Unstructured Finance

By Matthew Goldstein and Jennifer Ablan

All year the big money has been talking up one of the more intriguing trades to emerge from the housing crisis: buying up foreclosed homes in large scale and rent those out for several years and then unload them when the price is right. But questions about the so-called rent-to-own trade are being raised now that an early mover in the space, hedge fund giant Och-Ziff Capital, is looking to cash in its chips now and is abandoning the idea of operating foreclosed homes as rental properties for years to come.

Now we’re not quite ready to declare the foreclosed home rent-to-own trade is dead as the tireless, prolific financial bloggers at ZeroHedge did in a good riff on our exclusive story on Och-Ziff’s decision. But Daniel Och’s concern that the income to be generated from renting out foreclosed homes may not be as high as originally anticipated bears close scrutiny because it could spell trouble for other hedge funds, private equity firms and smaller money managers counting on rental income to generate an annual 8 pct or greater return on investment.

Way back in March, when we first wrote about all the big money that was racing into the foreclosed home market, we noted that some were concerned that a lot of the newer entrants might not really up to the challenge of managing and renting single-family homes for the long haul. Historically, the business of buying, rehabbing and renting foreclosed homes has been a mom-and-pop endeavor, conducted by people with strong community roots. The skeptics wondered whether institutional players were too blinded by the potential to capture yield and overlooking the challenges that comes with bringing often vacant foreclosed homes up  to code and habitable conditions.

If the potential to rake in a consistently solid return from renting out single-family homes is disappearing, that could also spell the end of the federal government’s experiment to sell-off Fannie owned homes in bulk sales. The whole premise of the program sponsored by the Federal Housing Finance Agency was to find big money managers willing to rent single-family homes for at least three years before selling them. If rental yields are shrinking due a combination of rising operating costs and slower growth in rent prices, then the bulk sale trade looks less attractive.

That said, there doesn’t appear to be any let-up in the interest in the foreclosed home space. Every other week there is another conference about investing in foreclosed homes. Earlier this month, Americatalyst sponsored a closed-to-the media forum in Austin, Texas, attended by all the big shots in this market, where the hot topic was “Renting the Future.” And new funds managed by lesser-named money managers seem to crop up every day.

Private equity giant Blackstone Group already has spent over $1 billion gobbling up foreclosed home in Florida, California and Arizona and shows no sign of stopping.

The thing is if the rent model is slipping away as a reliable income generator, the pressure to flip these homes as fast as possible grows. And if the foreclosed home space simply becomes a race to flip homes faster and faster, it could mean operators will be tempted to cut corners on needed renovations and simply set the stage for one set of speculators to replace another set of speculators.

As we have all year, we’ll keep on this market for the latest twists and turns. And if you’re just focusing on the foreclose home market for the first time, here’s some of prior articles:

The Wall Street Gold Rush in foreclosed homes

Bofa launches second round of bulk sales of foreclosed homes

Asset Manager TCW looks to cash in on foreclosed homes

Housing chief leave Morgan Stanley to start rent-to-own fund

Investors tout controversial ‘condemnation’ for housing fix

Ex-Goldman mortgage chief plans foreclosed home fund

Ex-Morgan Stanley chief launches foreclosed home fund

Och-Ziff looks to exit the landlord business