The Due Diligence Problem

A recent Housing Wire article headline reads:

Returns for REO-to-rental investors could reach $100 billion.

In the article CoreLogic is quoted with the following opinion:

 

“According to CoreLogic, West Palm Beach, Fla. (12.4%) offers the most attractive cap rate, followed by Cleveland (12.3%), Fort Lauderdale, Fla. (12%), Chicago (11.6%) and Las Vegas (11.4%).

The markets with the lowest cap rates include Honolulu (5.4%), Raleigh, N.C., (7.3%) and Austin, Texas (7.7%).”

 

As Treasury yields head toward zero, even Honolulu at a 5.4% cap rate looks like a bargain. I should better go get myself some of these distressed properties. Coincidentally, Fannie Mae is having a big bulk sale of 2,500 properties in Atlanta, Chicago, Las Vegas, Los Angeles, Phoenix and Florida. Since I am greedy, I am going to start with Florida (West Palm Beach) and check out some of these 12.4% cap rate investments.

From the Fannie Mae REO website, known as Homepath, there are 182 listings in West Palm Beach ranging from $10,000 to $444,900 in asking price. The $444,900 price may be misleading,  since only 14 of the 182 listings are above $200,000 and almost two thirds are below $100,000. I think I can safely assume that what Fannie offers in the bulk sale would be similar to what they have currently on the market, and likely tilted towards the lower end.

I am going to pick this property on Executive Center Drive to start my due diligence. The asking price of this 3 bedroom beauty is only $18,500. Again, from the article linked above:

 

“After making certain adjustments such as the normal REO 30% distressed-price discount, the cap rate for the nation's overall single-family rental market in January was 8.6%, down slightly from 8.8% a year earlier, but up about 3% from 2006 during the heath [sic] of the housing boom.

“If bulk sales do come to market, investors are likely to gain some concessions that are deeper than 30%,” CoreLogic said. “If the price discount rises to 40% to 50%, cap rates would increase to between 10% and 12%.”

 

It is such easy money, maybe I should be generous and pay $15,000 for this baby and start from there. A quick and dirty rent survey using miscellaneous rental websites suggests a rental value of $700 to $900 per month. Working backwards, to generate a 12.4% yield, all I need is $155 per month in net income from this $15,000 purchase price, so I should have plenty of room for profit.

Next, I need to inspect the property and budget how much is going to be needed to make the unit rent ready.

Since this is a condo, I would need to do the usual analysis.  How solid is the HOA [homeowner association, ed.]? Is there any deferred maintenance not covered by reserves? How many units are delinquent in their dues, and by how much?

Fannie is not offering financing for this unit. That is probably an indication that the owner occupancy ratio is not high enough, or there may be other reasons. It is also not likely going to be on the FHA approved list. In spite of its low price, a first time buyer may not be able to find financing for this unit.

By my buying this unit as an investor, I am exacerbating the problem by adding yet another non-owner occupant, reducing the likelihood of future agency financing for the project. Furthermore, as the price that I am paying is likely to be far less than what the other owners in the building paid for their units, would it trigger more strategic defaults? These are all sticky issues, but let me put that aside for now.

Then I noticed it was constructed in 1971, before asbestos was banned. That would be another check on top of the other usual stuff like mold or radon gas. While I am at it, I might as well check out lead based paint and ADA compliance issues.

Finally, there could be loose ends that may pop up as I inspect the property and read through the files. Since I am such an experienced professional, I estimate that I can complete all of the above in just one eight-hour day, a task that I am sure would take a rookie several days, if not weeks. Upon my findings, I make the necessary price adjustments and put that number down on my master bid list. I determine that not only should I have a 12.4% annualized yield, I may even have tremendous upside if the market recovers. Job well done.

Damn, wait a minute here. It takes me one day to do a thorough analysis on this one property. $15,000 invested at a 12.4% cap rate would yield me a whopping $1,860 per year, which seems hardly worth the effort. For this 2500 properties bulk sale from Fannie, it would take me seven years with no days off to complete my thorough due diligence.

How about if I find a few partners of equal competency and split up the work? Now the due diligence is down to a couple of years, still way too long. Maybe I should farm out the work to less qualified employees/contractors, but then my risk will increase commensurately. I need to reduce the risk. Maybe I should find some investors to bear some of the risk instead of using my own capital. With less of my own skin in the game, I could cut the analysis short, but it would still take way too long.

 

Making Money with Other People's Money

As I was sitting here procrastinating, a few big Wall Street firms called. They said they have tons of OPM (other people's money) burning a hole in their pocket. "What is expected of me?" I asked.

They said they needed some song and dance about how experienced I am regarding distressed properties. I should just make sure that I mention that I have some type of proprietary computer model. That one is easy.

Then they needed a bunch of fancy looking charts, preferably in color. The charts do not really need to say anything, they just have to look convincing. That one is also easy.

Finally, they needed some fancy looking spreadsheets. Once again, the content really doesn't matter. They only need the last spread sheet to clearly say that the proforma yield is over 15%.

How simple. My real estate investment model just turned into an OPM fee model where I will make money off all the fees, make more money if somehow the investments pay off and do not have to risk a dime of my own capital.

Come to think of it, I think these Wall Street firms are the very same Wall Street firms that told Countrywide to make as many subprime loans as possible because they could sell them to managers of OPM from all over the world.

How much OPM is out there chasing distressed assets? One recent Housing Wire article hinted that there may be 300-400 bidders submitting qualification packages for this 2500 properties sale by Fannie Mae. A recent "invitation" only auction of 500 properties by Bank of America supposedly attracted 175 qualified bidders. With so much interest from all these cash buyers, do I really stand a chance in picking up a bargain?

Not all properties are suitable for a rental pool. By the time you sort out the list, it is obvious that OPM and entry level buyers are in direct competition for the same properties. Is it the Bernank's intent to make money so inexpensive that Wall Street fat cats are throwing in cash to compete with the Joe Six Packs who cannot qualify even at these low prices and sub 4% mortgage rates?

Lenders are not complaining because it is a golden opportunity to dump the junk that has been sitting in their REO inventory for months, if not longer.

Builders are delirious. All the entry level buyers are forced into the new homes market via FHA financing! In addition, the Ma and Pa investors who cannot compete with the Wall Street fat cats are also forced into new homes, once again hoping to have an asset that may appreciate in value a little more than what Bernanke's zero interest rate policy offers for their savings.

Under these circumstances, prices at the low level should be experiencing a sharp ascent.  Yet, all we see so far is at best a degree of stabilization. I eagerly await the results of the bulk sales. They should be very revealing.

 


 

Case-Shiller 10 and 20 city composite home price indexes: still declining, but at a lower rate of change.

 


 
 

Emigrate While You Can... Learn More

 
 

 

Dear Readers! We are happy to report that we have reached our turn-of-the-year funding goal and want to extend a special thank you to all of you who have chipped in. We are very grateful for your support! As a general remark, according to usually well informed circles, exercising the donation button in between funding drives is definitely legal and highly appreciated as well.

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

2 Responses to “Who Wants To Buy Some REOs?”

  • Ramsey:

    zerobs, you are correct. The highest and best use, hence the highest value, may be something like a reverse condo conversion. The most likely buyer, hence the one who is willing to pay the highest price, should be a local operator who is familiar with the idiosyncrasies of West Palm Beach. As a bulk buyer, I would need to buy cheap enough so I can flip immediately to one of these operators and make my targeted return. With so many bidders, I doubted if I can buy it cheap enough.

  • zerobs:

    By my buying this unit as an investor, I am exacerbating the problem by adding yet another non-owner occupant, reducing the likelihood of future agency financing for the project.

    LOL! I sold my condo 12 years ago because I was worried about 1 deadbeat in 12. I can’t imagine how many deadbeat units are in that building now.

    These condos can’t be re-sold on a unit-by-unit basis. At best the entire building has to be sold to one bulk buyer – and that leaves the small minority of current remaining owner-occupants in a jam. The only way one can expect the deadbeat units to start paying again is if one buyer buys all the empty/deadbeat units. And that buyer will control the HOA. And they’ll vote in favor of an association fee increase that will make you so uncomfortable that you will want to sell to get away. And there will only be one buyer in the foreseeable future.

    These buildings need to become rentals and there is a whole issue of the current non-deadbeat occupants and what to do about them. Writ large, this is no different that Detroit or Youngstown de-incorporating residential blocks where only 1 or 2 houses are occupied. And there hasn’t been ANY interest in bulk-buying the vacant properties in those areas FOR DECADES.

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • safe spaceReality is a Formidable Enemy
      Political Correctness Comedy We have recently come across a video that is simply too funny not be shared. It also happens to dovetail nicely with our friend Claudio's recent essay on political correctness and cultural Marxism. Since this is generally a rather depressing topic, we have concluded that having a good laugh at it might not be the worst idea.   How to most effectively create a “safe space” on campus Cartoon by Nate Beeler   It is especially funny (or...
  • Gold bars are displayed at a gold jewellery shop in the northern Indian city of Chandigarh May 8, 2012. Gold imports by India, the world's biggest buyer of bullion, could rise on pent-up demand from jewellers after the federal government decided to scrap an excise duty on jewellery it imposed in March, the head of a trade body said on Monday. REUTERS/Ajay Verma (INDIA - Tags: BUSINESS COMMODITIES)Fresh Mainstream Nonsense on Gold Demand
      They Will Never Get It... We and many others have made a valiant effort over the years to explain what actually moves the gold market (as examples see e.g. our  article “Misconceptions About Gold”, or Robert Blumen's excellent essay “Misunderstanding Gold Demand”).  Sometimes it is a bit frustrating when we realize it has probably all been for naught.   Gold wants to know what it has done now... Photo credit: Ajay Verma / Reuters   This was brought home to...
  • fir wateringDrowning the Fir
      Presidential Duties Our editor recently stumbled upon an image in one of the more obscure corners of the intertubes which we felt we had to share with our readers. It provides us with a nice metaphor for the meaningfulness of government activity. First, here is a look at the picture – just quietly contemplate it for while and let it work its magic on you:   Yes, these two gentlemen are actually watering a tree in the middle of a downpour... Photo via...
  • swiss-cultureSwitzerland About to Vote on “Free Lunch” for Everyone
      Will the Swiss Guarantee CHF 75,000 for Every Family? In early June the Swiss will be called upon to make a historic decision. Switzerland is the first country worldwide to put the idea of an Unconditional Basic Income to a vote and the outcome of this referendum will set a strong precedent and establish a landmark in the evolution of this debate.   The Swiss Basic Income Initiative in a demonstration in front of parliament. As we have previously reported (see “Swiss...
  • Hollande 2The Wonder Years Are Over
      Everybody Is Unhappy PARIS – “France?” We were in a cab on the way from Charles de Gaulle Airport yesterday. We had innocently asked our cab driver how things were going in the country. He had some thoughts...   French president Francois Hollande: against all odds, he managed to attain the most powerful position in French society. And yet, even he is unhappy. Photo credit: Patrick Kovarik / AFP   “France is a mess. We have 5 million people unemployed. And...
  • mossack fonsecaGold – The Commitments of Traders
      Commercial and Non-Commercial Market Participants The commitments of traders in gold futures are beginning to look a bit concerning these days – we will explain further below why this is so. Some readers may well be wondering why an explanation is even needed. Isn't it obvious? Superficially, it sure looks that way.     As the following chart of the net position of commercial hedgers illustrates, their position is currently at quite an extended...
  • picture-social-contract-not-foundHeretical Thoughts and Doing the Unthinkable
      Heresy! NORMANDY, France – The Dow rose 222 points on Tuesday – or just over 1%. But we agree with hedge-fund manager Stanley Druckenmiller: This is not a good time to be a U.S. stock market bull.   Legendary former hedge fund manager Stanley Druckenmiller at the Ira Sohn conference – not an optimist at present, to put it mildly. Photo credit: David A. Grogan / CNBC   Speaking at an investment conference in New York last week, George Soros’ former partner...
  • ClintotrumpStaying Home on Election Day
      Pretenses and Conceits The markets are eerily quiet… like an angry man with something on his mind and a shotgun in his hand. We will leave them to brood… and return to the spectacle of the U.S. presidential primaries. On display are all the pretenses, conceits, and absurdities of modern government. And now, the race narrows to the two most widely distrusted and loathed candidates.   US election circus: Deep State Rep vs. Rage Channeller   The first, a loose...
  • Jackboot 2How the Deep State’s Cronies Steal From You
      Expanding in Ireland DUNMORE EAST, Ireland – We came down the coast from Dublin to check on our new office building. For this visit, we wanted to stay somewhere different than we normally do. So we chose a small hotel on the coast, called the Strand Inn.   Irish landscape with alien landing pads. Even the guys from Rigel II have heard about Ireland's corporate tax rate. Photo credit: Tourism Ireland   It is an excellent place for seafood and soda bread on a...
  • time100-grid-covers-whiteThe World's 100 Most Influential Hacks, Yahoos and Monkey Shiners
      Hacks and Has-Beens NORMANDY, France – What has happened to TIME magazine? Henry Luce, who started TIME – the first weekly news magazine in the U.S. – would be appalled to see what it has become.   Time cover featuring the sunburned mummy heading the globalist IMF bureaucracy (which inter alia advocates that governments should confiscate a portion of the wealth of their citizens overnight, even while its own employees don't have to pay a single cent in taxes). Once you...
  • YenThe Japanese Popsicle Affair
      Policy-Induced Contrition in Japan As we keep saying, there really is no point in trying to make people richer by making them poorer – which is what Shinzo Abe and Haruhiko Kuroda have been trying to do for the past several years. Not surprisingly, they have so to speak only succeeded in achieving the second part of the equation: they have certainly managed to impoverish their fellow Japanese citizens.   Shinzo Abe and Haruhiko Kuroda, professional yen assassins Photo credit:...
  • Bank of Japan (BOJ) Governor Haruhiko Kuroda attends a news conference at the BOJ headquarters in Tokyo, Japan, December 18, 2015.  REUTERS/Toru HanaiKuroda-San in the Mouth of Madness
      Deluded Central Planners Zerohedge recently reported on an interview given by Lithuanian ECB council member Vitas Vasiliauskas, which demonstrates how utterly deluded the central planners in the so-called “capitalist” economies of the West have become. His statements are nothing short of bizarre (“we are magic guys!”) – although he is of course correct when he states that a central bank can never “run out of ammunition”.   BoJ governor Haruhiko Kuroda Photo credit:...

Austrian Theory and Investment

Support Acting Man

Own physical gold and silver outside a bank

Archive

j9TJzzN

350x200

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]

 

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

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com