Single-family REO-to-rental is generating a lot of talk. This means it’s too late to be a first-mover in this space, but it’s still unformed enough to find pockets of opportunity if you play it right.
At least that’s the impression I got from DataQuick vice presidents Gordon Crawford (analytics) and Randy Wussler (product management and marketing) about the sector, which they and their business partner RentRange have respectively been helping investors compile real estate and rental data on.
Various real estate investment trusts, hedge funds and private equity groups have been exploring private REO-to-rental investment strategies as a source of higher returns than other investments, according to Crawford.
He said there are generally three catalysts that drive returns in the sector: macroeconomic data in an area that drives general property appreciation and equity values, the extent of the discount on distressed properties, and rental income.
Crawford noted that in some markets distressed discounts have faded as investors already in them have bid up prices.
“We’re seeing, in quite a few markets, the discount rate shrinking to the point where the REO-to-rental type of investment does not make as much sense as it did six months ago,” Wussler said.
Because of this, investors have been interested in localized data applying to a “very small slice of what someone might consider to be a market” down to the ZIP code or “ZIP plus one” level, Crawford said.
He said there have been some investors specific to individual markets.
There are other investors that invest across markets, Crawford added, “but they seem to all [be] careful not to spread themselves too thinly across too many markets.”
While some investors have been targeting a rent and hold strategy, Crawford said, “There has been a lot of interest in purchasing REO properties…where people purchase the property, maybe refurbish it, hold it for a fairly short time…and then sell it fairly quickly.
“Renting for an extended period of time in the interim is really a relatively newer feature for the disposition of…properties,” he noted.
“There can be a couple motivations to rent the property.
“One is rental income for [a period of time] and the other is to sell the property at a time when [the market] may have recovered not be quite as distressed,” Crawford said.
When asked about the potential challenges in sizing up potential returns in this investment sectors, Crawford said, “From what I can tell, the challenges for evaluating the rental aspect are more operational than data-driven.”
He said that “with one caveat…the operational challenges are that this is different than operating an apartment building where the properties are concentrated in one area with some economies of scale and cost reductions in terms of operating.
“Properties are not going to be uniform, and they’re going to be spread out across a geographic area,” Crawford said.
“They may be spread out across multiple cities and markets, making it more costly to operate.
“So it seems like the barrier to having a portfolio probably is operational.”
On the data side, “People need to be able to evaluate which markets to be in,” and these can be very small, to the point where they may be very small subsections of larger markets. But he said this appears to be less of a hurdle as these data are available, and primarily customers have been asking for.
He said this has been not so much about the mechanics of investment “although we can provide it and there is some level of interest there” but more “in terms of investors really trying to understand 'Where do I get started?’” and the extent of the opportunity.
When asked about the time horizon in terms of opportunity in the sector, Crawford said he believes based on data available to date that it will be “fairly long, at least a few years” given the large volume of foreclosed, delinquent or negative equity properties still remaining to be disposed of.
“Certainly it is not going to go away this year or next year, but this is not a 10-year investment for us,” Wussler said.
Crawford said some things that will determine the longevity of the opportunity will come from the household demand side.
If strict underwriting for new mortgages continues it could also have a bearing on this as it prevents people from purchasing homes that are on the border between renting and purchasing.