In Real Estate Investing 101, Part I we covered buying a house to resell for a short term profit, while minimizing risk and making it happen fast. We delved further into flipping in Real Estate Investing 201. In Real Estate Investing 101, Part II we covered buying and holding property for long term appreciation and wealth building. We also touched on class shifting to increase value. Real Estate Investing 202 continued on the Buy and Hold theme and offered deeper insight into making it profitable. In Real Estate Investing 203, we looked at shifting property classes for highest and best use, while increasing property value and return. Each of these articles is available on Ezines.
This time, we are going to look at investing from a different perspective. The previous articles have been about buying property "wholesale" and selling it "retail". But, there is another way to buy property that may be more efficient as well as more profitable.
Want to make $50,000,000?
Invest in REO Bulk Portfolios. The problem is that this is out of reach for the VAST majority of real estate investors. It requires a huge commitment of time, energy, and (most importantly) cash. For a $50M profit, one should expect to spend a little more than $100M. But, the result can be a fairly passive profit in the 40%-50% range within 6 months to a year.
Decoding the alphabet soup
REO is industry jargon for Real Estate Owned. This is property that has be foreclosed and repossessed by mortgage lenders. Some lenders retail the property through traditional channels. They hire real estate agents to market the properties along side any other area property. The lenders usually have a few more hoops for buyers to jump through, and often aren't in the best of condition. These are the foreclosed properties mentioned in the earlier articles.
Bulk REO portfolios are simply large groups of properties that the mortgage lender doesn't want to take the time to market. By gathering these properties together, they are able to dispose of them more efficiently. Since they often need to sell them quickly because of banking regulations, they price them to move. They can be priced any where from 40% to 70% of BPO or LTV. Of these, pricing relative to BPO is much preferred.
BPO is Broker Price Opinion. It is similar to an appraisal, but much simpler and less expensive. It is also like a CMA or Comparative Market Analysis that your local real estate agent might provide when you are looking at buying or selling a home. Contrary to the name, a BPO may be issued by a real estate agent that isn't licensed as a broker. When dealing with REO bulk portfolios, some sellers might not actually hire a broker or agent to do the opinion. In cases where the properties are new (builder loan defaults and other similar situations), they may rely on online valuations. This is rare, though. The bottom line is that is the property carries a BPO of $200,000, and is being sold at 50% in the package, it is costing the buyer $100,000. The BPO also takes into account the current condition of the property, including repairs it may have needed at the time the BPO was issued.
LTV stands for Loan To Value. In this case, if the property originally sold for $100,000, and the buyer put $5,000 down, the LTV would be 95%. So, in theory, if the property is being sold at 50% LTV, and the buyer is paying $100,000 for it, the bank loan was about $200,000. The problem is that we don't actually know what the property might be worth. On one extreme, the defaulting owner may have put 20% down. Sticking with our $200,000 house, this means that they put up $40,000, and the bank was on the hook for $160,000. At 50% LTV, the bulk buyer would be paying $80,000 for the property. At the other end of the scale, the buyer might have put nothing down, and they might have overpaid for the property. With the current real estate climate, there is a possibility that the property devalued. Further, when people aren't able to make their house payment, maintenance and repairs are often deferred. So, we might be talking about a property that was purchased at $200,000 with a 100% loan, but now is only worth $150,000. Buying it at $100,000 (50% off of LTV) still would yield a profit, but not as much as buying at 50% BPO, which would be $75,000. The biggest problem with buying based on LTV is predictability. We don't have as much of an idea about the retail value of the property in its current condition.
Now for more of the basics
As previously mentioned, these are portfolios, and are purchased in bulk. Calling up the local bank will not get you a 50% deal on property. Bulk REO portfolios are usually offered in packages starting around $50,000,000. Most are sold in packages priced at $100M to $500M per transaction. Some packages are $1B or more. There are a few consolidators that will sell smaller packages, but they are generally marked up as they are broken up. And, because these are broken up from bigger packages, it is more difficult to specify property types. Even the smaller packages generally start around $10M.
With the more traditional packages, priced at or above $100M, the buyer is able to custom order the properties. The buyer can request only properties within a certain geographic area, price range, and type (single family, attached, commercial, etc.). Keep in mind that we are talking about a LOT of property. Even with a valuation of $300,000 each, at 50% ($150,000), there would be over 650 properties in a $100M bulk portfolio. Finding all of the properties to fit the order would normally take a few counties, at least.
When the order is placed, the compiler puts a package together. The package may be from a single institution, or from multiple institutions. In order to place an order, the buyer fills out an order form, provides a Letter of Intent (LoI), and completes a Non-Circumvent, Non-Disclosure Agreement (NCND). They also must get the information ready for their Proof of Funds (PoF) letter that will be required by the selling financial institution.
A Letter of Intent may also include the order information. However, primarily the LoI is just a document that states that the buyer wishes to purchase a bulk REO package. It may also outline what types of properties the buyers wishes to buy, otherwise that info will need to be provided on the order form.
In order to maintain the security of the involved brokers and principals, a Non-Circumvent, Non-Disclosure Agreement is entered into by all of the parties. The NCND keeps the buyer's broker, the seller's broker and the principals from disclosing sensitive information to outside parties, as well as keeping them from going around anyone involved in the agreement to complete future sales.
A PoF letter is exactly that proof of funds. These transactions are seldom done with mortgages in any recognizable format. We will go into why this is the case in just a moment, but for now we will just say that the sales are done through a wire transfer. In effect, the sale is a cash sale. The property is sold without encumbrances, and with a clear title.
After the compiler gets the order together, there is a short period, generally about 48 hours, during which the buyer can reject specific properties from the package. At the beginning of the period, the buyer puts up a deposit (like earnest money) that is generally 10% - 15% of the package purchase price. With the completed list of properties in hand, the 48 hour countdown to reject properties begins. They have seven days to complete ALL due diligence. After seven days from the delivery of the order, the deposit goes hard. In other words, it is no longer refundable. The transaction is generally closed about 15 days from the delivery of the order to the buyer.
Since these deals go from beginning to end in 15 days or so, there is simply not enough time for a bank to go through the steps they would need to finance the property purchase based on using the property as security. However, after closing the transaction, it may be possible to get a package loan on 60% - 80% of the cost of the properties. However, this will complicate the disposal transactions and decrease profits. So, at closing the buyers need to have their funding in place, and it needs to not be dependant on the property.
Strategies for selling hundreds of properties
For most buyers, holding the properties isn't the option that they are looking for. Turning the properties is the goal. Generally, there are a few different strategies that sellers use to dispose of the properties. These depend on both the properties and the type of buyers.
Wholesale sellers sell to other investors at a discount from BPO. This allows them to minimize further expenditure, while maximizing return for less than optimal properties. The properties can often be moved fairly quickly. One drawback is that more expensive properties are more difficult to sell. Most retail investors are competing for the lower end of the market.
Retail sellers spread their properties around to real estate agents to list. These are often asset management companies and other similar business entities. These may be the properties that one sees listed as "corporate owned" in the MLS. In many markets, this can bring the maximum return, but is really only viable for the best of the properties. And, it may take a long time.
Properties that don't move through the other methods generally end up in auction. The biggest problem is that by the time get to auction; they have been left sitting for many months or even more than a year. Most properties will have degraded further from sitting disused. Even if they haven't grown mold or been trashed by squatters, they have cost money to carry. That may be directly if a loan was obtained to pull cash back out of the property, or indirectly through lost opportunity costs.
So, how should we get rid of the properties?
I would recommend a combination of the accepted methods, but with a twist. A good real estate agent will know which properties are likely to sell without much hassle. This agent should also be able to give pricing scenarios that minimize market time, while preserving at much margin as possible. So, feed this agent the cream of the properties, and price them aggressively to sell quickly.
For the properties that aren't going to sell at retail, mix them between wholesale and auction strategies. Surprisingly, auctions often deliver better prices for the seller, but if there are too many properties sold at once, the market is diluted. The same holds true for the properties that are to be sold wholesale to investors.
Finally, properties that aren't likely to sell well through the traditional channels might be best disposed of through selling at very deep discounts to contractors or other vendors. These super deals can really help to curry favor and move your other projects to the top of the scheduling heap, as well as provide leverage for pricing discounts.
Innovative strategies for smaller investors
Because of the financial resources required to complete one of these deals, they are generally restricted to only the highest level of individual investors, as well as institutional investors. Actually completing the transaction, from start to finish would normally take a bare minimum of $12M - $13M. In addition to the $10M for the property, there would need to be a reserve for improvements, taxes, commissions and other transaction expenses. Almost all of this needed to be effectively in cash (ok, not in cash, but in available capital. For a $100M bulk REO purchase, one might expect to spend an additional $10M.
By turning around the property disposal and beginning by auctioning off some of the properties that aren't cherry picked off of the top, additional cash is generated. This should reduce the additional capital requirement. Basically, it would fund the later stages of the transaction, as well as spin off cash to begin to pay back the investor, or investors.
A great strategy for smaller investors would be to form a group (I'm not a lawyer or accountant, so I can't go into structure such as LLC, Corp, or partnership, etc.). Instead of focusing on ownership of individual properties, the investment could be treated as more of a passive investment. Hire a good real estate professional, or have a major partner responsible to run the day-to-day operations of the properties. Aside from the marketing for the properties to be sold retail or wholesale, and any renovations that are needed for any of the properties, there isn't much management that needs to be done. There will need to be marketing for the auctioned properties as well, but if those are disposed of early in the transaction, that need will be minimized.
While there may be increased expenses from purchasing in smaller quantities, part of that may be offset by being able to sell at higher prices. When selling 50 to 100 properties, there are many more options than there are when selling 500 to 1000 properties. When looking to dispose of 750 (nominal number) properties, more will have to be auctioned and wholesaled simply to make the remainder logistically possible. Aside from renovation resources (time, money and contractors), marketing and selling properties can be expensive for a real estate agent. Hitting one with 300 properties might be counter productive. However, having too many agents can make logistics more difficult, as well as increase overall marketing costs because of duplicate efforts.
Building a relationship with the Bulk REO Portfolio sellers, by doing regular transactions (perhaps quarterly, or even monthly if properties can be sold quickly enough) will often allow for leverage on brokerage fees. Another advantage of working regularly with the same REO sellers is that they may be able to bundle small orders with larger orders to lower the price in relation to REO. For $10M packages, many compilers are looking to sell at 60% or even a little more. As the order size grows, the price may come down to 50% for $100M deals, and even as low as 45% for $1B packages. If a $10M order gets bundled to a $100M order, the smaller order might get filled at 55%. That extra 5% discount can translate to $500,000.
Research. Plan. Prepare. Remember the old adage that it takes money to make money. This holds true in buying Bulk REO Portfolios as well. This time it means it takes a LOT of money... to make a LOT of money. Also, understand your own market and your own limitations.
