Hedge Fund in California Swears to Put the Small Guys Out of Business

[Corey Dutton]

A prominent real estate investor in California related a story to me yesterday that nearly knocked me off my chair. This real estate investor specializes in real estate flips and rental properties in California, and has been in the business for 30 years. He currently has a portfolio of over 400 rental properties in California.

He was recently solicited by a hedge fund manager in California for a meeting. The first thing the hedge fund manager said to my friend was, “I really feel sorry for you small guys because we are going to put you all out of business.” My friend was obviously offended by this and replied, “I’ve been doing this 30 years, how long have you been doing this? Six months?”

This hedge fund manager offered to buy all 400 of my friend’s rental properties in California. He told him that his hedge fund was going to put all of the small real estate investors in California out of business. This hedge fund’s goal is to buy up all of the discounted real estate in the State of California and turn it into rental property. As many real estate investors can attest, these hedge funds are coming into the buying scene pretty hot, and are paying prices over retail for properties in California, Arizona, and other States in the West.

Needless to say, my friend flatly refused the hedge fund manager’s offer and walked out of his office. Does this pose a real threat to real estate investors in California? What is your take?

[Karen Margrave]

Corey Dutton There was actually an article on this in the Orange County Register a few months back. I posted it on BP. It's obviously a problem, because nobody can compete, and prices are being driven up for everyone. "Deals" are very rare. We've decided to build "new" projects.

[Joseph M.]

I believe these funds have been doing this for a while. I bet they are also getting deals that don't show up on the MLS as well. It seems inventory is extremely low in the L.A area right now. I do think hedgefund money is a threat to the regular/individual investor..I don't see how you could say that it is not.

It will be interesting to see how this all plays out especially with how they manage properties . Owning SFHs seems kind of inefficient for them, but even if they do a halfway decent job of managing them and prices go up in the future which it looks like they already are in many areas I'm sure they will come up ahead.

They also have the resources to create their own massive property management companies as well.

It's another case of the rich getting richer.

[Kyle J.]

Originally posted by Joseph M:
I bet they are also getting deals that don't show up on the MLS as well.

Of course they are. There are bulk sales of real estate that go directly to them.

This is a common topic on the Norris Group's real estate radio show. It's pretty interesting to learn about some of the things that go on behind the scene.

[Corey Dutton]

This friend of mine is a HUGE player in the California real estate market. The nerve this hedge fund manager had to say that to him. What a jerk eh?

[Jeff S.]

Poach their tenants and under price just a little. Let them do the heavy lifting. We all know if you overpay for a property you will regret it. How does that work when buying in volume?

[Chris Clothier]

I wrote about this a couple of weeks ago on the BP Blog. I will say that is absolutely different form market to market and that will effect the success of these funds. The one that is operating in our market is going to have some success buying, but they are going to crash and burn on the renovating and long-term management of the properties. That is my opinion based on my knowledge of the market and the facts.

Setting that little point aside, the best thing we can do as investors is solidify our hold on our piece of the market. Any investor who has been in he business for 30 years has life long relationships and probably a reputation of gold to have that kind of longevity. It's time to make those relationships count! The funds are going to get their piece, but they have no idea how to market to owner occ. sellers and they have no idea how to work with individual agents to help them make double commissions on their listings and they have no idea how to improve their contracts beyond competing on price.

So while funds make all markets they enter harder, they cannot make every market impossible to compete in. We just have to rely on our experience and knowledge and in some cases, wait for them to realize how much money they are losing in rehab and management before they leave the market.

Chris

[Corey Dutton]

Chris Clothier VERY well said. Thank you for that.

[Bill Worsley]

I have personally sold multiple units to 3 different hedge fund buyers and I will be very interested to see how it works out for them. As a very active lender prior to 08, we had our fair share of REO's (one day I will write an article of lessons learned in the crash of 08 - another story), and made decision that now was time to sell, thus giving me some experience working with these groups.

The positive for these hedge fund buyer is even in paying "top prices" by today's estimates, compared to what people were paying for rentals in 06-07, they are absolutely stealing properties in terms of acquisition price, putting themselves in position, if properties managed well, to earn returns 13-16% annually on their cash investment.

They are definitely making it challenging for the "main street" investor. As a seller of multiple assets, it was quite honestly a blessing to be able to sell a large number of properties to one buyer, versus selling property off piece meal. In terms of investment of time, combined with fact that their offers were competitive, and the closing process was VERY SIMPLE (often properties bought "as-is" within days of contract), no wonder they are getting a competitive advantage.

Now that said, I think there is going to come a point in the future where we are going to see buyer's remorse on the part of these funds. The returns are attractive, but the fact is, until you have managed a pool of rental assets, something that is historically a main street investment, you have no clue what you are getting into.

So yes, currently these funds are making it difficult for main street investors to pick up rental properties in today's market. However, my money is on there being in the not to distant future another round of properties hitting the market, this time being sold by these funds back to main street investors well positioned to acquire and hold.

[Fred Maul]

Black Stone Group is buying 15,000 homes in Tampa to rent. They are looking at single families from $100k-$170k with under 20 years of use.

I honestly think that the hedge fund manager in OPs posting is an idiot. I doubt any hedge fund could buy all the property out there. They are acting that way to try to get people like him to sell their portfolios.

[Rob K.]

Here's a story about it from CNN Money:

http://money.cnn.com/video/news/2012/09/26/n-private-equity-landlord.cnnmoney/index.html

I don't see this as a threat. A huge company will never be able to keep the low overhead of a private individual. Their higher prices will raise rents accross the board. Eventually, I predict they will get a reputation for lousy service and tenants will prefer to deal directly with the owner.

[Andrew O.]

I brought up the subject with my friend who has been buying at the courthouse steps for 15 years, he said 2 years ago he noticed the hedge funds come in with all their money, made life tough for everyone, running prices up to and above retail etc.

This lasted for around a year, then they did their calculations and realized they were getting 4-5% return on their buy and hold strategy, which for hedge fund investors was not ideal, my friend said since then he hasn't really seen much of them at all at the auctions.

They didn'tt know they're market, they created large swathes of vacancies, which forced them to compete with their own properties and dropped rents, so my friend who has been buying in this market for 15 years, simply stopped buying in those towns until they went away.

We took a drive to see some of the flips we have going and even now he was explaining there are still a few big money guys, who pay retail and have 6 vacancies within a half mile radius, in a town I would not care buy and hold at the moment.

Andrew

[Mark H.]

Originally posted by Rob K:
Here's a story about it from CNN Money:

http://money.cnn.com/video/news/2012/09/26/n-private-equity-landlord.cnnmoney/index.html

I don't see this as a threat. A huge company will never be able to keep the low overhead of a private individual. Their higher prices will raise rents accross the board. Eventually, I predict they will get a reputation for lousy service and tenants will prefer to deal directly with the owner.

I think it will be extremely tempting for these funds to select the "low-cost" suppliers for everything from materials, to service people & call centers. As someone who spent a lot of years in the automotive industry & watched the big three destroy their own reputations with that strategy, I can foresee a huge hairball in the making.

They're going to be looking for large companies to provide service work at a flat fee & they will find companies that will promise the moon and the stars but fall flat on delivery. The property management & contracting business is one that is easy to abuse, you'll need a full-time staff of qualified people to tear up *every* invoice looking for fraud & abuse & a network of field reps to inspect the jobs. Putting reps in the field on the road is expensive, I know, because I used to be one. Even with a network set-up, there's a constant battle against complacency. There will be millions of dollars in repairs & maintenance up for grabs & ripe for the taking & I'd fully expect them to get robbed blind & not even realize it.

It will be fun to watch.

[Karen Margrave]

http://www.ocregister.com/articles/says-370027-market-homes.html

Here, in Orange County, CA, they're buying up properties and renting them out.

[Account Closed]

Corey Dutton No doubt that hedge funds are buying. They pay more so it makes it harder for other investors to get in or to add decently priced inventory to their holdings. But your friend's story doesn't make sense. How does the hedge fund manager plan to put your friend out of business? Your friend owns 400 props, and he probably won't sell them to the hedge fund. Is the hedge fund going undercut rents to try to put your friend out of business?

Hedge funds will pay more to enter and build inventory. But to be "competitive" in the rental market they would have to charge less and provide the same or better service. This would be good news for renters....except it's probably not going to happen.

[Joe Bertolino]

I deal with several in my insurance business. They will buy a bunch, make or lose a lot of money very quickly and then get out. Landlording is very hard and they are not structured to deal with it or patient enough to get rich slowly. As another poster said... They will realize they are making 8% while their investors are demanding more so they will eventually get bored and/or find quicker profits elsewhere. A local investor will always have an advantage that out of area investors do not. These folks are great targets if you want to dump underperforming properties. I had one client dump serveral hotels in SF to a NY based group that didn't fully understand the difference between Union Square and the Tenderloin. It is only a few blocks away but it might as well be a different city.