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!

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

   
 

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:

  • How to Survive the Winter
      A Flawless Flock of Scoundrels One of the fringe benefits of living in a country that’s in dire need of a political, financial, and cultural reset, is the twisted amusement that comes with bearing witness to its unraveling.  Day by day we’re greeted with escalating madness.  Indeed, the great fiasco must be taken lightly, so as not to be demoralized by its enormity.   Symphony grotesque in Washington [PT]   Of particular note is the present cast of characters. ...
  • Credit Spreads: The Coming Resurrection of Polly
      Suspicion isn't Merely Asleep – It is in a Coma (or Dead) There is an old Monty Python skit about a parrot whose lack of movement and refusal to respond to prodding leads to an intense debate over what state it is in. Is it just sleeping, as the proprietor of the shop that sold it insists? A very tired parrot taking a really deep rest? Or is it actually dead, as the customer who bought it asserts, offering the fact that it was nailed to its perch as prima facie evidence that what...
  • The Strange Behavior of Gold Investors from Monday to Thursday
      Known and Unknown Anomalies Readers are undoubtedly aware of one or another stock market anomaly, such as e.g. the frequently observed weakness in stock markets in the summer months, which the well-known saying “sell in May and go away” refers to. Apart from such widely known anomalies, there are many others though, which most investors have never heard of. These anomalies can be particularly interesting and profitable for investors – and there are several in the precious metals...
  • A Falling Rate of Discount and the Consumption of Capital
      Net Present Value Warren Buffet famously proposed the analogy of a machine that produces one dollar per year in perpetuity. He asks how much would you pay for this machine? Clearly it is worth something more than $1.00. And it’s equally clear that it’s not worth $1,000. The value is somewhere in between. But where?   We are not sure why Warren Buffett invoked a money printing machine of all things – another interesting way of looking at the concept is by e.g....
  • Business Cycles and Inflation – Part I
      Incrementum Advisory Board Meeting Q4 2017 -  Special Guest Ben Hunt, Author and Editor of Epsilon Theory The quarterly meeting of the Incrementum Fund's Advisory Board took place on October 10 and we had the great pleasure to be joined by special guest Ben Hunt this time, who is probably known to many of our readers as the main author and editor of Epsilon Theory. He is also chief risk officer at investment management firm Salient Partners. As always, a transcript of the discussion is...
  • What President Trump and the West Can Learn from China
      Expensive Politics Instead of a demonstration of its overwhelming military might intended to intimidate tiny North Korea and pressure China to lean on its defiant communist neighbor, President Trump and the West should try to learn a few things from China.   President Trump meets President Xi. The POTUS reportedly had a very good time in China. [PT] Photo credit: AP   The President’s trip to the Far East came on the heels of the completion of China’s...
  • Is Fed Chair Nominee Jay Powell, Count Dracula?
      A Date with Dracula The gray hue of dawn quickly slipped to a bright clear sky as we set out last Saturday morning.  The season’s autumn tinge abounded around us as the distant mountain peaks, and their mighty rifts, grew closer.  The nighttime chill stubbornly lingered in the crisp air.   “Who lives in yonder castle?” Harker asked. “Pardon, Sire?” Up front in the driver's seat it was evidently hard to understand what was said over the racket made by the team of...
  • A Different Powelling - Precious Metals Supply and Demand Report
      New Chief Monetary Bureaucrat Goes from Good to Bad for Silver The prices of the metals ended all but unchanged last week, though they hit spike highs on Thursday. Particularly silver his $17.24 before falling back 43 cents, to close at $16.82.   Never drop silver carelessly, since it might land on your toes. If you are at loggerheads with gravity for some reason, only try to handle smaller-sized bars than the ones depicted above. The snapshot to the right shows the governor...
  • Business Cycles and Inflation, Part II
      Early Warning Signals in a Fragile System [ed note: here is Part 1; if you have missed it, best go there and start reading from the beginning] We recently received the following charts via email with a query whether they should worry stock market investors. They show two short term interest rates, namely the 2-year t-note yield and 3 month t-bill discount rate. Evidently the moves in short term rates over the past ~18 - 24 months were quite large, even if their absolute levels remain...
  • Heat Death of the Economic Universe
      Big Crunch or Big Chill Physicists say that the universe is expanding. However, they hotly debate (OK, pun intended as a foreshadowing device) if the rate of expansion is sufficient to overcome gravity—called escape velocity. It may seem like an arcane topic, but the consequences are dire either way.   OT – a little cosmology excursion from your editor: Observations so far suggest that the expansion of the universe is indeed accelerating – the “big crunch”, in...
  • Claudio Grass Interviews Mark Thornton
      Introduction Mark Thornton of the Mises Institute and our good friend Claudio Grass recently discussed a number of key issues, sharing their perspectives on important economic and geopolitical developments that are currently on the minds of many US and European citizens. A video of the interview can be found at the end of this post. Claudio provided us with a written summary of the interview which we present below – we have added a few remarks in brackets (we strongly recommend...
  • Precious Metals Supply and Demand
      A Different Vantage Point The prices of the metals were up slightly this week. But in between, there was some exciting price action. Monday morning (as reckoned in Arizona), the prices of the metals spiked up, taking silver from under $16.90 to over $17.25. Then, in a series of waves, the price came back down to within pennies of last Friday’s close. The biggest occurred on Friday.   Silver ended slightly up on the week after a somewhat bigger rally was rudely interrupted...

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