How hedge funds clean up the trash from the housing bust

Hedge funds act as the garbage scows of the housing bust, cleaning up bad loans and distressed properties using a variety of tactics.

squatter_scourgePrior 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. However, this isn’t all the trash left in the can. Millions of Americans still neglect to pay their mortgages, tens of thousands of properties remain vacant, and some properties are so far gone that nobody wants them. Hedge funds play a crucial role in cleaning up this mess.

Decluttering the detritus

The remaining garbage from the housing bust comes in two forms: loans that nobody pays and houses that nobody wants.

When borrowers quit paying FHA or the GSEs loans, these entities face the same choices any lender faces. Since they fall under government control, they first make every attempt to cajole the borrowers to repay, offering generous unilateral loan modification terms. If the borrowers refuse the deal, the entities evaluate whether they can recover their capital by foreclosure, and if they can, they generally do.selling_npls

If the FHA or the GSEs determine they can’t make a deal, and they don’t believe they can recover much capital in a foreclosure, they group their non-performing loans and sell the pools to investors. Two years ago investors bought these loans to add inventory to their REO-to-rental funds. They tried to workout loans with some of the borrowers, but if their workout failed, they were happy to foreclose to obtain the property as a rental.

Today, the hedge funds still buy pools of non-performing loans from the FHA or the GSEs. The quality of the loans and properties steadily worsened, and most of the garbage purchased today is the decaying crud caked on the bottom of the dumpster. If these weren’t grouped with a few nicer properties, the hedge funds probably wouldn’t buy them at all.

Of course, this means the hedge funds must deal with the worst of the worst properties.

Goldman Sachs, Lone Star Among Winners in Latest Fannie NPL Sale

By Jacob Passy, September 6, 2016

Affiliates of Goldman Sachs, Lone Star Funds and Neuberger Berman are among the winners of Fannie Mae’s latest nonperforming loans auction.

Goldman Sachs subsidiary MTGLQ Investors won the first pool, which contains 2,887 loans with an aggregate unpaid principal balance of $469 million. The average loan size of the pool is $162,418, while the weighted average note rate is 5.49%. The loans were delinquent on average by 44 months. …


So what does Goldman Sachs or anyone else do with these properties they obtain from the bad loans?

Homes that nobody wants

The houses that nobody wants are often in economically depressed areas like Detroit. Investors will purchase properties in more economically vibrant areas even if they must be demolished because the lot itself has value. If a small builder can demolish a house, build a new one, and sell it for a profit, then they will recycle the property.

When the house is worth so little that it can’t be demolished and rebuilt, a property rehabber may still purchase it, fix it up, and resell it for a profit. However, if the cost of rehabilitation exceeds the resale value, rehabbers won’t touch it. Investors with special knowledge and fortitude may purchase the property and sell it to a low-income buyer on a land installment basis.

When a property is so far gone that builders don’t want the lot, rehabbers don’t want to fix it, and investors don’t believe they can find a low-income land installment buyer, the property becomes a zombie that nobody wants.


Wiping out housing’s ‘zombies’: Banks sell off foreclosed remnants of crash

Diana Olick, Thursday, 8 Sep 2016

Halloween isn’t here just yet, but the zombies are already multiplying by the thousand — zombie foreclosures.

After having left the worst remnants of the housing crash in foreclosure limbo-land, banks are now taking those vacant, foreclosed homes and selling them at a fast clip. They are the so-called zombie foreclosures.

The result is that the numbers have shifted. Vacant homes in the foreclosure process are expected to drop 9 percent in the third quarter from a year ago, but vacant bank-owned properties are expected to jump 67 percent during the period, according to ATTOM Data Solutions. There are now just over 46,600 vacant bank-owned properties (known as REOs) littering neighborhoods nationally.


“We believe it’s a combination of market conditions that are ideal for selling properties, along with political pressure for banks to deal with these properties and not allow them to linger in foreclosure indefinitely,” said Daren Blomquist, senior vice president at ATTOM (formerly RealtyTrac).

Municipalities toughened their stance on these properties over the last few years. The owners walked away, the banks refused to foreclose, and nobody was paying property taxes. To make matters worse, squatters and drug dealers often took over these properties using them as meth labs and grow houses adding to crime problems in these neighborhoods. The municipalities acted to fix these neighborhood problems.

More low-priced homes would seem to be a windfall for a housing market plagued with extremely short supply, but that is not the case. The vast majority of these zombie foreclosures are in the least desirable markets for investors. New York, Philadelphia and Chicago have the highest number of vacant foreclosures, but they are in some of the most troubled areas economically. The homes are also in terrible disrepair.

As I described above, if these houses had any value to anyone, they wouldn’t be zombies ten years after the collapse.foreclosure_meat_grinder

… the zombie foreclosures, must need thousands of dollars of work to make them either rentable or sellable. Government-backed mortgage entities like Fannie Mae and the FHA have strict lending requirements when it comes to distressed properties.

“Imagine a zombie foreclosure that’s been vacant two to three years somewhere in the Northeast now becoming a bank-owned property. That is not for a first-time homebuyer and maybe not even for an investor. These are not properties that are going to fix the inventory problem, at least not when they are first repossessed,” added Sharga.

Much of this inventory is in the wrong place and in markets where prices are already depressed. While the increase in foreclosures sounds promising, these properties are not salable, and many aren’t livable, so it won’t impact the housing market in any meaningful or measurable way — unfortunately.

So what will happen to these properties? Many will end up demolished, and the lots will grow over with weeds until some enterprising entrepreneur figures out some way to extract value from them again. This fate befell many properties in Detroit, Cleveland, and New Orleans already, and like the unwanted refuse buried in modern landfills, the worst of these properties will be buried and forgotten.

Market InSite

Two weeks ago I moved back to Irvine and accepted a position as the Chief Economist of Market InSite Real Estate Advisors. Regular readers will notice some changes to the blog including some new menu items at the top to explore. Over the next few months, more changes will gradually be phased in.logo1

I intend to take the writing on this blog to the next level. My daily posts will have much the same style, but I will focus more on topics of particular interest to the homebuilding and development industries.

Since my beginning nearly 10 years ago, I always strived to break down complex topics and explain them in terms a layman can easily understand. For the most part, that will not change, but once a week, I will write a newsletter directed toward industry insiders that I will repost here. That post may have more industry jargon than usual.

My irreverent style will remain, but some of my more crass humor and caustic statements will tone down. I’m no longer a lone blogger clamoring for attention on the internet, so I need to be a bit more dignified. I would like to believe the title of Chief Economist brings recognition and credibility I earned through publishing a book and writing about real estate issues for ten years. Short of that, I hope it gets me quoted in the newspapers a little more often.

My new position provides me access to a treasure of new information. Bringing this information to you on this blog will improve the content and help take it to the next level.

My co-workers and superiors at my new firm want you to remain loyal and engaged readers. The ongoing conversation in the astute observations is one of the key assets of this site, and we hope to expand it by attracting more people in the homebuilding and land development industries.

I want to thank you for reading me for all these years, and I look forward to ten more.


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