Och-Ziff Calls Top Of "REO-To-Rental", And Distressed Housing Demand, With Exit Of Landlord Business
The primary, if not only, reason there has been a brief spike in subsidized demand for housing in recent months, has been the GSE/FHFA endorsed REO-To-Rental plan, and associated securitization conduits, in which large asset managers have been encouraged to take advantage of government funded, risk-free financing (and entirely bypassing banks who have given up on loan origination due to legacy liability issues which have every bank tied up in litigation from now until Feddom come - just see today's Bank of America results) and purchase foreclosed properties in bulk, with the intention of converting them into rental properties. Needless to say, the subsidization of this wholesale purchasing of foreclosures, coupled with the ongoing "foreclosure stuffing" pursued by the big banks (as a reminder days to foreclose in New York just hit a record 1,072 per RealtyTrac as banks simply refuse to clear housing inventory faster knowing full well withheld inventory is an additional clearing price subsidy) is the main reason why the punditry has been confused into believing there is a housing rebound. That this "rebound" is merely a subsidized demand pull phenomenon a la the "cash for clunkers" auto sales program is patently clear to most. Nonetheless what little confusion is left, is finally coming to an end, thanks to none other than one of the first entrants in the REO-To-Rental space, $31 billion hedge fund Och Ziff, which a year after entering the program with hopes of quick riches, is now looking to cash out.
As Reuters reports, "Och-Ziff Capital Management Group LLC, the $31 billion hedge fund led by Daniel Och, recently told its investment partner, 643 Capital Management, that it wants to exit from the foreclosed homes business, said several people familiar with the matter." Why is Daniel Och calling it a day: "the New York-based hedge fund is looking to sell now because the returns it is generating from rental income are less than expected and it is looking to take advantage of a recent rebound in home prices in northern California." And so yet another myth unravels. Look for all the other piggybackers and late entrants to follow promptly in Och-Ziff's steps as the primary driver of distressed housing demand goes as easily as it came.
Reuters explains how REO-to-Rental is coming to an end:
The hedge fund is looking to make a profit on a portfolio of about 300 foreclosed homes in northern California that were acquired at distressed prices, said the sources, who did not want to be identified because they were not authorized to discuss the matter.
Though the total value of the portfolio is not known, its business model involved buying homes at an average price of about $100,000 apiece. In addition, Och-Ziff and its partner needed to spend tens of thousands of dollars on each home for potential renovations before renting them out.
The decision by Och-Ziff to exit the market after just a year is notable since the hedge fund was one of the first institutional investors to see the large supply of foreclosed homes in the United States as a new asset class that could generate consistent income if operated as rental properties.
What is effectively happening is that once again the large institutions, in this case those who are unburdened by legacy liabilities, i.e., hedge funds (it should be rather distressing that instead of banks serving the roles of landlords, this time around it is it is big hedge funds who are offering homes for rent) who have access to ZIRP are attempting to arb out the retail borrowing spread. The problem however is that while those who have access to Fed funding are expecting large, consistent ROEs, the other side of the equation is missing, and as rental prices increase fewer and fewer Americans can take advantage of the hedge funds' "generosity." This is what happens as the middle class collapse continues and as America's society sees its nominal (not to mention real) income continue to decline as hourly earnings collapse (as we pointed out last week).
And since the Fed has both broken and massively distorted the business cycle (recall: JP Morgan Finds Obama, And US Central Planning, Has Broken The Economic "Virtuous Cycle"), an investor can make an asset allocation decision in a far shorter length of time. In this case it took Och Ziff just one year to go from start to finish, and now to cash out as it sells to other, less sophisticated investors who have yet to discover the lack of IRR associated with the REO-to-Rental program.
Och-Ziff's move could indicate that institutional investors may have to dial back their expectations, especially with regards to rental income.
"It's not surprising that some investors may have overestimated rental returns," said Rick Sharga, executive vice president with Carrington Mortgage Holdings, a division of Carrington Capital, which has been buying and renting foreclosed homes since 2007. "If you are an investor getting into this cold you were probably making assumptions based on models rather than experience."
Gregor Watson, founder of 643 Capital Management, which is Och-Ziff's partner, said he is not marketing the portfolio of homes but declined to comment further. An Och-Ziff representative declined to comment.
Och Ziff is the first to wave goodbye...
Over the past year, other high-profile Wall Street names, such as Blackstone Group, Oaktree Capital Management, Colony Capital and TCW, have all committed money to investing in foreclosed homes. Oaktree has invested in a fund managed by Carrington.
Wall Street analysts estimate that this year alone, private equity firms, hedge funds and other investment firms have raised between $6 billion and $8 billion to acquire single-family homes at either foreclosure auctions or from banks. So far, private equity giant Blackstone has emerged as one of the biggest buyers, spending more than $1 billion to gobble up foreclosed homes.
Sharga said it was not surprising that an early market entrant like Och-Ziff would look to get out and take advantage of the recent appreciation in home values. He said other early financial investors also may change direction and decide to cash in sooner rather than later.
"This is a normal winnowing-out process," Sharga said. "We will see other early entrants depart."
... but it won't be the last. Expect all other subsidized "buyers" in the space to proceed to dump their properties en masse shortly. The problem is that once the greater fool is no longer clearly defined at the poker table, and the get rich quick scam has been exposed, the offerless market quickly goes back to being bidless. Which is precisely what will be the catalyst for the 4th leg down of the dead cat bouncing housing market, and the end of the illusion that this time it's different and Bernanke has actually done something right.