WILL RENTING OUT FORECLOSURES HELP THE HOUSING MARKET?

Is this the initiative that could turn things around? Presented by Fred Leamnson, AIF Another big idea with a big opportunity attached. No magic wand will repair the sluggish housing market, yet the idea of converting foreclosed homes into rental properties has opened eyes especially the eyes of private equity firms. The federal government and major lenders are now putting that idea into action. Inventory abounds between them, Fannie Mae and Freddie Mac are saddled with about 180,000 foreclosures, and the Federal Housing Administration has about 32,000 REOs. RealtyTrac says banks own more than 600,000 REOs by themselves.1,2 In Q4 2011, home ownership hit its lowest level (66%) in 14 years. The rental market is red-hot right now, and private equity firms see some amazing potential profits within their short-term reach.2 How catalytic could this effort become? Karl Case (yes, the Case in CaseShiller), who co-created this proposal, thinks that the seeds to a recovery are being planted via this program. Accompanying visions of recovery, there is genuine excitement: a principal at a California private equity firm told Bloomberg that this will be a new institutional asset class in the next 24 months.2 Trial programs launch in April. As a first step, the Federal Housing Finance Agency (Fannie and Freddies parent) is auctioning off almost 2,500 downtrodden residential properties this month in eight metro areas. They will be offered to institutional investors in bulk (for example, 99 properties in Chicago and 572 properties in Atlanta) and investors must agree to rent them out for X number of years (the number has not been determined).3 In the private sector, Bank of America is launching a program this spring with a slightly different slant. It will give 1,000 homeowners in Arizona, Nevada and upstate New York a chance to stay in their homes as renters as the foreclosure process plays out. BofA plans to sell these REOs to investors within three months (or as soon as the occupants surrender ownership and start paying rent). Borrowers cant apply for the program themselves, but they can alternately ask BofA to cancel their mortgages via a deed in lieu of foreclosure

and then contractually agree to rent the same home for up to 36 months at or below market rates. This program could go national if it succeeds.4 Could the ROI go through the roof? One private equity firm thinks it can package its envisioned portfolio of converted foreclosures into a public REIT with an internal rate of return approximating 25% within three years. Reuters recently cited other institutional investors with more cautious visions of ROI of 8%-15% from their efforts. Still, that looks pretty rosy next to current yields from 10-year Treasuries and CDs. If the housing market perks up, perhaps it may prove true.1 What about the ethics of this? Not all economists think this is a great idea. Detractors ask: should hedge funds become landlords? Should homes owned by Fannie and Freddie be sold to institutional investors at deep discounts? Is this another example of the 1% benefiting from the misfortunes of the 99%? Other proposals were up for consideration. Some of the ones not chosen by the federal government could be copied in the private sector. Dean Baker, codirector of the Center for Economic and Policy Research, pitched the idea that Fannie and Freddie could offer borrowers the chance to stay put in their foreclosed homes and pay market rent. Morgan Stanley lobbied for special loans to institutional investors and tax breaks on rental income.5 Is this the cure for the housing blues? These public and private foreclosure conversion programs boast intriguing potential: a possibility of sizable profit, and a chance to fight blight. A Morgan Stanley report notes that by 2016, circa 7.5 million homes with a present market value of $1 trillion will be liquidated via foreclosures and short sales. This could expand the total of rental homes in America from the current 20 million to 27.5 million. Morgan Stanley reminds investors that single-family homes operated as rentals have yielded annual returns averaging 8.1% since 1990.2
Fred Leamnson may be reached at 703-714-9500 or fred@leamnsoncapital.com www.leamnsoncapital.com
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Citations.
1 2 3 4 www.reuters.com/article/2012/03/21/us-usa-foreclosures-investors-idUSBRE82J12M20120321 [3/21/12] www.fa-mag.com/fa-news/9855-foreclosures-draw-private-equity-as-us-sells-homes.html [1/31/12] money.cnn.com/2012/02/29/real_estate/Fannie_foreclosure_homes/index.htm [2/29/12] articles.latimes.com/2012/mar/24/business/la-fi-home-rental-20120324 [3/24/12]

5 www.washingtonpost.com/blogs/ezra-klein/post/can-a-new-plan-to-rent-out-foreclosed-properties-actuallywork/2011/08/10/gIQAO0YA7I_blog.html [8/10/11]