The news from the housing market continues to be grim. The foreclosure machine, which ground to a halt last year, is firing up again. In February, distressed sales accounted for 34 percent of existing home sales. The massive inventory of foreclosed homes, owned by banks, and by Fannie Mae and Freddie Mac, acts as a damper on the overall market. Until all the failure is processed, the home sales market can't hope to regain some sense of equilibrium. But dealing with foreclosures is a retail business, not a wholesale one. Efforts to process foreclosed properties them en masse by servicers led to robo-signing and a host of legal problems.
Still, some entities are thinking about ways to accelerate the process of moving ownership of busted properties from mortgage holders to new owners. Earlier this week, the Wall Street Journal reported, hedge funds and other financial institutions, including John Paulson's Paulson & Co., and a fund associated with mortgage bond pioneer Lewis Ranieri, are gathering funds together in the hopes of purchasing foreclosed properties in bulk from mortgage giants Fannie Mae and Freddie Mac. Then, they would rent them out to tenants.
What could go wrong? Well, as Aaron Task and I discuss with Jonathan Miller, president and chief executive officer of appraisal firm Miller Samuel and proprietor of the authoritative Matrix real estate blog, pretty much everything.
To begin with, several years after the housing market peaked, too many investors and lenders continue to analogize houses to stocks, Miller says. "There's still this huge disconnect. Housing is seen as a liquid transaction. But it's a slow moving inefficient transaction, and you can't get in and out very quickly."
In addition, when it comes to homes — unlike with other distressed assets — there are significant costs to ownership. Many of the homes in foreclosure are in disrepair and have to be upgraded, which means the purchase price is just the beginning. Owners must pay property taxes, which have been rising in many areas due to the continuing public fiscal crunch. Landlords have to recruit tenants, collect rent, and make repairs.
There's an established business model for doing this with multi-family homes or apartment buildings. But for individual homes scattered around a metropolitan area? Not so much, says Miller. One hundred apartment units in a single building share plumbing, heating, and cooling systems, and other infrastructure. An on-site superintendent and staff can deal with issues as they arise, and ensure that tenants are following rules and paying rent. With a portfolio of individual homes, there are no such synergies available. If someone buys a house for $50,000 and finds a tenant at a rent that yields a small profit, the whole proposition can be upset if the ancient furnace blows and it requires a $5,000 investment to install a new one. "The rental of single family houses, which are the bulk of the problem, is a far more labor-intensive and challenging issue than multifamily housing," said Miller. "So I'm skeptical that it will be a large phenomenon."
In addition, the prospect of Fannie and Freddie selling hundreds of homes to hedge fund managers sets up some very bad optics. High-living hedge fund managers, the type of people for whom "house rental" means paying out $200,000 for a Hamptons summer home, will be thrust in the position of being landlords. And while rental housing is a long-term proposition, hedge fund managers tend to have a short-term focus. They won't hesitate to kick people to the curb if they fall behind on the rent, or scrimp on repairs and maintenance if it means a few extra dollars in their pocket. Should one of these outfits manage to turn a huge profit by buying a portfolio of homes from Fannie Mae or Freddie Mac and then flipping them, it'll be yet another example of public entities absorbing losses while private entities rack up gains.
For all these reasons, it's hard to see the idea getting off the ground."I'm very skeptical that this will gain traction," says Miller. "It's more of a test, and it won't be a great hit, and we'll move on to the next creative idea."
Rather than sell homes to hedge funds who can rent them out, it would be smarter for owners of foreclosed property simply to rent the homes to the people who already live in them.
Daniel Gross is economics editor at Yahoo! Finance
Follow him on Twitter @grossdm; email him at email@example.com
His next book, Better, Stronger, Faster: The Myth of American Decline and the Rise of a New Economy, will be published in May and is now available for pre-order.
- Fannie Mae
- Freddie Mac