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The Faux Demand For Foreclosed Homes

 May 21, 2009 12:33 PM

The Wall Street Journal's"Investors Pounce on Distressed Homes" implies that when 38% of April single family home sales in Phoenix were all cash, as was 67% in Punta Gorda, FL and 39% in Las Vegas, investors must be controlling the market. At the same time Barclays Capital estimates that foreclosed inventory won't peak until mid to late 2010 at roughly 1.3M units, investors are currently outbidding end users on the approximately 765.5K foreclosures currently in inventory. When this investor owned inventory returns to the market, end user demand will truly be tested.

The Journal cites Hudson-Cross Financial, Gorilla Capital and smaller funds with $6M to $30M to invest in single family homes at prices difficult to resist. These big time speculators are managed by alumni from major firms such as Deutsche Bank (db), Morgan Stanley (ms) and D.R. Horton (dhi). Banks find them attractive REO customers because they make all cash offers for homes in bulk (10 to 200 units). After the purchases, the funds then hope to finance up to 50% of their purchases to keep the ball rolling.

The speculators expect a small positive rental return until the housing market improves and they can sell their inventory at a profit. This story sounds similar to the "Big Time Buying in Foreclosed Single Family Homes" article I wrote about Silver Portal's ventures in the San Diego area. I did not think that a large fund could find the profit in single family home rentals the way experienced mom and pop operators have.

The numbers did not seem to add up, but Silver Portal's Managing Principal Burland East emailed me to vigorously disagree with my assumptions on occupancy rates, taxes, maintenance and operating expenses. East claimed rents of $1900 per month were factual, a 98.5% lease rate in the San Diego area single home market, an estimated net yield on rentals of 8.8%, and a projected IRR at sale in 5 years of 25% to 30% with 50% leverage. East expects "that prices will not recover in 5 years, they will get back about half the loss since 2005."

To be fair, The Wall Street Journal's"Plying the Foreclosure Market" reported that East was looking for moderately priced homes in desirable neighborhoods, so he had a reasonable chance at achieving appreciation success.

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