The Economics of Large Pools of Property Assets

Selling real estate is usually quite simple.  First you determine the highest and best use of the product.  Then you focus on who would be the most suitable buyer of the product. Finally, you proceed to market the product to the most suitable buyers.

For spot REOs [REO = 'real estate owned', the euphemism for properties repossessed in foreclosures, ed.], which are primarily all single family, condos and some 1-4 family units, the pecking order of potential buyers could not be simpler:

 

  1. Owner occupants.
  2. Small investors who own no more than a handful of units.
  3. Large investors who own multiple units in one market.
  4. Large investors who own multiple units in multiple markets.
  5. Mega bulk investors.

 

For some strange reason, our government is comtemplating bypassing all the more suitable buyers listed above in favor of the worst buyers possible. There can be no explanation for this aside from stupidity and/or corruption.

 

The logic behind this is simple. Economies of scale so to speak tend to work in reverse when it comes to spot REOs. At each level of the pecking order, the expenses one incurs are higher rather than lower. For example, an owner occupant or small investor may purchase a property that requires minor repairs and budget nothing but 'sweat equity' for these items.  A large local investor may have a crew or an inexpensive contractor for these repairs.  A mega bulk investor has to contract a local manager, who then gives the job to sub-contractors to have the work performed.

Spot REOs are in various places all over the map. The houses in the best locations are usually gobbled up at top prices immediately. The second tier ones may require a few rounds of price reductions and re-appraisals to move them off the books. Then there are the junk units that may not be marketable at all for one reason or another. When an asset manager is burdened with hundreds of properties to sell, the junk properties usually are set aside, resulting in a growing 'dead pool' as time passes.

If there are to be bulk sales, these are certainly properties that should be included in the pools. However, for a mega bulk buyer, there may be no discount that is steep enough to justify buying them.  For example, if a bulk investor buys 1,000 apartment units in five completely run down projects, then those are five projects where investors can hire a team for each site and bring the respective property back to the standards associated with its highest and best use. If there are 1,000 different locations spread all over a region, then we are looking at 1,000 different projects – logisitically an entirely different proposition.  These properties may be located in, say, Atlanta and may only have a price tag of $20-30 million, certainly not low enough to whet the appetite of  a big investor, not to mention a mega bulk investor.

The GSEs reportedly carry an inventory of approximately 200,000 in REOs on their books. If those were divided into $1 billion pools at an average price of $100,000 per property, that would require 20 pools consisting of 10,000 properties per pool. Unlike the purchase of loans or securities, buying such a pool involves taking ownership of properties and assuming liabilities that one may be eager to assume.

Do you have any idea what it takes to assemble a pool of 10,000 REOs and prepare the required due diligence packages? If the GSEs were able to miraculously conduct one of these billion dollar bulk sales every quarter, it would still take 5 years to liquidate their existing REO inventory.

 

An Alternative Proposal to Mega Bulk Sales

Location, location, location. The metro areas that have somewhat stabilized do not need mega bulk sales in any form. The metro areas that have excessive REO inventories usually have large supply/demand imbalances where a bulk sale may tend to exacerbate the problems.  Just imagine the poor homeowners struggling with an already underwater mortgage, only to find out that their newest neighbor is some hedge fund who bought the same house at a discount of 30%-40% – or most likely more.  Imagine the poor little investor with negative cash flow trying to compete against the hedge fund for a tenant in such a down market.

How much of a discount is required in order for a mega bulk buyer to offset all the inefficiencies associated with a bulk purchase and still generate a reasonable internal rate of return? It is a near certainty that mega bulk buyers would demand a very big discount, combined with some sort of below market financing and some form of indemnification.

Here are a few alternatives that illustrate how incredibly stupid the mega bulk sales idea is.  For the purpose of this illustration, I am going to make the assumption that a bulk buyer is going purchase at 70% of the most recent appraisal and is happy with 70% financing at the prevailing rates available to an owner occupant.  This assumption is generously conservative – in reality I cannot picture any mega bulk buyer willing to pay so much for the GSE inventory.

 

Alternative 1, target the owner users:

Sales price set at the most recent appraisal.

Nothing down financing at prevailing rates for owner users.

No points, no fees, no closing costs. They are all factored into the loan.

A minimum credit score of, say, 650.

Buyer must show they have been paying rent for the past six months at or above the project PITI (principal, interest, tax and insurance).

This alternative would open the door to a great many buyers. They are not going to hurt the market because they are paying full price. They are not going to hurt the other properties listed for sale,  because they would not be buyers if a down payment were required. They would have already demonstrated that they can afford the monthly payment in the form of rent. As owners, they would most likely improve the property, which a tenant would not do.

In comparison to a bulk sale, an owner user is paying 30% more, offering the GSE a big cushion on top of all the aforementioned benefits.

 

Alterative 2, target small investors:

Sales price set at the most recent appraisal.

20% down payment. Financing at prevailing rates for owner users.

No qualifications needed, the downpayment is the security.

This alternative would open the door to all the local investors that may currently have a tough time with financing. Based on the Federal Reserve's analysis, these properties are supposed to generate an 8% cap rate or even better return. With a 20% down payment, the property should generate a copious cash flow for the buyer. These buyers are not going to hurt the market because they would be paying full price.  They would be more likely to take care of the property with the pride of ownership, much better than what can be expected of an impersonal hedge fund owner who is at several removes via a few layers of asset and property management staff.

In comparison to a bulk sale, a small investor is paying 30% more and is putting up 20% cash.

There are numerous other ideas to correctly market REOs but just the two alternatives mentioned above should put a big dent in any inventory.  If the properties are not selling at a satisfactory pace, there are many follow up steps that could be implemented. I will discuss those in a future post.

In conclusion, any mega bulk sales by the GSEs would certainly be a big loss for taxpayers.  If the mega bulk buyers think they are going to rip off the country the same way their predecessors did during the RTC giveaway, they may be in for a big surprise.  They may eventually find themselves holding cans of worms all over the most undesirable markets. 

As for the real estate market, I have no idea what mega bulks would do to the already depressed metro areas. They could prove to be very destabilizing. Maybe they would be the last straw that breaks the camel's back.

 


 

 

 
 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • The Biggest Stock Market Crashes Tend to Happen in October
      October is the Most Dangerous Month The prospect of steep market declines worries investors – and the month of October has a particularly bad reputation in this respect.   Bad juju month: Statistically, October is actually not the worst month on average – but it is home to several of history's most memorable crashes, including the largest ever one-day decline on Wall Street. A few things worth noting about 1987: 1. the crash did not presage a recession. 2. its...
  • Canada: Risks of a Parliamentary Democracy
      A Vulnerable System Parliamentary democracy is vulnerable to the extremely dangerous possibility that someone with very little voter support can rise to the top layer of government. All one apparently has to do is to be enough of a populist to get elected by ghetto dwellers.   Economist and philosopher Hans-Hermann Hoppe dissects democracy in his book Democracy, the God that Failed, which shines a light on the system's grave deficiencies with respect to guarding liberty. As...
  • Federal Reserve President Kashkari’s Masterful Distractions
      The True Believer How is it that seemingly intelligent people, of apparent sound mind and rational thought, can stray so far off the beam?  How come there are certain professions that reward their practitioners for their failures? The central banking and monetary policy vocation rings the bell on both accounts.  Today we offer a brief case study in this regard.   Minneapolis Fed president Neel Kashkari attacking a block of wood with great zeal. [PT] Photo credit: Linda Davidson...
  • Thoughtful Disagreement with Ted Butler
      Too Big to Fail?   Dear Mr. Butler, in your article of 2 October, entitled Thoughtful Disagreement, you say:   “Someone will come up with the thoughtful disagreement that makes the body of my premise invalid or the price of silver will validate the premise by exploding.”   Ted Butler – we first became aware of Mr. Butler in 1998, and as far as we know, he has been making the bullish case for silver ever since. Back in the late 90s this was actually a...
  • Donald Trump: Warmonger-in-Chief
      Cryptic Pronouncements If a world conflagration, God forbid, should break out during the Trump Administration, its genesis will not be too hard to discover: the thin-skinned, immature, shallow, doofus who currently resides in the Oval Office!   The commander-in-chief - a potential source of radiation?   This past week, the Donald has continued his bellicose talk with both veiled and explicit threats against purported American adversaries throughout the world.  In...
  • Precious Metals Supply and Demand Report
      Fat-Boy Waves The prices of the metals dropped $17 and $0.35, and the gold-silver ratio rose to 77.  A look at the chart of either metal shows that a downtrend in prices (i.e. uptrend in the dollar) that began in mid-April reversed in mid-July. Then the prices began rising (i.e. dollar began falling). But that move ended September 8.   Stars of the most popular global market sitcoms, widely suspected of being “gold wave-makers”. From left to right: Auntie Janet...
  • The Donald Can’t Stop It
      Divine Powers The Dow’s march onward and upward toward 30,000 continues without a pause.  New all-time highs are notched practically every day.  Despite Thursday’s 31-point pullback, the Dow is up over 15.5 percent year-to-date.  What a remarkable time to be alive.   The DJIA keeps surging... but it is running on fumes (US money supply growth is disappearing rapidly). The president loves this and has decided to “own” the market by gushing about its record run. During...
  • 1987, 1997, 2007... Just How Crash-Prone are Years Ending in 7?
      Bad Reputation Years ending in 7, such as the current year 2017, have a bad reputation among stock market participants. Large price declines tend to occur quite frequently in these years.   Sliding down the steep slope of the cursed year. [PT]   Just think of 1987, the year in which the largest one-day decline in the US stock market in history took place:  the Dow Jones Industrial Average plunged by 22.61 percent in a single trading day. Or recall the year 2007,...
  • Stocks Up and Yields Down – Precious Metals Supply & Demand
      Where the Good Things Go Many gold bugs make an implicit assumption. Gold is good, therefore it will go up. This is tempting but wrong (ignoring that gold does not go anywhere, it’s the dollar that goes down). One error is in thinking that now you have discovered a truth, everyone else will see it quickly. And there is a subtler error. The error is to think good things must go up. Sometimes they do, but why?   Since putting in a secular low at the turn of the millennium,...
  • The 2017 Incrementum Gold Chart Book
      A Big Reference Chart Collection Our friends at Incrementum have created a special treat for gold aficionados, based on the 2017 “In Gold We Trust Report”. Not everybody has the time to read a 160 page report, even if it would be quite worthwhile to do so. As we always mention when it is published, it is a highly useful reference work, even if one doesn't get around to reading all of it (and selective reading is always possible, aided by the table of contents at the...
  • The Falling Productivity of Debt
      Discounting the Present Value of Future Income Last week, we discussed the ongoing fall of dividend, and especially earnings, yields. This Report is not a stock letter, and we make no stock market predictions. We talk about this phenomenon to make a different point. The discount rate has fallen to a very low level indeed.   We add this chart to provide a slightly different perspective to the discussion that follows below (and the question raised at the end of the article)....
  • Precious Metals Supply and Demand
      Fundamental Developments The prices of the metals shot up last week, by $28 and $0.57.   Heavy metals became pricier last week, but we should point out that the stocks of gold and silver miners barely responded to this rally in the metals, which very often (not always, but a very large percentage of the time) is a sign that the rally is unlikely to continue or hold in the short term. [PT]   Last week, we said:   “One way to think of these moves is...

Support Acting Man

Top10BestPro
j9TJzzN

Austrian Theory and Investment

Archive

350x200

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com