The shadow market now has its first formal government program.
The Federal Housing Finance Agency (FHFA) took the first step in its Real Estate Owned (REO) Initiative on Wednesday, outlining how investors could pre-qualify to bid on transactions in the initial pilot phase.
The Initiative allows investors to purchase pools of foreclosed single-family properties in the nation’s hardest-hit metros, with a catch—those properties must remain rentals for a certain number of years.
During the pilot phase, Fannie Mae will offer pools of various types of assets, including homes already being rented, vacant properties, and non-performing loans. But it’s just a guinea pig to test investor interest, operational strategies and financing structures to prove the idea out.
While Fannie will supply the first round of foreclosures in the experiment, Freddie Mac and the Federal Housing Administration will also offer pools to investors in subsequent phases of the program.
In the broad strokes, the plan makes a lot of sense—there are simply too many single-family homes, and not enough rentals, in general across the nation. But the devil is in the details. The pre-qualification process focuses on not just the investors’ financial wherewithal, but its ability to manage the assets as well. And as in any scattered-site development, a collection of single-family homes offers different operational challenges than managing a multifamily development.
“Mismanaging these rentals would make an even bigger mess out of our already struggling housing sector,” said Cindy Chetti, president of Government Affairs for the Washington, D.C.-based National Multi Housing Council, in a joint statement with the National Apartment Association. “We would encourage the government to rely on trained, professional management entities to handle these properties.”
The impact of this program on the multifamily industry is difficult to gauge in the early stages. The highest concentration of REO homes is typically in areas that exhibit weak rental demand to begin with. And given the existing shortfall in apartment supply, the impact on national multifamily occupancy rates should be minimal. Chetti points out that apartment developers should be building about 300,000 new units a year to keep up with demand, yet last year, the industry started less than 150,000 units.
Goldman Sachs recently wrote a research paper on the program, calling the possible effect “positive but modest,” with an upside of producing a 0.5 percent increase in home prices the first year, and a 1 percent increase in 2013, though “the actual effect would likely be less.”
Goldman Sachs sees three huge obstacles to the program’s success. First, these newly converted rentals could stay vacant, which would just transfer vacancy rate increases from the for-sale to the rental market. Second, banks and other institutions could be encouraged to bring more product to the market as these pools are sold—a one-for-one replacement—thereby keeping the overall stock of for-sale supply the same. And the last factor is simply the fact that some of these properties are absolute dogs, either because of their condition or location.
The REO Initiative’s pilot phase is expected to kick off this month with the sale of 500 to 1,000 foreclosed assets, which is just a drop in the bucket—together, the agencies have more than 250,000 foreclosed homes on their books.
The initiative may lack some transparency, though. FHFA’s pre-qualification test lists three minimum criteria—financial clout, experience and expertise in analyzing risk, and, importantly “agreement to keep certain information about the REO and related matters confidential.”
For more information, visit FHFA's REO-to-Rental site here.