REO-to-Rental

Housing analysts have been giddy for the past year about the comeback of their industry, whose collapse led to the Great Recession. 2012 ended up being the third worst year for housing ever, but still beat 2011 and 2010. New and existing home sales, housing starts, and prices jumped in 2012; Countless experts expect an even stronger recovery for 2013.

I imagine people are excited because a major housing rebound typically leads to a broader economic recovery. The logic is as more people put equity into their homes, they experience a psychological effect causing them to feel more free to spend disposable income, increasing economic activity - a phenomenon known as the “wealth effect.”
 
Can bullish expectations for housing actually simulate a long-awaited recovery to Main Street? The more I think about it, the clearer it becomes that it’s not being driven by the typical American families who lost their homes in the economic crash. In fact, it’s being fueled by the banks, private equity firms, and hedge funds whose powerful speculation caused that crash in the first place.

Currently, one of the hottest trends in the financial sector is known as “REO-to-rental.” Over the past couple years, hedge funds, private equity firms, and the biggest banks have raised massive amounts of capital to buy distressed or foreclosed single-family homes, in bulk, and at bargain prices.

According to a recent JPMorgan Chase report, the top ten most active REO-to-rental investment firms have already collectively raised enough capital to purchase 15% of all bank-owned homes.  Blackstone is spending over $100 million a week on buying homes.

The strategy involves fixing up, or "rehabbing," distressed houses to rental standard, then renting them out usually for a duration of 3-8 years. By converting distressed properties into strong, steady cash flows for a few years before reselling them, part of this investment strategy essentially entails a macroeconomic bet that prices will significantly appreciate in the nearby future.

Most firms are scooping up properties in the hardest-hit areas, promising high returns from rental revenue streams, usually at least 10% percent annually. It’s the next Wall Street gold rush, with warning signs of a renewed speculative bubble.

-MEHYAR AFKARI