Uncertainty in REO Rental Programs - What does it mean?

REO Rental ProgramsWe have mentioned previously that some markets are rapidly improving in California and that the cause is a lack of inventory. This lack of inventory has been caused by a dramatic decline in the number of REO properties available.

The big banks have stopped foreclosing, thus pulling millions of REO homes off the market. Many of these delinquent homes are turning to short sales or REO Rental programs. In the first scenario, banks work a deal with the borrower to sell the home, short of the outstanding loan balance. In the second, banks take homes back and then rent them to the former borrower or another tenant.

Back in March we wrote about the first REO rental program by a big bank, Bank of America. We could foresee the large hurdles that would be coming to these banks to make such programs successful.

One of the things most folks neglected to consider was how the REO rental programs could and would be financed. This presents one of the largest hurdles. Banks finance the purchase of homes by securitizing large pools of loans; this means they lump millions of loans together to create pools with 100s of millions or billions of dollars. Then they chop them up into smaller pieces and sell them to individual investors and other banks.

The securitization of loans is relatively easy with standard mortgages. They can pool loans with similar rates, risk profiles, and terms together that all act similarly as a large pool. They can predict the return, the expected pay off and the expected delinquency rate.

However, when it comes to financing REO rental programs, the securitization is dramatically more difficult and complicated. This is because with REO rental programs, none of the loans behave the same, so they are much more difficult to predict and pool together. The reasons are plentiful but the biggest are varying time lines and varying acquisition and operating expenses.

No one really knows how long it takes to move a property from delinquent to REO. This article points out that two well respected organizations, the California Association of Realtors (CAR) and CoreLogic, came up with very different answers when asked “how long does it take to move an REO?”

CAR came up with a 60 day time frame, which I know from experience is WAY too short. CoreLogic, a market research firm owned by Lawyers Title, came up with 6 months or about 180 days, which is probably closer to being accurate. If banks cannot determine how long it takes to become an REO, it’s also nearly impossible to determine the costs of acquiring and the time line it would fall into for an investor. This makes it very difficult to package loans and sell them to investors.

The other is a cost to acquire issue. These homes are “purchased” sight unseen and need various different repairs. Some REOs are in relatively good condition and only require several hundred to a few thousand to rehab prior to renting. On the other hand, some REOs are in very rough shape and require 10s of thousands to rehab. These costs vary dramatically, especially when compared to standard mortgages that are securitized (most mortgage originations have the same costs).

As we have said time and time again, the banks will be the largest players in what happens to the housing market. If they are unable to get their hands around securitizing these REO rental homes, they will be unable to sell them to investors and therefore unable to finance future acquisition of more REO rental homes and the operation of the existing ones.

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Source: http://www.housingwire.com/rewired/reo-rental-exposes-uneven-timelines-securitization-path
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