Hedge Fund Watch: How are Funds Impacting your Market and Business?

[Steve Cook]

With plans to spend billions on foreclosures and to convert single family rentals into a new asset class of securities, well-heeled hedge funds are creating both challenges and opportunities for the individual investors and small partnerships that ignited the residential investing boom.

How are hedge funds impacting your market and your business? Help us chronicle how they are changing face of residential real estate.

[Brian Burke]

If you really dig into all of the announcements, plans, and hype, three seems to be about $8 billion going into play. Some estimates of remaining shadow inventory by respected analysts are as high as $840 billion. That means that capital is coming into play to capture ONE percent of the potential opportunity.

The bulk of the larger groups in this space operate the same way. They buy in the same areas, they buy the same types of properties, they underwrite the same way, and run their operations in a similar manner.

They are much less concerned with rental yield than buying as many houses as possible, as fast as possible. They underwrite to 5-7% net yield, which in many markets calculates to prices that actually exceed market value. The whole game is a macro play on housing prices, and it carries very high pricing risk.

In order for these groups to simply break even, housing prices must rise at least 20% to cover their exit and renovation cost. Simply, it's just not a good model.

It's not all bad news. Despite having to compete against more than one of these groups in my areas, I'm still able to get robust deal flow. Increasing my price bracket for flips allows me to operate outside of their influence. In lower price brackets, I'm still able to get a lot of houses that have enough margin to flip, but don't meet my metrics to hold as a rental because the yield is too low for me (even at wholesale price). The funny thing is, the large funds buy most of them from me after flipping them, at retail price. Go figure. They have also raised the value of my rental portfolio. I knew these guys were coming, and I told all of my investors that would be exactly what would happen...

Finally, Steve commented about the REO-to-rental pilots. I was a qualified bidder on the 2,500-house FNMA pool sale earlier this year. Ultimately, I chose not to bid because as I was underwriting the assets of one of three sub-pools that I was interested in, I could see a lot of issues with the assets that I found less than thrilling, and I could see the handwriting on the wall as to where the bidding was headed. All I can say is that all of the talk about this program and its effect on the RE market and individual investors was coming from sources that were forming their opinions without knowing the facts. It is not a threat to those of us that typically operate in a one-off strategy, whether homeowner or investor.

The bottom line: the landscape is changing, but it always does. Being a real estate investor is like sailing a boat in a stream that winds through a meadow. If you try to sail in a straight line, you will run aground. You have to shift course to stay afloat. Change up your strategy to react to the changing landscape. Use some creativity, and you will be just fine.