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'REO to Rental' Draws Investors Back into Real Estate

Sorohan, Mike
DALLAS--Since peaking at 69 percent in 2006, the U.S. homeownership rate has fallen to its current 65.4 percent. That’s a lot of former homeowners.

Now, investors see opportunity. Even as the housing market bottomed out and investors, burned by the housing downturn, left real estate, others saw new opportunities to convert these properties into rental units, targeting in many cases the same cohort of former homeowners who can’t--or won’t--get back into homeownership.

“We’re looking at a $1.5 trillion market and 12 million homes,” said Toni Moss, CEO of AmeriCatalyst LLC, Austin, Texas. “And there are five million homeowners who have been foreclosed on since 2006. There are a lot of people who prefer access over ownership.”

Laurie Hawkes, president of American Residential Properties, Scottsdale, Ariz., said the REO to rental opportunities began presenting in the Phoenix area as early as 2008.

“We saw this as an opportunity as the market began to over-correct itself,” Hawkes said here at the Mortgage Bankers Association’s National Short Sale/REO Summit. “The bubbles aren’t coming back. Without the REO to rental market, the entire housing market would be so much worse now.”

Hawkes, whose company now operates REO to rental programs in nine states, said just as lenders have tightened their underwriting standards, consumers interested in REO to rental have better financial situations.

“For most of our customers, the percentage of their income spent for housing is 21 percent,” Hawkes said. “That’s a long way from the housing crisis, when many homeowners were spending more than half of their income on housing.”

For some people, the REO to rental market represents a tremendous opportunity to move distressed properties through the housing inventory. For others, enthusiasm for REO to rental strikes to closely to the last housing crisis.

Moss estimated that 70 percent of current investors in the REO to rental business are in it for the short term. “We’re seeing a tremendous amount of hype, and the last time we saw this kind of hype was during the subprime period,” she said. “[But] I think it’s a long-term trend; I’m not sure that [former homeowners] are going to readily get back into homeownership soon.”

Wendy Forsythe, executive vice president and head of global operations with Atlantic & Pacific Real Estate, Los Angeles, a brokerage network, said the REO to rental investment class has become important to her 1,100 agents.

“We spent a lot of time last year in training and educating, working with our investors and agents in taking advantage of this huge opportunity,” Forsythe said. “Investors are looking for agents who can meet their needs. We have a huge demand from investors and we need to know how to serve that demand.”

Forsythe said many brokers are looking for smaller properties or portfolios of properties. Her company developed a formula enabling brokers to identify properties through Multiple Listing Services to assist with individual investors. “It’s the small investor who is going to make the biggest difference in these markets,” she said.

MBA data show household formation, while improving, continues to lag. Over the past 20 years, household formation occurred at a rate of 1.2 million per year; since the end of 2006, however, as the housing downturn kicked in, the U.S. added 4.8 million renter households and lost 1.7 million owner households.

MBA Chief Economist Jay Brinkmann said since 2010, the U.S. has seen creation of more than one million new households per year, the majority of which has been rental units. And despite a low interest rate environment and data showing higher rental rates and growing dissatisfaction among renters, the “tipping point” back toward homeownership has not yet occurred.

“We have yet to see this turnaround in the market to homeownership,” Brinkmann said. “We have yet to see any real motivation among renters to move into a home purchase.”

Hawkes said many of these current renters could make the transition back to homeownership. “In about five years, we’re going to have a large group of renters who have a solid financial history who we could help purchase their next home,” she said.

Hawkes was critical of rules that make sale leasebacks to previous owners difficult, if not impossible. “We could have helped so many more people who had a chance to stay in their homes as renters,” she said.

Marie Chung, owner and director of Modern Estates, Los Angeles, said the REO to rental market is having an immediate impact on inventory and homeownership.

“Quite a few of the properties in Southern California are being sold as ‘occupied,’ and I can only assume that the investors are in this for the immediate financial return [from rentals],” Chung said.

Forsythe said the type of properties they look for depend on the investor. “What kind of rent are they looking for? What is their long-term strategy?” she said. “One of the factors involves how quickly they can get the property rented. Many investors think they can have the property rented within 30 days of closing, but they have to understand that there is some renovation involved to get it rent-ready, then marketing property, then actually getting the person into the property…there’s an education process involved.”

“To make this work, you need long-term price appreciation,” Hawkes said. “The question to watch is if the high-yielders stay in it for the long run.” She noted that in most markets, properties are still below-market priced. “There’s still a lot of room to grow,” she said.

Over the next 12-24 months, Hawkes said she expected a number of companies to seek investment to take on large-scale portfolio investment. “This sector could dwarf multifamily over time,” she said. “I would like to see more financing from banks.”

But Hawkes acknowledged that banks continue to show wariness about REO to rental-focused companies, and for good reason. She said companies must be able to show a “record of best practices and operational efficiencies” that has yet to prove out over the long term.