Housing downturn spurs boom in foreclosure-to-rental conversions

WASHINGTON — Gene Richards is a lifelong Vermonter, but on a recent weekday afternoon he found himself back on Florida's west coast, scouting foreclosures to add to the collection of rental properties he has amassed in the wake of the housing crisis.

“I just started buying them and I haven't stopped. I have 15 right now, and I'd buy another 15,” said Richards, 51, who runs a mortgage company and also owns rental properties back home in Burlington, Vt. “This to me is a no-brainer of an investment.”

With home prices at historic lows and rental rates on the rise, Richards and a growing number of investors with cash to spare are seeking lucrative returns by gobbling up foreclosures in distressed markets across the country and turning them into rentals.

“The investors are seeing bargain opportunities,” said Lawrence Yun, chief economist for the National Association of Realtors. “The numbers are just very attractive, given the alternatives.”

The real estate data firm CoreLogic estimated in a report this month that the burgeoning foreclosures-to-rental business could become a $100 billion industry this year as bigger and bigger investors get involved in hard-hit markets from Florida to California to Arizona to the Midwest.

Yun cited a recent NAR survey that shows sales of investment homes soared nearly 65 percent in 2011 over the previous year. By contrast, the number of purchases by owners who intended to occupy the homes fell more than 15 percent, the survey showed.

Those numbers reflect the fact that investors often have the ability to purchase in bulk and with cash, bypassing the need to rely on credit approval from banks. But the survey also suggests that the combination of bargain prices and a steady stream of rental income seems more attractive to many investors than having their money languish in banking accounts or bonds.

Of course, the speculators who furiously acquired properties and flipped them in search of quick profits played a key role in fueling the housing bubble that wrecked the U.S. economy. But for the moment, Yun believes, the current investor boom in turning foreclosures into rentals could actually help to heal the ailing housing market.

“In the current market situation, I would say the investors are very helpful ... We don't want to see foreclosed properties linger. The investors are clearing this inventory out of the system,” Yun said. “Investors during the bubble years were not helpful; they were just adding fuel to the fire. But now they're playing a stabilizing role.”

In the past, the investors willing to buy up bank-owned, single-family homes and turn them into rentals predominately were individuals or mom-and-pop outfits with only a handful of properties.

That's still the case, but larger players have entered the business, and even larger ones — including hedge funds and private equity firms — have said they plan to invest hundreds of millions of dollars in such properties.

In California, Waypoint Homes has amassed about 1,300 rental houses in the state since the business began in 2008 and has begun expanding into Phoenix.

“We're not looking at this as a short-term opportunity in a distressed market,” said Waypoint co-founder Colin Weil, noting that some large hedge funds and private equity funds are currently looking to spend hundreds of millions of dollars going into the single-family rental business. “There's so much big capital that's so eager to get into this space. ... It's the emergence of an enormous industry.”

In the Washington area, investor Dan Magder recently left his job with the private equity firm Lone Star Funds to start the Washington D.C.-based Rock Creek Capital Group and focus on the single-family rental business.

He has partnered with Greenlet Investments of Texas that owns hundreds of homes throughout the South, and he expects to spend as much as $200 million in coming years buying foreclosures, renovating them and renting them out.

“There are a tremendous amount of these homes that are going to be sitting there. At the same time, you have many people who were in these homes who are looking for a place to live,” Magder said, adding that between rising rents and low vacancy rates, “the financial proposition starts to look good.”

Banks and lenders currently own 634,282 distressed properties across the country, a 16-month supply at the current sales pace, according to RealtyTrac. Another 717,874 properties are in the foreclosure process but have not yet been repossessed.

In February, the federal agency that oversees government-backed mortgage giants Fannie Mae and Freddie Mac announced its intention to hold bulk sales of about 2,500 foreclosed homes in some of the nation's hardest hit areas, such as Las Vegas, Chicago, Atlanta and parts of Florida. The program could expand if successful.

The following month, Bank of America announced that it will test a pilot program to allow as many as 1,000 struggling homeowners to hand over the deed but stay in their homes and rent from the firm. The bank said it will work with property management companies to maintain the homes and eventually sell them to investors.

Some housing advocates say that the idea of hedge funds and other large investors becoming large-scale landlords raises red flags. Will they abide by fair housing laws? Will they actually maintain the homes or just slap on a coat of paint and ignore tenants until it's time to sell?

“It's a whole different thing than an apartment building, where all of your tenants are in one place. The fact that you have properties that may be scattered across a metropolitan area has its own set of challenges,” said Debby Goldberg, special projects director for the National Fair Housing Alliance. “We've never been in this kind of situation before where you have so many vacant properties in so many places.”

The Federal Reserve itself recently issued a policy statement about bank-owned rental properties in which it urged banks to hire only reputable vendors and to comply with all landlord-tenant laws and property maintenance provisions.

Investors such as Weil and Magder say they are aware of the potential problems and are using updated technology and infrastructure to make sure their properties are well maintained and their tenants well treated.

“The onus is on us to be effective stewards of these assets,” Magder said. “We're dealing with real people and their lives, and you have to be sensitive to that. ... It's actually the right business proposition, but it's definitely the right thing to do.”

It's a business proposition that isn't likely to lose steam anytime soon. From institutional investors to small-time buyers, turning foreclosures into rentals seems to be one boom that has emerged from the housing bust.

Richards, the investor from Vermont, says he has no plans to cease his regular trips to Florida.

Unlike the cavalcade of speculators who flocked to the state during the boom years to make a quick buck, he said he intends to be a responsible landlord and watch his investment grow over time.

“It isn't about the flip for me,” he said of the foreclosures he has purchased. “I really like fixing them up. I feel like I've helped stimulate the economy down here. I don't want to be the one who continues to hurt it.”