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Some Hedge Funds See Growth Potential In Renting REOs

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Recent Federal Housing Finance Agency efforts to interest buyers in the foreclosure-to-rent market may be off to a good start with an unlikely type of investor even though it still is everyone’s guess whether this management strategy will effectively ease off inventory pressures and speed up the recovery.

Judging from recent client demand, says Diane Gozza, executive vice president of business development of Integrated Mortgage Solutions, Houston, following the Federal Housing Finance Agency promotion of REO-to-rent initiatives more hedge fund investors are approaching the market along with some very large private investors. (She would not reveal the names of said investor clients currently pursuing foreclosure-to-rent properties.)

Eric Lichtenheld, president of Integra Group, Tucson, Ariz., agrees that there has been a significant increase in the number of investors interested in purchasing bank owned properties.

In his view investors can be grouped in four basic categories: large bulk purchasers, specialized regional investors, part-time or "wannabe" investors and note purchasers who pay attention to the quality of inventory, rental management and marketing strategies. And they are responding to the large inventory of foreclosures for sale, FHFA’s efforts to interest investors in the REO-to-rent market and some signs of overall economic recovery.

Fannie Mae’s open bidding of 2,500 properties in Atlanta, Chicago, Los Angeles, Las Vegas, Phoenix and four markets in Florida appears to be another catalyst. It is the first part of a pilot program that according to some unconfirmed reports has already attracted thousands of investors and may continue to grow until the bidding is closed in a few months.

“The bidding is open so many hedge funds and other investors are going to bid, we’ll see how many will win, how far those 2,500 properties will spread out,” Gozza said.

Integrated Mortgage Solutions, which specializes in both field services and asset and tenant management, is focusing its core business strategy on assisting private investors and hedge funds, both existing and future clients who are entering the foreclosure-to-rent market.

Investors have a certain amount of time to review the listings and decide how much they are willing to invest before Fannie makes a price offer on the bid. The selection process will take a few months before final decisions are made.Currently, Fannie Mae’s REO inventory is at about 122,000 and Freddie Mac at 60,000 so the success of this process will also determine whether the GSEs will eventually open new bids after this first pilot goes through.

“Based on what I’m hearing there’s no way that process is over before May,” she said. “Fannie is being quite selective on what investors they will allow to bid but there already is a number of investors willing to be part of the process.”

Fannie is being conservative about who they allow to bid on these properties. Investors must have the financial power, experience in rental management and long-term goals that can ensure these properties will be well managed and there is no risk of flipping.

Investors, on the other hand, are doing their own homework before they purchase REO-to-rent properties or further invest to turn vacant units into tenant-habitable homes before they start leasing them at fair market value.

And in the case of hedge fund investors, they will have to partner with field servicers such as Integrated Mortgage Solutions to determine the best course of action in property management that may include anything from securing required documentation, such as getting a new lease signed by tenant to inspecting the property to ensure it is in good condition, conduct repairs if necessary.

In a nutshell the process entails data reporting, repairs and ongoing management on behalf of the investor.

“It is a slightly different spin to field services since it is both field services, which traditionally involves property management and tenant management,” she says.

Tenant management has changed field services during the past few years. Challenges include following all the local guidelines and tenant statutes for different geographic areas that have quite specific habitability criteria on for-rent properties. 

Municipalities are getting much more stringent with property registration they’re going after the servicers and requiring they pay upfront. “It is such an ongoing problem in our industry that until the markets settle it is not going away,” Gozza says.

Different municipalities tend to have different vacant property registration codes, even though the property is not real estate owned, for instance, she recalls so a field servicer must provide tenant emergency services related to problems with electricity, heat, air conditioning, plumbing and water supply maintenance and damage control “at times in the middle of the night.”

Residential property maintenance is a continuous challenge since for instance, ensuring that a building is not suffering any structural damages that can turn life threatening for the tenants.

“Even before a property is rented out we have to look at everything to make sure it is in good and working order,” she says.

When a tenant is living in a damaged property than the challenge is to get access to the property while complying with other requirements that demand the servicer needs to give the tenant a 24-hour notice before they access the property unless there’s an emergency.

This approach is a little bit different from the traditional field services approach, she says, because now “there a sense of urgency” to getting properties fixed.

“If it’s an REO and it takes the field serivcer four to five days to go fix it, it is an issue, but it is not that big of an issue if there’s a tenant in there, when those issues must be addressed immediately. It’s a difference sense of urgency when managing rental properties.”

Given the challenges involved Fannie’s preferred investor criteria follow certain basic guidelines such as proven financial capacity, expertise and management plan that will ultimately keep these properties habitable for the agreed period of time whether they are rented out or not. The bottom line is that qualified investors would commit time and capital into a management strategy that still is being tested in the marketplace.