The shadow market now has its first government program.
The Federal Housing Finance Agency (FHFA) rolled out the pilot
phase of its Real Estate Owned (REO) Initiative in February. The
program allows investors to buy foreclosed single-family properties
in the nation's hardest-hit metros, with a
catch—those properties must remain rentals for a
certain number of years.
Fannie Mae is supplying the first round of foreclosures,
offering pools of various types of assets, including homes already
being rented, vacant properties, and nonperforming loans. But
it's just a guinea pig to test investor
interest, operational strategies, and financing structures to prove
the idea out.
In all, Fannie put 2,490 properties on the block at the end of
February, with the highest concentration, about 23 percent, in
Atlanta, followed by Los Angeles–Riverside (19.4
percent) and southeast Florida (16.8 percent). Freddie Mac and the
Federal Housing Administration (FHA) will also offer pools to
investors, in subsequent phases of the program.
The program has the potential to help the still-struggling
for-sale market, but it also holds the potential to make life
difficult for some apartment owners. Since we're
in the early innings, many questions remain unanswered. Here are
five of the biggest unknowns:
1. Will It Impact the Multifamily Market?
The shadow market has always been an elusive X-factor in the
apartment world, a notoriously difficult market to quantify. But
with about 250,000 for-sale homes languishing on the
agencies' books, apartment owners are growing a
“If all of a sudden, the inventory of for-rent
single-family homes goes way up, that's going to
be competitive pressure for apartments in a number of
markets,” says Hessam Nadji, managing director of
research at Encino, Calif.–based Marcus &
Millichap. “But I don't think
it's a big enough factor to change the
Still, real estate is a local business. And the program may make
an already bad situation worse by increasing the rental stock in
areas that already have high vacancy rates. Markets such as South
Florida, Atlanta, Phoenix, Las Vegas, and
California's Inland Empire already felt the
sting of the shadow market well before the REO-to-Rental Initiative
Yet, the demographics of who rents a single-family home
aren't expected to threaten the apartment market
all that much.
“There's a certain kind of
renter who's going to want a house to rent. It
might be somebody who has been foreclosed on, it might be a larger
family that really needs the rooms that a house has,”
says Jeff Hayward, executive vice president at Washington,
D.C.–based Fannie Mae. “Our
core renter is a single person 25 to 34 years old, and
they're not looking to rent a house. So I think
these things can peacefully coexist.”
2. How Will Investors Finance the Deals?
One of the main hurdles for investors is that buying houses in
bulk is mainly an all-cash business—and there
are only so many all-cash investors large enough to handle such a
There really aren't any debt programs on the
market tailored to a scattered-site deal. But that may soon change.
Freddie Mac has started working on a new,
“multi-site” multifamily loan, the
first scattered-site commercial mortgage product that the company
has ever offered.
“We are working very hard on trying to develop
a multifamily mortgage product to serve the needs of large
investors in single-family properties,” says David
Brickman, senior vice president of multifamily at McLean,
Va.–based Freddie Mac.
The program would likely be a shorter-term, lower-leverage,
floating-rate execution, and only available for deals of $100
million or more. The multi-site loan program would target large,
cross-collateralized pools owned and managed by a single
For its part, Fannie Mae has no plans to introduce a similar
product. But Freddie's program would likely be a
game changer. A loan program tailored to a multi-site execution
would open up the investor pool, clearing the market of more houses
3. Who Will Buy Them?
Even before the FHFA's recent announcement,
some investors were busy scooping up unsold homes and repositioning
them as rentals.
Waypoint Real Estate Group recently received a $250 million
initial investment from Menlo Park, Calif.–based
GI Partners to purchase foreclosed single-family homes and convert
them to rentals. Over the next two years, GI Partners plans to
invest $1 billion in Waypoint to buy and manage new acquisitions. A
natural fit for the program, the company is looking into
scattered-site deals in Phoenix, Atlanta, Las Vegas, Chicago, and
“Geographic concentration is the
most-talked-about factor,” says Doug Brien, managing
director of Oakland, Calif.–based Waypoint.
“We're only looking at areas
with growing economies and attractive percentage yields for buying
But the program has its share of caveats. In a white paper, the
Federal Reserve noted that some of the properties are
“badly damaged, in low-demand areas, or otherwise
of low value.” This certainly isn't
lost on investors. Many are hoping to have the option of
cherry-picking properties within each pool to help manage the scale
of the investment.
It's rumored that Freddie
Mac's program won't be as
restrictive as Fannie's bulk-only sale, that
investors would be able to use a variety of methods to purchase
specific REO single-family homes within an asset pool.
“I hope it's not an
all-or-nothing situation,” says Brien.
“Ideally, we'll be able to
choose the ones we want to keep.”
4. How Do You Effectively Manage Scattered
Los Angeles–based private equity firm Oaktree
Capital Management (an owner of this magazine) recently teamed up
with Santa Ana, Calif.–based property manager
Carrington Holding Co. in a $450 million joint venture (JV) to buy
distressed homes and turn them into rentals. Carrington,
incidentally, manages more than 3,000 single-family rental homes
for Fannie Mae's Deed-for-Lease and
That JV offers a blueprint for success. The
Initiative's most daunting aspect is the
management-intensive nature of a scattered-site deal, prompting
many investors to team with property management firms.
The biggest question is, how will that management challenge cut
into an investor's return?
“The yields in scattered single-family are still
very uncertain—it could be on par with the low
cap rates we're seeing, because of how
management-intensive they are,” says Ben Thypin,
director of market analysis at New York–based
research firm Real Capital Analytics. “Figuring
out how to manage scattered sites is the puzzle. Whoever can figure
out how to do that properly will make a lot of
5. How Will It Impact the For-Sale Market?
Injecting some health back into the single-family sector will
only strengthen the metro housing market in general. But many
industry watchers wonder just how effective the program can be.
Goldman Sachs recently wrote a research paper on the program,
calling the possible effect “positive but
modest,” with an upside of producing a 0.5 percent
increase in home prices the first year, and a 1 percent increase in
2013, though “the actual effect would likely be
Goldman Sachs sees some obstacles to the
program's success. First, these newly converted
rentals could stay vacant, which would just transfer vacancy rate
increases from the for-sale to the rental market. And second, banks
and other institutions could be encouraged to bring more product to
the market as these pools are sold—thereby
keeping the overall for-sale supply about the same.
Ultimately, though, many wonder if the program is just another
way to kick the can down the road, only delaying the need for the
for-sale market to take its medicine. “The
percentage of investors continues to go up as a component of total
home buyers. Now, we're talking about
institutionalizing the process,” says Nadji.
“So what happens in two or three years when home
prices improve and these investors want out?
There's going to be a flood of these homes
thrown into the market.”
Additional reporting by Les Shaver and Derek