REO to Rentals: What's in it for Investors?

The government, in its bid to seek solutions to extricate itself from the mortgage business, is asking investors for help.  In August, the FHFA (who oversees the government’s conservatorship of Fannie Mae and Freddie Mac) along with the Departments of Treasury and HUD, openly solicited ideas on how to divest itself of over 250,000 homes. Stealing a profitable page from the investor communities’ playbook, these three agencies are extremely interested in whether or not investors would step up to buy blocks of government-held REOs for transition to rentals (R to R).  And with good reason: over the past few years, savvy investors seized the opportunity to snap up bank-owned bargains.  Through this anemic housing market they have implemented a “buy and hold” strategy and are renting out these properties.  This not only meets the growing demand for single family rentals, investors are enjoying a healthy revenue stream on their investments.  In this context, a governmental R to R strategy appears to be a slam-dunk.   At least, that’s how the government would like to position it. 

It’s easy to see how this R to R strategy benefits the government.  If you add the 800,000+ delinquent mortgages on the foreclosure fast track to the 250,000 the government has had to take back, you can feel the lump in the administration’s throat starting to rise if it doesn’t get the private sector to back this strategy. 

This strategy benefits the community as well.  Occupied homes increase the value of the community. Vacant homes lead to disrepair, crime, and depreciation of value.  And clearly, this strategy benefits the average consumer and distressed borrowers in that it should provide more affordable housing options including the possibility of leasing lost properties back to their distressed borrowers to keep them in their homes with continuity for families.  

The real question is, will investors jump in knowing that an investor/landlord status in this scenario will potentially saddle them with questionable returns.  The private sector needs to be convinced that this R to R strategy does have merit for them.  While such a plan could clear the backlog of foreclosed homes off the government’s books, if there’s no real benefit to investors, the strategy will be seen as merely shifting the albatross to the private sector without curing the problem.  Success, therefore, is predicated on three conditions favoring investors and the government’s willingness to implement them:

1. Below-market pricing on foreclosed properties.  Government entities will need to make serious price concessions on already discounted pools of distressed properties to mitigate the risk and expense of investors inheriting potentially non-paying tenants. As an example of how steep discounting of assets created a win-win for the government and investors, the FDIC disposed of a large pool of distressed properties to fellow investors at a significant discount. With below-market rates and aggressive LTVs, the government also gave loss-sharing security to further motivate the pool purchases.
2. Favorable financing conditions.  As part of the program, the government would need to facilitate financing that provides investors with a rate that needs to be very favorable to insure an income stream. The length required to hold any property as rental cannot exceed five years and must include a recovery measure that may allow the disposition by the investor in as little as three years.
3. No government involvement.  The government needs to allow the private sector to manage its newly-acquired assets without interference. The bureaucracy and micromanagement typically associated with Federal “participation” after the deal is done would only stymie efficiency and ultimately erode long-term investor profitability.  The idea is not to create a new “Government Landlord Agency.” An efficient system of compliance can be monitored with clear penalties for non-compliance by investors. The paramount concern will be to assure that these rentals do not in actuality bring down a neighborhood. Investors must agree that property maintenance cannot be neglected.  Such neglect will only perpetuate declining values for years to come.

In a recent town-hall speech, President Obama conceded that the government needed the help of not only the public and bankers, but also the help of investors to tackle the current housing crisis head on. The investor community will be more than willing to help if the government can make it worth their while and not over-regulate.

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