The Economics of Large Pools of Property Assets
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:
- Owner occupants.
- Small investors who own no more than a handful of units.
- Large investors who own multiple units in one market.
- Large investors who own multiple units in multiple markets.
- 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.
It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
Most read in the last 20 days:
- Ganging Up on Gold
So Far a Normal Correction In last week's update on the gold sector, we mentioned that there was a lot of negative sentiment detectable on an anecdotal basis. From a positioning perspective only the commitments of traders still appeared a bit stretched though, while from a technical perspective we felt that a pullback to the 200-day moving average in both gold and gold stocks shouldn't be regarded as anything but a normal - and in this case actually long overdue -...
- Gold Sector Correction – Where Do Things Stand?
Sentiment and Positioning When we last discussed the gold sector correction (which had only just begun at the time), we mentioned we would update sentiment and positioning data on occasion. For a while, not much changed in these indicators, but as one would expect, last week's sharp sell-off did in fact move the needle a bit. Gold - just as nice to look at as it always is, but slightly cheaper since last week. Photo via The Times Of India The commitments of...
- Australian property bubble on a scale like no other
Australian property bubble on a scale like no other Yesterday Citi produced a new index which pinned the Australian property bubble at 16 year highs: Bubble trouble. Whether we label them bubbles, the Australian economy has experienced a series of developments that potentially could have the economy lurching from boom to bust and back. In recent years these have included: the record run up in commodity prices and subsequent correction; the associated...
- A Looming Banking Crisis – Is a Perfect Storm About to Hit?
Andy Duncan Interviews Claudio Grass Andy Duncan of FinLingo.com has interviewed our friend Claudio Grass, managing director of Global Gold in Switzerland. Below is a transcript excerpting the main parts of the first section of the interview on the problems in the European banking system and what measures might be taken if push were to come to shove. Andy Duncan of FinLingo.com (left) and Claudio Grass of Global Gold (right) Andy Duncan: How do you see the...
- Pope Francis: Traitor to Western Civilization
Disqualified There has been no greater advocate of mass Muslim migration into Europe than the purported head of the Catholic Church, Pope Francis. At a recent conference, he urged that “asylum seekers” be accepted, “through the acts of mercy that promote their integration into the European context and beyond.”* Before we let Antonius continue with his refreshingly politically incorrect disquisition, we want to remind readers of two previous articles that have...
- Prepare for the Unthinkable
Red Ink Growth and profits mask a variety of problems. They hide business inefficiencies and the money suck of corporate adminis-trivia. They also conceal unproductive staff. The final career leap But most of all growth and profits obscure the extreme value subtracting forces of bloated management teams. During good times it is unclear what these smug fellows do. During bad times it is lucidly clear that most of them ain’t worth a darn. When the...
- US Stock Market - a Spanking May be on its Way
Iffy Looking Charts The stock market has held up quite well this year in the face of numerous developments that are usually regarded as negative (from declining earnings, to the Brexit, to a US presidential election that leaves a lot to be desired, to put it mildly). Of course, the market is never driven by the news – it is exactly the other way around. It is the market that actually writes the news. It may finally be time for a spanking though. Time for some old-fashioned...
- Doomed to Failure
Larded Up and Larded Over We’ve been waiting for the U.S. economy to reach escape velocity for the last six years. What we mean is we’ve been waiting for the economy to finally become self-stimulating and no longer require monetary or fiscal stimulus to keep it from stalling out. Unfortunately, this may not be possible the way things are going. As Milton Jones once revealed: “A month before he died, my grandfather covered his back in lard. After that, he went...
- Meet Your New Stimulus Allocation Czar
March Towards Midnight The march towards midnight is both stirring and foreboding. Like a death row inmate sitting down to savor his last meal, a grim excitement greets the reality of impending doom. Thoughts of imminent mortality haunt each bite. Tic-toc, tic-toc... As far as the economy’s concerned, there’s no stopping its march towards midnight. The witching hour’s rapidly approaching. We intend to savor each moment and make the best of...
- Are the Deep State’s Drones Coming for You?
What’s Aleppo? Look out kid Don’t matter what you did Walk on your tip toes Don’t try "No Doz" Better stay away from those That carry around a fire hose Keep a clean nose Watch the plain clothes You don’t need a weather man To know which way the wind blows – “Subterranean Homesick Blues,” Bob Dylan The entrance to Baghdad's “Green Zone”. Photo credit: Karim Kadim / AP DELRAY BEACH, Florida – Biggest foreign policy blunder...
- Interview with Doug Casey
Natalie Vein of BFI speaks with Doug Casey Our friend Natalie Vein recently had the opportunity to conduct an extensive interview with Doug Casey for BFI, the parent company of Global Gold. Based on his decades-long experience in investing and his many travels, he shares his views on the state of the world economy, his outlook on critical political developments in the US and in Europe, as well as his investment insights and his approach to gold, as part of a viable strategy for...
- The Bamboozled Middle Class
Gassy and Bloated BALTIMORE – What a great time for an observer with a sense of mischief! This year’s presidential campaign is the most absurd and remarkable we have ever witnessed. After more than two centuries, Americans are finally getting the democracy they deserve – one that is grotesque... slimy... and immensely entertaining, albeit in the mud-wrasslin’ genre. The mud-wrestlers – well, we did promise you in these pages it would be entertaining like never...