Private Equity Has Too Much Money to Spend on Homes

Funds planning to invest more than
$6 billion to buy and rent foreclosed homes are finding it easy
to raise money. The difficulty is spending it.

The number of low-cost foreclosed homes coming to market
has dropped, bulk sales have been slow to materialize and prices
are recovering in markets such as Phoenix, making it hard for
private-equity firms, hedge funds and pension systems to buy as
many homes as they need.

“The folks that raised capital are worried about under-
accumulating properties and how to get capital out in an
efficient way,” Richard Ford, a managing director in the real
estate investment banking group at Jefferies Group Inc., said in
a telephone interview. “A lot’s being raised. Less than $2
billion of institutional capital has been spent.”

Investors are trying to spend at least $6.4 billion on
single-family rentals, including from funds such as Colony
Capital LLC, GTIS Partners, KKR Co., Oaktree Capital Group
LLC (OAK), Och-Ziff Capital Management Group LLC (OZM) and the Alaska
Permanent Fund Corp. They want to take advantage of U.S. home
prices that are 35 percent below the 2006 peak and growing
demand for rentals as the homeownership rate sits at the lowest
level since 1997.

The largest pending bulk sale is a portfolio of 2,490
properties by Fannie Mae, the Washington-based mortgage-finance
company controlled by the U.S. government. Final bids, announced
in February, are still being reviewed.

Bulk Sales

The Federal Housing Administration, which manages about
35,000 repossessed homes whose mortgages it insured, plans to
sell loans on about 5,000 properties with delinquent loans
beginning in September for possible conversion to rentals,
Secretary of Housing and Urban Development Shaun Donovan said
June 8.

Future bulk sales by Fannie Mae (FNMA) and McLean, Virginia-based
Freddie Mac (FMCC), also government-controlled, may be delayed by
political pressure to monitor the properties in the pilot
project, making it harder for investors to accumulate real
estate owned — or REO — homes that were repossessed, according
to a June 7 note by Jaret Seiberg, a policy analyst with
Guggenheim Securities LLC in Washington.

“This could be a disappointment to many investors who
expected Fannie and Freddie to unload thousands of properties
through the REO-to-rental program,” Seiberg wrote.

Auctioning Properties

Bank of America Corp. (BAC), which had more than $40 billion of
losses related to mortgages and foreclosures, has conducted only
two bulk auctions of a “few hundred” properties, according to
Rick Simon, a spokesman for the Charlotte, North Carolina-based
bank.

“That isn’t a large part of our strategy,” Simon said in
a telephone interview from his office in Calabasas, California.
Rather than selling in bulk, the bank is agreeing to short
sales, in which homeowners sell their properties for less than
they owe; selling foreclosures through real estate brokers; and
auctioning off properties one at a time, Simon said.

PropertyAccess, a unit of FirstService Corp. (FSV) that manages
about 10,000 single-family rentals a year for banks and
institutional investors, is starting an “acquisition platform”
to help large funds find properties, said Jim Warren, senior
vice president of the Austin, Texas-based division. By the
fourth quarter, PropertyAccess will be able to procure 500 to
1,000 homes a month for investors, he said in a telephone
interview.

Colony Builds

“You’ve got Warren Buffett saying he’d buy 200,000 homes
if he could find the operational ability to do so,” Warren
said. “The reverse of the conversation is, Where the hell do
you think you’re getting 200,000 properties? The operations
exist.”

Colony Capital, the private-equity firm founded by Tom Barrack, is building an in-house staff to realize its plans to
acquire $1.5 billion of rental homes by April of next year, said
Justin Chang, acting president of the firm’s Colony American
Homes unit. Colony, based in Scottsdale, Arizona, has acquired
1,200 homes and hired 125 people to buy and maintain properties
in Arizona, California and Nevada, with plans to add at least
three other states this year, Chang said.

“Our view is there’s tons to buy, and tons to buy
attractively,” he said in a telephone interview. “Once you own
the homes, it’s fixing them up, leasing them up and managing
them on a go-forward basis which is challenging.”

An exception is Nevada, the U.S. leader for delinquent
mortgages for more than five years, according to RealtyTrac Inc.
Foreclosures in the state slowed after a law that took effect in
October raised the burden of proof on lenders seeking to
repossess property, making it “a less attractive part of our
business,” Chang said.

‘Sharpshooter’ Buying

Tom Shapiro, chairman of New York-based GTIS Partners,
expects to invest $1 billion by 2016, in what he estimates is a
$1 trillion market for single-family rentals. He said he’s
buying properties one at a time, like “a sharpshooter,” rather
than purchasing them in bulk because houses aren’t a commodity
like oil or gold.

“If you buy by the pound, I think you’ll underperform,”
Shapiro said in a telephone interview from New York. “If a firm
that wants to put in $500 million today at $100,000 a house,
that’s 5,000 houses, and they’re not doing the level of work
they need to. They’re not going to every house and looking at
the Google street map.”

The homes in the Fannie Mae bulk sale will be sold in
regional pools in Atlanta, Chicago, three regions of Florida,
Las Vegas, Southern California and Phoenix, according to a
summary prepared by Credit Suisse (CSGN) Group AG, the financial
adviser for the sale.

Andrew Wilson, a Fannie Mae spokesman, and Steven Vames, a
spokesman for Credit Suisse, both declined to comment because
the transaction is a private placement.

Outright Sales

The pools will be either sold outright to investors or used
for joint ventures with Fannie Mae, according to six people who
reviewed the offering and asked not to be identified because of
a nondisclosure agreement. Buyers of the homes, 85 percent of
which come with rental tenants, will face sales restrictions to
prevent flipping or flooding the market with distressed
properties, the people said.

About 8 percent of the 114,157 homes in Fannie Mae’s
inventory of foreclosed properties had tenants as of March 31,
according to a regulatory filing.

Deploying Funds

Carrington Capital Management LLC, based in Santa Ana,
California, announced a $450 million commitment in January from
Los Angeles-based opportunity investment fund Oaktree to buy
single-family rentals.

“We’re finding the hardest thing is deploying funds,”
Carrington Executive Vice President Rick Sharga said in a
telephone interview. “It’s hard to find investments in any
volume.”

Real estate brokers oppose bulk sales to large funds,
arguing there’s enough demand by small investors and individual
buyers planning to live in the homes to absorb the inventory
coming to market.

Large-scale foreclosure sales “would put further downward
pressure on home prices, take away local investment
opportunities and enrich Wall Street investment funds,” Richard Smith, chairman of Realogy Corp., said in a telephone interview.
“It’s a solution in search of a problem.”

Realogy, based in Parsippany, New Jersey, handled about a
quarter of all U.S. listed home sales last year through such
brands as Coldwell Banker and Sotheby’s International Realty.
Its parent, Domus Holdings Corp., on June 8 filed papers for an
initial public offering that would raise as much as $1 billion.
Brokers wouldn’t receive commissions from bulk sales.

Potential Investors

Opposition to bulk sales isn’t deterring potential
investors. Oliver Chang, who estimated last year that 7.5
million homes with a market value of $1 trillion would be lost
to foreclosure by 2016, left his job as an analyst with Morgan
Stanley in May to start a fund investing in rental homes.

“We are seeing tremendous interest in our fund from
investors, and expect to close on a significant allocation
shortly,” Chang said in a departure note to his colleagues. He
declined to comment for this story.

Treehouse Group LLC, a Tempe, Arizona-based real estate
company, and London-based property investor Regis Group Plc
formed a partnership to buy and manage $1.5 billion of single-
family homes, Treehouse Chief Executive Officer Dallas Tanner
said at a Jefferies conference last month in Falls Church,
Virginia, according to three people at the gathering, who asked
not to be identified because they weren’t authorized to speak
for the company and the conference was closed to the media.

“Treehouse Group and Regis Plc have formed a strategic
partnership and are creating a national platform,” Tanner said
in an e-mail, declining to comment further.

Discounted Foreclosures

The flow of discounted foreclosures has slowed since late
2010, when some of the largest mortgage servicers, including
Bank of America, imposed a temporary moratorium on home seizures
amid allegations they used faulty or forged paperwork to seize
properties from delinquent borrowers. Even after a $25 billion
settlement in February between the five largest loan servicers
and attorneys general from 49 states, foreclosure processing
hasn’t recovered.

Banks repossessed 185,451 homes in the first quarter, a 14
percent decline from a year earlier, RealtyTrac data show. The
number of REOs bought by third parties in the first quarter was
123,778, down 15 percent from a year earlier, according to the
Irvine, California-based company.

Delinquent Borrowers

Rather than seize properties from delinquent borrowers,
banks have stepped up the number of short sales, which rose to
their highest level in three years during the first quarter and
are expected to surpass the number of REO sales this quarter,
according to a May 31 RealtyTrac report.

About 1.6 million homes were in the so-called shadow
inventory — meaning they’re more than 90 days delinquent or
already held by banks and not listed for sale — according to a
March 21 report by CoreLogic Inc. (CLGX) The total balance of loans on
homes in the first quarter’s shadow inventory was $1.13
trillion, Standard Poor’s said in a May 8 report.

About 6 million borrowers will lose their homes in the next
five years because of inability to pay their mortgages, creating
demand for as many as 4 million new rental households, according
to Scott Simon, head of mortgage bonds at Pacific Investment
Management Co. in Newport Beach, California. If funds spend $6
billion on foreclosures, that buys only about 40,000 homes at
$150,000 apiece, leaving plenty more for investors of all size
to buy rental housing, he said.

Foreclosure Surplus

“There will be millions of new foreclosures,” Simon said
in an e-mail. “Renting is now more expensive than owning in
most areas. However, if you can’t get a loan, housing is in
practice infinitely expensive.”

While there’s a foreclosure supply surplus nationwide,
Phoenix, one of areas hardest-hit by the housing crisis, is
running dry, according to Simon. Investors are competing to buy
a shrinking pool of distressed homes, helping home values find a
floor, he said. Prices there jumped more than 11 percent from a
year earlier in April, the biggest increase among the 10 largest
U.S. metropolitan areas, according to CoreLogic.

That’s prompting some single-family investors to look
elsewhere. Landsmith LP, a San Francisco-based firm with about
$100 million to invest in single-family rentals, sold 75 of its
250 homes in Phoenix, said Chief Executive Officer James
Breitenstein. The deal, announced yesterday, was for $7.5
million, about $2.2 million more than Landsmith paid for the
properties.

Phoenix Rising

“We’ve attained key investment objectives in Phoenix, and
are now entering other U.S. markets exhibiting the traits we
first identified in Arizona,” Breitenstein said in a statement.
“There are a select number of other cities
and sub-markets that offer the right combination of currently
distressed housing prices, a stable if not rising employment
rate, and investment fundamentals that fit our model.”

American Residential Properties Inc. raised $225 million in
a private real estate investment trust offering that was
completed on May 11, President Laurie Hawkes said. She expects
the REIT, now limited to institutional investors, to go public
next year. The Scottsdale, Arizona-based investment firm
previously committed about $85 million for more than 650 single-
family rental homes in Arizona and Nevada through a separate
fund.

“There’s no question the Phoenix market has become more
competitive,” Hawkes said in a telephone interview. “But we’re
still finding a lot of opportunity in Phoenix as well as our
other target markets.”

Prices have also begun to recover in Miami as the supply of
foreclosed homes dwindles. Home values were up 2.8 percent
through March from a post-peak low in April 2011, according to
an SP/Case-Shiller price index for the area.

Going Public

A $25 million fund raised by Delavaco Properties Inc., a
Fort Lauderdale, Florida-based owner of about 450 single-family
properties, was “more than two times over-subscribed” with
investors drawn to the 7.5 percent interest on the debt plus
options to buy shares of the company, said Chief Executive
Officer Andy DeFrancesco. The firm plans to go public, with a
listing on the Toronto Stock Exchange, late this year, he said.

Delavaco, which buys homes costing an average of $70,000
that rent for $1,500 a month, will grow by accumulating
properties with steady returns, not by purchasing in bulk,
DeFrancesco said in a telephone interview.

“I don’t know how you can put $1 billion to work and
maximize your profit,” he said. “To spend $1 billion in short
order, you’d need to buy 10 homes a day or more. You’d have to
take a lot of junk.”

The Alaska Permanent Fund tentatively agreed on May 27 to
invest as much as $400 million in single-family rentals through
American Homes 4 Rent, a property-management company owned by
Wayne Hughes, the retired chairman of Public Storage. (PSA) Hughes
didn’t respond to telephone messages seeking comment.

Expected Returns

“Nobody’s ever done this on a scale before,” Michael Burns, chief executive officer of the Alaska Permanent Fund,
which had $41.5 billion under management at the end of the first
quarter, said in a telephone interview from Juneau, Alaska.
“These people’s background is in public storage, which is about
as close as we could find.”

The Alaska fund expects unlevered returns on its investment
of 6 percent to 7 percent a year, Burns said. The expected
yield, while better than Treasury bonds, is an indication that
the single-family rental market’s risk is lower — and so are
potential rewards — than the usual draw for opportunistic
investors, said Steve Duffy, managing director of real estate
investment banking at accounting firm Moss Adams Capital LLC.

“It’s logical that early capital had the view to get a
higher return from their investments,” Duffy said in a
telephone interview from his office in Irvine, California.
“That’s no longer the case. The risk is down because the
economy is recovering and there’s stabilization in housing.”

While the market for single-family rentals is experiencing
growing pains, there’s still a lot of opportunity as investors
gain a better view of cash-flow potential and financing becomes
easier to get, said Ford of Jefferies.

“You’re still talking millions of homes,” he said. “Real
companies are being built.”

To contact the reporter on this story:
John Gittelsohn in Los Angeles at
johngitt@bloomberg.net

To contact the editors responsible for this story:
Kara Wetzel at
kwetzel@bloomberg.net;
Rob Urban at
robprag@bloomberg.net

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