Hedge funds made billions at the expense of the banks
Hedge funds profited from banks that failed to execute the same business plan to recover more of their original loan capital.
If banks had taken the same approach to the bust as hedge funds, they could have recovered much more on their bad bubble-era loans. By 2012 they bankers finally realized they could stop foreclosing and selling the REO for rock-bottom prices and instead wait until prices recovered to execute an equity sale. However, there was another business model they could have used to recover more money quicker.
Special Home Investment Trust
By far the fastest and most efficient way to recover lender capital was to foreclose on their non-performing loans, rent the properties (perhaps even to the former owners), package the properties into a REIT, and sell this REIT for enough to recover all their capital.
As banks converted more and more of their non-performing loans into real estate, they became less of a bank and more of a real estate investment trust (REIT). If they packaged all of their bad loans into a special home investment trust (SHIT), they can dump their SHIT on Wall Street.
We already know Wall Street is willing to buy this stuff; in fact, REO-to-rental companies are buying non-performing loans from banks specifically to foreclose, rent the properties, and securitize the income stream. By failing to do the same, lenders committed the same error that made the REO-to-rental business model work in the first place.
Investors buying shares in these new REITs pay more than the liquidation value of the portfolios. In fact, they pay premiums of 20% or more, betting on continued rent growth. Rather than having to wait for the actual liquidation of the assets to regain their lost capital, the banks can get the capital from investors as they sell their SHIT in a REIT.
Look at this from an accounting standpoint:
First, lenders had a non-performing loan with a book value in excess of the collateral value of the property.
Second, they could have foreclosed on the property and transferred this fictitious book value to the house, which was the collateral.
Third, they could rent the property and place it in a REIT, so then they would hold shares in a REIT on their books — but with one major difference. The REIT shares are worth the original fictitious loan value because REIT investors will pay a premium equal to the lost value of the underlying real estate; thus lenders could have sold off shares of the REIT and regained the full cash value they had on their books.
If this premium didn’t exist, REO-to-rental companies wouldn’t be buying these non-performing loans and going through steps two and three above. That’s how they make money — at the expense of the banks.
To see proof of how well this would have worked, examine what the hedge funds did — and what they are doing now.
Invitation Homes, the largest U.S. home rental company, raised $1.54 billion in an initial public offering on Tuesday, the company said, setting the stage for a pick-up in IPO activity in 2017.
The stock market debut is the largest by a U.S real estate investment trust (REIT) since Paramount Group raised $2.29 billion in 2014 and represents a big win for its private equity owner Blackstone Group and Jonathan Gray, who runs the firm’s real-estate business.
The New York-based buyout firm founded Invitation Homes in 2012, about five years after the housing market began crashing and it started buying foreclosed homes in bulk. It has spent about $10 billion on the 48,000-home portfolio, representing one of Blackstone’s biggest bets. …
Invitation’s two closest rivals, American 4 Rent and Colony Starwood have seen their shares rise by around a third and nearly 40 percent respectively since the end of 2015.
Prior to the housing bust, mom and pop investors and professional property rehabbers acquired most distressed residential properties. However, since the housing bust was so large, the volume of these properties far exceeded the capacity of small investors to absorb the inventory. This lack of capacity diminished demand and caused home prices in many markets to fall to such low levels that institutional money came to the rescue. Institutional investors created the REO-to-rental business model and funded it with billions of dollars.
The large institutional investors accomplished what the moms and pops ordinarily do: they bought properties, fixed them up, and rented them out. Hedge funds played a crucial role in cleaning up this mess, and now they will reap their rewards.