It used to be that Wall Street saw an opportunity in acquiring and renting out scores of REO properties. During 2012 and 2013, Blackstone purchased almost 45,000 single-family homes through its Innovation Homes subsidiary. But the inventory of foreclosed homes is shrinking. According to RealtyTrac, there were 1.12 million foreclosure filings in 2014. In both 2009 and in 2010, filings exceeded 2.8 million.
So what is to be done?
Last week, I ran across this investor presentation from AltiSource Residential. I would commend it to you, as I found it to be very interesting. Essentially, it is a playbook on how corporate investors have found a new entry point into distressed housing. AltiSource is buying non-performing mortgage loans at about 60 to 70 cents on the dollar. Most are from loan pools serviced by Ocwen. Under a business model that can ultimately result in one of many outcomes: a loan modification, a short sale, a flip, or rental.
- Acquire pools of non-performing loans at distressed prices. On a $100,000 NPL (probably with a face value of about $130,000), put down 25 percent and borrow the rest.
- If the NPL can be cured, then enjoy the restored cash flows.
- Consider a loan modification. As acquisition cost is below nominal principal value, this is likely to mean an immediate gain. If the modified loan performs, then hold or set aside for resale (EXIT)
- If the loan continues to not perform, then consider a short sale if the opportunity presents itself. EXIT at a profit (Outstanding Principal Balance - Distressed Loan Price).
- If not, foreclose. (At this point they are about 6 months into the process). Take ownership of the property.
- Spend an average of $21,200 to fix up the home and about $800 annually for maintenance on a yearly basis going forward.
- Conservatively, plan for a 3 percent rate of appreciation in the property itself.
- Securitize the cash flows from those rents and then additional revenues from sales of the appreciated homes.
But you could water it down to two parts. First, go from NPL to REO. Then, go from REO to leased property.The first involves a lot of heavy-touch loan servicing. The second could hardly be more different: turn the utilities back on, change the locks, fix it up, get the inspections, show the house, rent the house....
It turns out that AltiSource believes that getting a loan modification on a distressed note is a great deal. In the last quarter, AltiSource generated 10.3 percent on its modified and reinstated loans. Almost one-quarter of their loans were either reinstated or modified during the last quarter. To me, this is the most significant conclusion that can be made from their results. That high yield shows that once a loan goes into default, a loan modification is a net positive for everyone.
But even though a loan modifications is positive, the company and its investors seem to prefer to replace the homeowner.
First, consider how this process creates an incentive for short selling. If an investor can buy mortgage debt at 60 to 70 percent of face value, then any short sale at anything near face value is VERY profitable. Nonetheless, it is also "sticky."
But long-term, it is rental that seems to be the most attractive to the company. Exiting by sale creates a one-time gain, but renting out while also enjoying appreciation is even better.
At the moment, the company has 4,400 homes in REO. Approximately 900 are leased. When asked by an analyst why the share of loans converted to rentals was lower than expected, AltiSource's President tried to make the case that dollars were good no matter how they came back:
"Aspirationally, obviously, getting pulled through to rentals, the rental is key and that is the focus," said AltiSource President George Ellison. "That ratio is around, it is running a bit heavier on sale than it is on rental. But the point is, we want that pull-through to be as much as we can. If you think about it in terms of a portfolio, that is actually an AAMC issue (manager of rentals)...As long as money is coming out at every step of the process, as long as money is pouring out, as long as money drops out when you do early resolution, as long as money drops out when you sell that early resolution stuff, again that is good, high return...as long as you sell it...as long as you are selling those homes you are creating liquidity, you make positive P&L, we watch that ratio and we want that ratio to be high in terms of rentals, but as long as you are making money at every step of the way, that is an issue we watch. But the primary thing is get the right return for RESI and so far there is money coming out of the sale channel, I'm not concerned."
The motive is because while a modified property realizes a return of about 10 percent, a rented property is generating a gross return of approximately 13 percent. Three percentage points means that even if it requires a lot of work, moving homes past foreclosure is ultimately their optimal outcome.
"You have to get this servicing stuff behind you," said Ellison. There is always some blips along the way. Some states are a little more challenging than we thought. Some issues, as you read about, crop up every day. This is very sensitive stuff, dealing with foreclosures."
The company is financed by Wells Fargo, Credit Suisse, and Nomura.