Wall Street-backed landlords take bad mortgage route

[NEW YORK] Wall Street- backed landlords are showing a greater appetite for bad mortgages as a source for cheap property as the supply of foreclosed homes declines while housing prices continue to climb.

The companies have dominated US foreclosure auctions in the last two years by buying as many as 200,000 single-family homes. Now, American Homes 4 Rent, the second-biggest single-family landlord, Barry Sternlicht's Starwood Waypoint Residential Trust and Altisource Residential are leading acquisitions of non-performing loans, or NPLs, to expand their holdings of rental properties.

The shift to loans comes after foreclosure starts dropped to the lowest level since 2006 and house prices jumped in Atlanta, Phoenix and other markets where investors have made the most purchases. The development is raising concern among housing advocates that private equity firms and hedge funds will be more likely to take possession of the properties rather than offer loan modifications. Residents may be displaced or transformed into renters of their former houses.

Doug Brien, co-chief executive officer of Starwood Waypoint, said that his firm plans to give delinquent residents a chance to stay put as owners or renters.

"Our intent is to approach some of these folks where it just doesn't look like they're going to get caught up on their loans," Mr Brien said. The firm can "offer them the opportunities to stay in their homes and keep their kids in the same school". Starwood Waypoint invested US$219.7 million for 1,736 non-performing loans compared with US$707.5 million to own 5,049 rental houses, according to a January presentation to investors. That averages about US$127,000 per distressed loan compared with US$140,000 per home.

Mr Brien said that an estimated 30-50 per cent of the NPLs will end up as rentals for the company. In other cases, the borrowers will resume paying the loans after a modification or the homes will be sold because the location or quality doesn't match Starwood Waypoint's criteria.

"We're always going to take the outcome that's most economically beneficial," Mr Brien said.

Hedge funds, private-equity and real-estate investment trusts, which have raised more than US$20 billion to buy rental homes, are getting opportunities to buy soured home-loan debt as banks face new regulations that make it more expensive to hold. The Department of Housing and Urban Development is also auctioning loans to stem losses at the financially troubled Federal Housing Administration.

The government, lenders such as Bank of America and investment firms sold about US$34.7 billion in non-performing loans last year, up from US$13.1 billion in 2012, according to David Tobin, principal of Mission Capital Advisors, a New York-based real estate loan broker.

JPMorgan Chase & Co this month offered US$390 million of NPLs. HSBC has hired BlackRock to manage the potential sale of as much as US$1 billion in delinquent loans, and Goldman Sachs is handling an auction of about US$700 million of modified debt for Regions Financial.

About 5.4 per cent of mortgages, or almost 2.2 million loans on US homes, are at least 90 days delinquent or in foreclosure, the Mortgage Bankers Association reported on Thursday. That's down from the fourth quarter 2009 peak of 9.7 per cent. Investors buying NPLs to increase their rental portfolios is a cause for alarm because they stand to profit by pushing people out of their homes, said Kevin Stein, associate director of the California Reinvestment Coalition, a San Francisco-based tenant and consumer advocacy group.

"They should be modifying those loans to keep the homeowner in there, but it runs counter to their business model," Mr Stein said. "They shouldn't be in the business of buying distressed loans for the purpose of foreclosing on people."

Altisource Residential, which bought 13,500 delinquent loans last year, resolved about 288 in the fourth quarter. One hundred and fifty-one of those were foreclosures or deeds in lieu of foreclosure, where the resident gives up rights to the property. The firm expects that more loans it bought last year will be converted into rental properties by the end of this year or early 2015, CEO Ashish Pandey said on Thursday. He anticipates that NPL sales will reach US$40 billion this year.

"Our NPL acquisition strategy will continue to give us access to properties and healthy markets nationwide," Altisource chairman William Erby said. The company's shares fell 2.6 per cent to close at US$27.61 in New York, paring their gain in the past year to 73 per cent.

American Homes 4 Rent, a landlord with more than 21,000 homes founded by billionaire B Wayne Hughes, announced a joint venture in September to buy distressed mortgages. Jack Corrigan, chief operating officer of the Agoura Hills, California-based real estate investment trust, didn't reply to a phone message seeking comment.

Mr Hughes, who pioneered warehouses for Americans needing storage space, saw the opportunity to create a rental empire after the housing crash. He brought together a group of executives from his company Public Storage to begin buying homes in early 2012. At around the same time, Blackstone started Invitation Homes, a single-family landlord that has spent US$8 billion on 43,000 homes.

While Blackstone once bought US$100 million of homes a week, it has slowed acquisitions after prices climbed almost 24 per cent since March 2012, according to the S&P/Case-Shiller index of 20 US cities.

"The challenge now for us is as the prices go up the yields go down," Jonathan Gray, Blackstone's global head of real estate, said this month at the Harbor Investment Conference in New York. "So we have been winding down, not ending, but reducing the amount we are investing."

American Homes 4 Rent and Tom Barrack Jr's Colony Capital also have said that they've been purchasing fewer homes. Colony, Blackstone and other investors are increasingly lending to smaller landlords as an alternative way to bet on the rental business.

Invitation Homes "has not and will not purchase NPL's", Blackstone spokeswoman Christine Anderson said.

Bayview Asset Management, a Coral Gables, Florida-based mortgage investment company backed by Blackstone, has been the largest buyer of NPLs sold at HUD auctions, spending US$1.47 billion since 2012, according to data from the sales. Bayview "always attempts to modify first", Ms Anderson said.

Delinquent loans are trading at around 65 per cent to almost 80 per cent of the current property values, according to Ellington Management Group, which oversees US$6 billion in investments, including rental homes and NPLs.

Michael Vranos, CEO of Old Greenwich, Connecticut-based Ellington, said that it's hard to predict how many of the discounted loans will become rentals.

"There are many paths that can be as or more profitable," said Mr Vranos. They include getting borrowers to start making monthly payments or conducting a short sale, when the house sells for less than the mortgage balance.

Homes acquired through non-performing loans have often gone years without maintenance as the owners struggled to pay their debts, adding to renovation costs. Loans on homes that received foreclosure filings in December were an average 920 days delinquent, up from 255 days late in January 2008, according to data provider Black Knight Financial Services.

"The longer the borrower is in a house that's non-performing, the amount of deferred maintenance just grows and grows and grows," said Jon Daurio, co-founder of Kondaur Capital, which started buying delinquent loans in 2007. "For me, it's too risky." Mr Daurio left Kondaur in 2011 and is raising money to start a mortgage origination firm.

Starwood Waypoint's Mr Brien said that NPLs are a valuable tool to build his company, which began trading on the New York Stock Exchange on Feb 3. "We're optimistic about it," he said. "We think there's a great opportunity to buy NPLs over the next year to two years and put some capital to work." -Bloomberg