Distressed-mortgage investors are descending on troubled Puerto Rico. There are big names among them: Goldman Sachs Group Inc. and Perella Weinberg Partners and TPG Capital. What’s luring them is the opportunity to scoop up home loans and foreclosed properties for pennies on the dollar.

The gambit could certainly work out — many of the homes, after all, have spectacular views of the Caribbean that could be pitched to well-heeled Americans — but long-time Puerto Rico investors see trouble ahead. Chief among their concerns: bidding wars are breaking out for the loans at the same time that their quality is deteriorating. It’s a tell-tale sign that the market is getting frothy and that turning a profit could prove tricky on an island where the government is mired in default, the economy has been contracting for a decade and foreclosure is a long and cumbersome process.

“A lot of competitors came in,” said Sam Kirschner, an investor with New York-based CPG Real Estate, which partnered early on with Goldman and Perella Weinberg. “A couple banks started hiring brokers, and our phone lit up. And all these hedge funds — we were getting calls from 10 hedge funds a week, saying we would like to partner on such and such a portfolio.”

The investors’ success is thus far unknown. In many cases, the investment vehicles snapping up homes left behind are structured as private equity funds, and returns aren’t disclosed to the public. Goldman, Perella Weinberg and TPG Capital all declined to comment, as did Lone Star Funds, another group that’s been active on the island.

Holding on

The firms are wagering they can strike a deal with borrowers to make the debt viable or go after property in court and resell it. Many have made out well investing in such properties on the mainland, where U.S. housing prices have rebounded about 40% from post-crisis lows. Yet investors risk inundating the market with foreclosed properties, driving down prices even further and impeding an economic recovery — a concern to working-class Puerto Ricans hoping to protect the last shred of equity in their homes.

The woes of Puerto Rico, on the hook for $74 billion in debt, are compounded by unemployment running around 11%. Tens of thousands of residents — U.S. citizens by birth — have fled for the mainland. The population has dropped about 2% annually for the past three years.

“That demographic trend of an exodus is really bad news for the real estate market, because real estate is dependent on demand,” said Daren Blomquist, senior vice president at Attom Data Solutions, which tracks foreclosures in the U.S.

It’s also hard even to quantify the crisis, and thus the opportunity. Puerto Rican government data show a record 5,424 completed foreclosures last year, but the figure includes only institutions that report to the financial regulator, known as OCIF, and excludes most mortgages held by outside investors. (Investors with residency outside the commonwealth can handle foreclosure proceedings in federal courts, instead of local ones.)

Because they take so long, the past year’s foreclosure completions may have begun a half-decade earlier. Some 4.4% of the 388,709 mortgages tracked by the institution were in foreclosure as of March, a rate that surpasses those of most U.S. states during the financial crisis. Delinquency, an early indicator of foreclosure, is running around 12%.

Even those daunting numbers may be misleading. Ariel Acosta, an assistant OCIF commissioner, said they would probably be more dire if they included offshore holdings.

Price points

The properties investors snap up run the gamut. They’re not just run-down single-family homes being foreclosed upon in San Juan and its suburbs — although there are plenty. They also include an entire distressed condominium-and-retail project. CPG bought that development after it stalled and turned it into one of the island’s most luxurious properties: Paseo Caribe. On a recent Wednesday, residents headed in and out of its multimillion-dollar residences. Two towers are sold out, while a third is on the market, featuring loft apartments with quartz countertops and floor-to-ceiling windows with ocean views.

Elsewhere, developer Nick Prouty has been expanding his $110 million Ciudadela condominiums. He bought the then-bankrupt project in 2012, and undertook an ambitious expansion when no other cranes could be seen on the San Juan skyline. Billionaire John Paulson has also been scooping up assets, including the Vanderbilt and La Concha hotels in San Juan, which his firm Paulson & Co. agreed to pay $260 million to acquire in 2014.

But the market can be a minefield: Foreclosures can last as long as four years, compared with less than a year in some U.S. states, according to Rafael Blanco, a former head of OCIF. “It takes forever,” he said.

Illiquid oceanfront

Blanco, who ran OCIF until December, when he became a real estate investor himself, said he remembers a dozen funds investing in Puerto Rico mortgage pools during his tenure.

“They did OK on some assets, and they didn’t do as well in others,” he said. “The foreclosure thing is one problem. Then there’s another problem, and it’s that Puerto Rico is still in financial straits. The economy here isn’t moving very well. So to dispose of assets is not easy.”

CPG’s Kirschner said the island is no place for the faint-hearted.

“It is a very, very substantial economic hole that we’re in with a big mountain to climb,” he said. “And I believe it’ll happen. But it’s not happening in the next two or three or four years. It’s going to take that long before we start seeing the light.”

Bloomberg News