties and go elsewhere. That could result in large numbers of properties being dumped on local markets.

Let me go to that last point first. I have a real hard time envisioning a scenario where there’s property dumping on a large scale. Investors are in this for profit. Will they sell these properties off at some point? Yes. Will it be at a point where they are going to take a profit on the sale? Most likely. You’re probably not going to see discounted sales on these properties unless the economy goes completely sideways, and in that case we will have a whole different set of issues to deal with.

Do I see continued demand? Yes, I do. Everything I read suggests that we are going to see a large amount of household formation without necessarily the same proportion of home buyers returning to the marketplace as in the past. So, I think we will see continuing increases in demand for rental properties and as long as there is demand and as long as rental rates are healthy, there will be investors who are interested in that category. Will some of these major players get out at the end of three to five years. Yes, probably. As the market dynamics shift and you see more buying activity, perhaps rental prices weaken a little bit, then some investors will move on to something else.

The most likely scenario is, let’s use a round number and say that going into this cycle 20 percent of rental units were single family homes,.It wouldn’t be unreasonable to assume that perhaps we get out of the cycle with 25 percent being single family units—and that will be 25 percent of a growing denominator as the total number of renters rise. So, single family rentals will be a higher percentage of a growing number.

But the single family rental is more of an alternative for the homeowner than the renter. That 25 percent is coming out of the hide of the potential homeowner than the potential multifamily renter.

We’re saying the same thing. What I’m saying is that I don’t expect homeownership rates back at 68 percent. We’ll have a higher number of renters. I expect homeownership rates to continue to dip, and then they will climb back little bit but if we get top 64, 65 percent that will be pretty high, and that will be a high percentage of a bigger number as the tide of household formation lifts both boats, homeownership and rental.

In this scenario three or four years from now, what role will there be for the individual investor?

First of all, there are over 3000 counties in the country. Institutional investors right now seem to be focusing on about a dozen. There are opportunities for individual investors across the country, especially in markets that are off the radar of the bigger guys.

Short term there’s an opportunity for that individual investor to shift gears a little bit and change their business model. The hardest thing for the institutional investors to do is to find properties that meet their model and buy them. There’s an opportunity for the local individual investors to be their eyes and ears, arms and legs. They can profit by buying and reselling to the bigger guys.

This is not a zero sum game. There will be properties that are available for the individual investor to buy and hold as rentals because they simply won’t meet the requirements an institutional investor is looking at. For example an institutional investor is probably looking for a, geographic concentration. So if there’s one home in a neighborhood, that might not be as attractive as if there were three or four, from an economy of scale perspective. There will still be opportunities for the “one offs” that are problematic for larger scale investors.

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About Author

Steve Cook is the editor of Real Estate Economy Watch and writes for a several leading outlets in addition to BiggerPockets, including Equifax and Total Mortgage. He also provides communications consulting services to leading real estate companies. Previously he was vice president of public affairs for the National Association of Realtors.

2 Comments

    • Ryan;

      I agree with Rick that there will be plenty of room for individual investors in the future but the days of the deep foreclosure discount are ending, especially in markets popular with institutional investors like Phoenix, Vegas, Atlantam most California markets. However, Florida is full of opportunity todat (see http://www.realestateeconomywatch.com/2013/02/foreclosures-re-infect-florida-markets/).

      The plus side of the equation is I beleive the single family rental is here to stay, and will be an increaskingly popular option for young famiiliies who cant affort to buy. There arent sso m many SFRs in Midwest and Northeastern cities where there are sill a lot of foreclosures coming on market. If I were a young investor, I would certainly check out Philly, Trenton, Cleveland, Chicago. greater NYC…

      Ryan, thanks for you question…Good luck.

      Steve

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