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.

[Steve Cook]

Marc:

As Brian, Chris and others on this thread have pointed out, funds are going about acquisition in different ways but the goal, as you say, is to accumulate large numbers in their portfolios.

From all reports, they are most active in the "sand states" that accounted for a lion's share of foreclosures until just a couple of years ago. Today, however foreclosure inventories and foreclosure discounts are growing in judicial state markets like Philadelphia, Cleveland, Baltimore, Chicago. It will be interesting to see if they follow the foreclosures to the Midwest and Northeast.

[Steve Cook]

Here's the story that NPR's Marketplace did on hedge funds and first=time buyers...
http://www.marketplace.org/topics/economy/hedge-funds-crowd-first-time-buyers-out-housing-market

[Jon Klaus]

Linked http://www.marketplace.org/topics/economy/hedge-funds-crowd-first-time-buyers-out-housing-market

[Jason Lipovsky]

Just a couple of thoughts... great post!

I heard the FNMA pilot program sold their assets at 100% of market value with multiple bidders.

Any backlog of foreclosures and homes with negative equity will be gone in the next 24 months. With the supply shortages and the fierce bidding to acquire assets we have realized huge price gains this year. As prices increase, many troubled properties will no longer be underwater. Existing notes will be modified. In the end inflation will fix our nation’s housing crisis.

[Xing Zhu]

Hedge funds are mostly uninformed. Most of the fund managers have little knowledge of investments. It is the unfair way they take fees from their investors that makes them money.

If you have time and professional skills in real estate, you may also raise money to form your own hedge fund. You should be able to beat most funds easily.

[Bryan Hancock]

Originally posted by Brian Burke:
It is also true that these groups are starting to obtain large allocations of debt financing. It's not because they are trying to stay in the game, it was the plan all along to employ leverage once it became available. There are a few banks coming online with product to accommodate this model.

Well that sounds like a recipe for disaster! Chasing cheaper debt dollars to hit their hoped-for returns is scary to me. Do you have any idea how their capital was structured and what they promised their investors?

[Tiger M.]

I'm not seeing debt used here in Vegas, it is all cash. One group is sending a >$100,000,000.00 verification of funds with each offer.

[Xing Zhu]

(1) Unlike developers, most funds don't need money from banks. They have cash from investors.

(2) Yes! some of them just want to grow large enough to become public. As long as houses are still undervalued based on their pricing models, they just buy, regardless the rental return. This is the same way they buy growth stocks, which do not generate dividend income.

(3) I am not worried about their unloading. Of course, one day they may start doing it. But they cannot unload all overnight. There will be enough public information for us. Big funds are the ones who should worry about liquidity collapse. Small investors can always choose to get out first.

[Brian Burke]

Bryan Hancock, I don't have the specifics of the deal structure (and they are all different), but what I have seen, and heard from the fund managers, is a structure where the capital source is paid a preferred return and a split of the profits after the allocation of the pref. It seems that they are in the 5-7% range on the pref. When this opportunity first became apparent, they were assuming this to be a 30's IRR model, but after seeing reality, many of them are now underwriting to a high-teens model. I'd be surprised if they get that, given that they are paying full market value (or more) and the first 10% of market move just barely covers their exit costs.

Tiger M., they aren't levering on the buy. They are amassing a portfolio then many of them will do (or have done) a take-out. They will then use the debt funds to either buy more property, or return capital to their capital source. Returning capital that costs them a 5 or 6% pref with debt at 4 or 5% does make sense.

I was talking with a large bank not long ago seeking such a take out for my portfolio. They were looking to place a minimum of $25 million but would really prefer higher, in the neighborhood of $100 million. It didn't work for me, my portfolio was too small, but it is a clear indicator of the direction that large banks and life insurance companies are headed. They like the model, and availability of debt elevates the enthusiasm in the investment world. That explains some of the crazy buying.

[Chris Martin]

It would be nice to see some transparency. There are no SEC filings to even have a hint as to what they are doing. So part of me says this enthusiasm is with low $... just testing the waters. Och-Ziff was supposed to be a big player. But SEC filings don't confirm this. In the last few years, Och-Ziff Real Estate Parallel Fund II A, L.P. raised $50.5M per SEC filings. Och-Ziff Real Estate Parallel Fund II B, L.P. raised $9.5M per SEC filings (and paid $1.5M finders fee).... but are these the players? The numbers are too small.

Anyway... maybe the effect is to get people excited to the possibility. I don't know.