Buying Up Foreclosed Single-Family Homes - Smart?

The Wall Street Journal “Plying the Foreclosure Market” reports that small real estate investment bank Silver Portal Capital LLC is 75% toward raising $150M to purchase 1500 distressed single family homes in the San Diego area. Managing principal Burl East has been soliciting pension fund advisors and opportunity funds. Housing prices have dropped 25% year over year in the San Diego market, so it’s difficult know if it’s the right entry point.

Silver Portal is looking for more modest properties by California standards - properties that had a peak value of no more than $600K and have lost at least 50% of their peak value. They are using the "Starbucks test" to determine the desirability of neighborhoods. A Starbucks within a five minute drive indicates civilization. But they also look at the character of the neighborhood surrounding the potential purchase. This appears to be a highly labor intensive procurement process.

Silver Portal is allocating $25K to maintain each house for five years. Most houses will need at least $5K in cosmetic repairs before they can be occupied. Ongoing maintenance, tenant acquisition and insurance will be expensive because of the discrete location of each unit. This is why institutional investors have long favored large apartment complexes.

Investors are targeting a five year wait to profit from appreciation. Silver Portal might learn a few things from mom and pop professional landlords. Professional landlords never count on appreciation to bail them out; properties must be cash flow positive from the start. It appears to me that Silver Portal will be running cash flow negative.

Let’s do the math. Silver Portal is targeting tenants earning $68K per year, which leaves about $1900 a month available for rent. Rent should not exceed one third of the tenant’s income. I am assuming at least $6000/year in taxes, $5000/year in maintenance, $3000/year insurance and $16,000/year in financing cost. The financing is based on $150M in capital divided by 1500 homes giving a $100K down payment per $300K home. Financing cost is based on a generous 8% interest rate on a $200K balance per home.

On an annualized per home basis, costs will run $30,000 and rent will provide less than $23,000 for a loss of at least $7,000 per year. If everything goes according to plan, Silver Portal will lose about $580 per month per home. The loss calculation doesn’t even include vacancy periods.

I don’t believe housing values will return to their peak within five years because lending standards have forever changed, and the cost of operating a single family home has increased sharply. If the value of the homes purchased does actually double in five years, it implies a 12% annual return before expenses. Not worth the risk.

Comments

[mkreisel:]

It's only a matter of time before pension funds start scooping up REOs.

Chinese and Japanese are also clamoring for those master planned REOs. 3000 sqft single family homes in California are now MUCH MUCH cheaper than 1000 sqft 2 bed room condos in Shanghai where you can never see the sun.

2008 Aug 07 03:12 AM

[RobertsJim:]

If Silver Portal can acquire houses the average cost of which is $150K renting them for $1900/month, then they'll do well especially since their ownership costs are forecast at unreasonably high levels.

I'd say Silver Portal's biggest problem will be finding enough good renters.

2008 Aug 07 09:09 AM

[neeb??:]

And there is the rub. The same random population that got into these weird drug trip mortgages are being looked for by Silver Portal to 'rent' these homes? Cosmetic repairs? After these places sat for how long?
Naaahh! can't see it !!

2008 Aug 07 09:32 AM

[notsosmart:]

the lack of ethics & responsibility is also a factor in the rental market. i think these people will lose their shirt.

2008 Aug 07 10:12 AM

[xsuddensam:]

They could easily make this work my massaging the numbers using low interest teaser rate ARMs. I'm sure there's got be some creative crooks on Wall Street that could accomodate this plan.

2008 Aug 07 10:22 AM

[CLH:]

More power to anyone who knows how to buy on the cheap. Most people would rather buy at the top. Real estate in 2006 and 2007 and now commodities and gold at the top. Its easy to make money --go against the crowd.

2008 Aug 07 11:05 AM

[mouth:]

The quality of the renters will be the determing factor on success

2008 Aug 07 01:57 PM

[jjason:]

This idea will be a money looser. It is too risky and there are too many unknowns.

2008 Aug 08 08:07 AM

[mrresponsible:]

Won't work! Been in the rental business for over 35 years and have rented many single family homes. Real estate is not finished going down and another 10 percent drop has to be factored into the formula. There are only a few renters with any credit and the renters without good credit, largely, will destroy the houses.

2008 Aug 09 05:31 AM