The Online Auction Process: The New Frontier for Real Estate Investors

It's a simple concept found everywhere --- volume purchases equal volume discounts.  And, during the last recessionary cycle, both GSEs and investors learned to leverage the concept to their advantage. Fannie and Freddie's pilot "REO to Rentals" program that moved thousands of distressed assets off their books through bulk sales to investors captured industry headlines in 2012. Other examples include savvy private equity firms with deep pockets sweeping up multiple foreclosures at bargain prices at courthouse auctions, as well as the FHA employing the same strategy to shed underperforming notes in bulk deals. We’re seeing that a previously underpublicized conduit for disposing of distressed assets is gaining traction among both lenders and private investors as a way of moving distressed assets in volume --- the online auction process. It comes along at a great time to continue housing’s forward momentum.

Along with other industry watchers over the past few years, I’ve been following the progress of the “shadow inventory” comprised of increasing delinquencies, rising foreclosures, and REO. Today, year- over-year mortgage delinquencies have fallen. Short sales, loan workouts, and new state laws are slowing the flow of distressed assets into the foreclosure pipeline.  The all-cash investor has emerged as the white knight rescuing lenders and servicers from their toxic REO problem. The online auction process currently serves to connect volume REO sellers and qualified volume buyers in an efficient manner to dispose of distressed assets. The auction process has shown itself indispensable in removing huge blocks of extremely nonperforming REO from lender and servicer balance sheets at steep discounts, and the online auctioneer is carving out a special niche as a new type of servicing agent to the housing industry.  As a result, sellers win by disposing of assets, and a new type of servicer solidifies its presence in the industry. But most of all, private investors have found a new way to participate in the market. Government -run bulk sales programs carried with them the expected baggage and inefficient red tape that is ultimately less-profitable to investors. Acquiring bulk assets through the auction process allows investors a faster return on their money as they can get property to market more quickly to either generate rental revenue, or flip faster for sale to take advantage of our current environment of rising equity and tight supply.

Some real estate analysts and professionals have argued investor participation at the bulk level could be counterproductive to nurturing a fully-balanced and healthy housing climate. It’s no secret that the current rise in home values is directly related to low supply of available homes for sale. The REO inventory currently moving through the online auction conduit could possibly modulate appreciation in select markets by preventing abnormal price spikes and keeping values at more affordable levels if sold on the open market. This argument doesn’t take into consideration three important factors. First, scarce inventory is mainly the result of existing homeowners still sitting on the sidelines waiting for the right moment to sell.  Second, much of the REO inventory sold via the auction channel requires substantial work to get it to market standards, and investors can leverage the capital necessary to do so. Third, many investors are following a “rent and hold” strategy with acquired properties, which fills a very important gap in housing by creating affordable single family homes rentals.

Recently, through our escrow services, we have been actively involved in the auction process by facilitating some of the back-office administration and closings for hundreds of bulk transactions. We are optimistic that the quiet yet positive impact it is having on the industry will continue to mate investors with opportunities, continue to deplete distressed inventory, and ultimately facilitate new sources of affordable housing.

The Balancing Act between Affordability and Inventory

What a difference one year makes in virtually changing the course of real estate. The specter of the shadow inventory and its predicted drag on the industry has been dispatched in a flurry of workout solutions, bulk REO to Rental strategies employed by GSEs, and the influence of all-cash investors snapping up bargains at a rapid pace. When combined with cautiously optimistic reports on the economy’s performance and improved consumer sentiment, the average American homeowner is enjoying the return of rising equity. What has not seen improvement at the same pace is the availability of affordable housing for rank and file consumers.

In today’s market, affordability is an elusive target due to the number of factors that define it. What homeowners applaud as “increasing equity” as the price of homes in their neighborhoods rise, potential buyers perceive as homes pricing themselves out of reach requiring a larger mortgage. The 30-year fixed rate mortgage benchmark is inching its way north of 3.5% as the economy improves, becoming another barrier to affordability for potential homeowners. Affordability is equally a concern for rank-and-file renters who face the never-ending cycle of rising rents, as demonstrated by the greater Los Angeles market where rents have increased by nearly 30% since 1993 while renter incomes have decreased by 6% over the same time period.

The real culprit here is not affordability, but available inventory, or rather, the lack thereof.  One of the consequences of the last cycle was a contraction in single-family and multifamily construction as developers felt the crunch of a debilitating housing downturn. Moreover, the growing numbers of foreclosures and REO created the new “shadow” inventory class that gave the perception of surplus housing units available to the market. But that same downturn created opportunities for cash investors to snap up those distressed bargains in bulk from lenders and government entities. Additionally, foreclosure prevention activity initiated on both the state and government level capped the flow of new distressed assets into the available inventory. Now with a perceived end to the housing crisis and a return to stability, the industry finds there are simply not enough housing units at reasonable prices for renters and entry-level homeowners to comfortably afford. We are currently partnering in an affordable housing condo project in Oxnard, California and can attest to the overwhelming demand we have experienced from qualified buyers unable to find any housing.

If affordability is tied to available inventory, investor participation is absolutely critical to restore equilibrium. During the darkest moments of the housing crisis, multifamily property activity was the one bright spot in a lackluster housing market providing housing for those displaced as a result of foreclosure or other relevant lifestyle shocks. Developers in the single-family sector have already begun to seize the moment of a post housing crisis with new projects. New projects require fresh sources of capital. While the “thawing” of traditional capital channels via commercial lenders is continuing, lenders should bring more to the table in terms of flexible credit conditions to support more development in both multifamily and single-family arena.

Bringing more new units to market overall should also coax more existing single-family units into the housing supply. Many potential sellers are still waiting on the sidelines waiting for prices to appreciate even further before listing their property with an agent. As prices stabilize with new inventory, sellers should be motivated to put their property on the market before values begin to level off. The principles of supply / demand economics should modulate appreciating home values in such a way to allow more buyers into the market with more homes for sale.

This market is on the verge of a breakout year, but only if more buyers gain access to the market with available inventory to meet demand. The market must create favorable conditions not only for sellers with fair home values, but also for buyers whose purchase power can afford the homes on the market.