According to a report from financial services firm Keefe, Bruyette & Woods titled “Single-Family REO: An Emerging Asset Class,” the REO-to-rental segment is set to experience robust growth over the next 12 to 24 months.
Currently, $6 billion to $9 billion has been raised for investments in the single-family REO market, which accounts towards acquiring 40,000 to 90,000 properties without the use of financial leverage.
While these figures seem positive, the Federal Reserve Bank of New York noted it only amounts to around 15% of the 443,000 unsold REO inventory. represents 20% of the 354,000 properties already in REO, according to CoreLogic, and less than 5% of the 1.8 million units in foreclosure, Lender Processing Services said.
Also, the numbers are less than 1% of the approximately 13.8 million attached and detached single-family rental properties, according to the U.S. Census Bureau.
“There is a supply and demand issue on the institutions being able to find good quality potential REO properties to acquire and also having quality rentals for distressed homeowners who want to stay in single-family homes to actually rent,” Wally Charnoff, CEO of Westminster, Colo.-based RentRange, told Mortgage Servicing News.
Despite challenges investors are facing now to acquire good quality inventory which results in adequate yield for them, KBW analyst Jade Rahmani remains optimistic for the sector’s future.
“We believe restrictive mortgage credit, negative equity, continued deleveraging of borrowers and lenders, and the overhang of delinquencies will continue to suppress homeownership rates and increase the percentage of renters,” Rahmani stated in the report.
Data from the Census Bureau reveals that the U.S. homeownership rate was relatively stable during 2012 and ended the fourth quarter at 65.4%, down from 66% a year ago. However, since 2004, annual homeownership rates have been on a steady decline nationwide falling approximately 3%.
Additionally, apartment rental rates have increased on an annual basis approximately 4.5% since the end of 2009 as demand for these units have risen.
Rahmani expects REO-to-rental acquisitions to remain mostly unlevered, but over time to become available. Potential financing options for these units include secured credit lines, lending syndicates, high-yield debt, seller-provided financing by government sponsored enterprises, and securitization.
KBW estimates cash returns on REO investments to be in the 5% to 7% range—which is not as attractive compared to a year ago when less investors were focused on this sector—while total returns could reach anywhere between 15% and 20%, depending upon the type of leverage and home price appreciation.
“Competition today is ferocious. You have to be very disciplined about your buying-and-operating strategy,” said Gary Beasley, president and CEO of Waypoint Homes, as a panelist at the American Securitization Forum.
Ron D’Vari, co-founder and chief executive of NewOak Capital, said at the ASF that investors don’t really “need a whole lot of leverage to generate relatively ‘juicy’ cash-on-cash returns, which are very attractive even without much home price appreciation.”
“After expenses and management fees, the generated cash-on-cash often range in high single digits but gets adjusted down by vacancies,” D’Vari explained during a session at the conference. “Therefore, the flexibility of bank lines makes them more attractive versus somewhat rigid terms in securitization.”