The business of buying up foreclosures and renting them out is no longer the exclusive, private domain of individuals and small companies. REO-to-Rentals is quickly becoming a business plan for multi-million dollar investment groups, a fundamental force in the nation’s real estate economy and a public policy strategy to soak up REOs and preserve property values.
The combination of lower vacancies, increasing rental rates, and affordable REO properties has attracted big time money to the rental markets. Many see the same dynamics that made residential real estate investing what it is today: the potential for strong and sometimes instant cash flows combined with the promise of future appreciation. Carrington Holding Company, Amherst Securities Group, and Waypoint Financial are just examples of investors now active in purchasing single family REOs and turning them into rentals and holding for longer terms rather than the typical short term holds.
In fact, the REO-to-Rental strategy is squeezing individual investors who are paying more distress sales, competing with well-heeled competitors for properties and tenants, and watching their potential profits dwindle.
Demand for REOs is so strong that sales prices for REO properties (as measured on a median price per square foot basis) are rising at a much faster pace than non-REO sales. Over the last year, REO-only prices have jumped a healthy 5.5 percent, while fair market sales dropped 2.9 percent. This is a significant 8.4 percentage point difference between the two sub sectors of the national market, according to Clear Capital’s latest Market Report with data through April 2012 released yesterday.
A negative consequence for individual investors is a shrinking of the REO discount that is the profit potential for flippers. Discounts are declining fastest in major investor markets like Phoenix where REOs are being snapped up for the rental markets.
The combination of rental demand, fueled both by displaced homeowners who have been foreclosed upon (See Secrets of Single Family Rentals) and those who have opted to rent rather than buy, is driving a thriving rental market that is strongest where foreclosures have been greatest and the supply of single family rentals most plentiful.
The scope of the opportunity is huge. Falling vacancy rates are continuing to drive up rents across the nation. Check out the chart below fromIt shows the inverse relationship of rental vacancies to year-over-year rental rate changes. This relationship is clear since 2000, with a precipitous drop in vacancies starting in 2010 coinciding with a sharp increase in rates.
REO-to-rental, of course, is now underway by Fannie Mae. Not only are federal policy makers watching Fannie’s pilot project carefully in hopes that it can be expanded significantly at the GSE level, it’s a contingency strategy for large lenders should the backlog of foreclosures being freed by the multistate AG agreement disrupt local markets and impede the recovery.
Going forward, the sensitive balance between REO supply and demand will help determine how market prices react to shifts in REO saturation. If REO-to-Rental investment activity continues or increases, it is likely to provide the lift needed to support price increases, especially as we enter the summer buying season. It’s likely this balance will ebb and flow over the next several years with the markets recalibrating and normalizing along the way.
“There has been quite a bit of buzz in the housing industry surrounding turning REOs into rentals. Our data suggests early activity from these programs could be starting to take effect, with national REO-only home price gains on a price per square foot basis vastly outpacing fair market prices on a national level,” said Clear Capital’s Chief Economist Alex Villacorta. “Should investor interest continue to drive the expansion of REO-to-rental programs over the next several months, there could be a significant impact on the market overall in terms of providing a rising floor to home values.”