Earl Cummings: REO-To-Rental Could Be A Sustainable Strategy

14449_earl_cummings Earl Cummings: REO-To-Rental Could Be A Sustainable Strategy PERSON OF THE WEEK: Earl Cummings is president and CEO for BestAssets, a nationwide REO (real estate owned) management company.

MortgageOrb interviewed Cummings to get his perspectives on REO investment and management strategies.

Q: Is there a ‘typical’ or representative REO investor? Are they looking at single properties or larger portfolios?

Cummings: There are two types of buyers for REO properties – a homeowner (a buyer who occupies the property) or an investor (a buyer who will generate revenue from the property). While investor activity is creating a lot of attention, the owner-occupant purchases represent the majority of purchases from the multiple listing services (MLSs).

Most of the owner-occupants are first-time homeowners looking for affordability. Each month, our company closes 550 to 600 properties with 71% of the sales going to homeowners and not investors. Therefore, the typical REO buyer from MLS is a homeowner, not an investor.

Investors range from small "mom and pop" operations to large, bulk acquisition specialists. The first-time investor looking for a single property to own as a rental is usually a small "mom and pop" hoping to acquire five to 10 properties for rental income. This buyer is usually purchasing from the MLS. The small investor usually does not intend to dispose of the properties.

The large acquisition specialist attempts to buy 100 to 1,000 properties at a time, aggregating 5,000 to 10,000 properties for net operating income with the eventual goal of selling the inventory at a premium. This buyer does not typically purchase properties from MLS. The investor is usually buying in bulk through programs designed by the banks and the government-sponsored enterprises, Fannie Mae and Freddie Mac, to move volume. These programs aggregate properties in pools to sell at a discount with no ability to change the quantity or character of the properties in the pool.

There is a new trend in the REO market where mid-size to large investment firms make purchases of REO properties on a one-by-one basis to acquire a portfolio that meets specific criteria. This trend is driven by the cost of idle properties (non-revenue generating properties) within the portfolio of bulk acquisition specialists. Acquisition specialists who buy in bulk achieve deep discounts on the price of the properties in exchange for the risk derived from repair and holding costs.

To avoid holding costs, the investors acquire only the properties that meet their criteria. They are not willing to buy in bulk, which would require them to assume the cost of demolition and disposal of non-performing properties. This investor may buy five to 10 properties at a time, through designed programs or through MLSs.

Q: What are some basics of a good REO disposition strategy for investors and lenders/servicers?

Cummings: Before the mortgage meltdown took place, most lenders had a strategy that stressed only speed in getting rid of REO. This has definitely changed. Speed is still a priority, but it is no longer the single most important factor. Influenced by legislation after the crisis, as well as increased competition from investors, the entire industry shifted to preserving communities, meeting local compliance and maximizing the return on the sale of each property.

The REO-to-rental strategy has fundamentally changed the buying and disposing of properties. Previously, the strategy was to buy and then quickly flip the property for a profit. Now, properties are bought and held as rental investments, then sold on a cyclical basis to cash out the investment.

The single greatest impact has come from the investments made to rehabilitate the properties. Prior to the current investment in REO-to-rental, most of our clients sold their properties with less than $6,000 dollars in improvements. In many cases, the properties were sold "as is." Investors are performing total "makeovers" on their portfolio to create value. It has raised the bar for the quality of every listing on the market for sell or lease.

There is now competition among small and large investors, as well as the banks and GSE listings. It's not unusual for a bank or investor to spend $25,000 to rehab a property today. When a property is listed without improvements, it sells at a discount. In 30 days, the same property will return to the market with a complete makeover, listed at its market value for sale or lease.

In a market where the quality of the property now determines holding times and costs, the best strategy for the large banks and the GSEs is to quickly segregate their inventory into the following categories:

1. Ready to list;
2. Requires rehab; and
3. Sell "as is"

The large banks and GSEs should develop a process to get each property into the proper channel as quickly as possible to get it to market as soon as possible in order to reduce holding costs from maintenance and potential vandalism.

Investors will have a real balancing act as interest rates increase. Usually an increase in the interest rate causes a decrease in the price of the property. Depending on the duration of a fund and the change in the interest rate, some investors may consider disposing of parts of their property portfolio each year, then hold some capital in reserve to acquire more properties in two to three years as interest rates increase and values go down. Â

Q: Does the current REO-to-rental cycle have an ‘end game,’ or do you see a sustainable single-family rental market for an extended period?

Cummings: There has always been an REO market even prior to the mortgage crisis. Up until then, REO has never been the main focus of the industry. Today, the REO segment is front and center because the process to reduce the default inventory of loans from 5 million down to 1 million has created a national brand for the abbreviation "REO." In three to five years, we hope to see normal levels of delinquencies and defaults with REO's accounting for a small percentage of the nation's housing inventory.

If the REO-to-rental market were being supported only by buyers with credit problems who want a single-family residence but simply are not able to obtain a loan, I would have no confidence in sustainability. The greatest clarity for all of us has been revealed by consumers who are millennials: This group is totally okay with renting because they feel no pressure to own a home – and they like the freedom of moving to adapt for a new job, a new school or a community. The millennial generation, along with future homeowners with credit issues, make the REO-to-rental strategy a sustainable idea. The investor recognizes this demand and is seizing the opportunity.

The mortgage, real estate and finance industry are in an excellent position to innovate and adapt to a volume strategy around aggregating single-family properties for rental. If the demand, the technology and financial exit strategies are perfected, we may have a new asset class in five years.


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