Investors Buy Delinquent Mortgages to Get Cheap Properties

<Promo Codep>Real Estate

With home prices rising, big real estate investors have discovered another source of cheap property: bad mortgages. , the second-largest single-family landlord after , Barry Sternlicht's Starwood Waypoint Residential Trust, and are stepping up acquisitions of nonperforming loans, or NPLs, to expand their holdings of homes to operate as rental properties.

Hedge funds, private equity firms, and real estate investment trusts, which have raised more than $20 billion to purchase rental homes, are buying mortgages as banks face new regulations that make it more expensive to hold soured loans. The Department of Housing and Urban Development is also auctioning loans to stem losses at the financially troubled Federal Housing Administration.

The shift to buying loans comes after the pace of foreclosures slowed and house prices jumped in Atlanta, Phoenix, and other hard-hit markets where investors have made the most purchases. Average home prices in Phoenix have risen 44 percent since hitting bottom in September 2011, according to the S&P/Case-Shiller Home Price Indices. Atlanta prices are up 37 percent since March 2012. Paying more for homes makes it harder for landlords to make money from rentals. "Our NPL acquisition strategy will continue to give us access to properties and healthy markets nationwide," Altisource Chairman William Erbey said on a Feb. 20 call with investors. The company bought 13,000 delinquent loans last year.

The large-scale loan purchases raise concern among housing advocates that residents may be displaced or transformed into renters of their former houses, according to Kevin Stein, associate director of the California Reinvestment Coalition, a San Francisco-based tenant and consumer advocacy group. "They should be modifying those loans to keep the homeowner in there, but it runs counter to their business model," Stein says. "They shouldn't be in the business of buying distressed loans for the purpose of foreclosing on people."

Douglas Brien, co-chief executive officer of Starwood Waypoint, says his company plans to give delinquent residents a chance to stay put as owners or renters. "Our intent is to approach some of these folks where it just doesn't look like they're going to get caught up on their loans," he says. The company can "offer them the opportunities to stay in their homes and keep their kids in the same school."

Starwood Waypoint and its predecessor companies have paid $220 million for 1,736 nonperforming loans since 2012, according to a January presentation to investors. That's about $127,000 per distressed loan, compared with $140,000 per rental home.

Brien estimates that 30 percent to 50 percent of the NPLs will end up as rentals for the company. In other cases the borrowers will resume paying the loans after a modification, or Starwood Waypoint will sell the homes because the location or quality doesn't match its investment criteria. "We're always going to take the outcome that's most economically beneficial," he says.

About $34.7 billion in nonperforming mortgages were sold last year, up from $13.1 billion in 2012, says William David Tobin, principal of Mission Capital, a real estate loan broker. Altisource CEO Ashish Pandey predicts that more than $40 billion may be sold this year.

Homes acquired through NPLs have often gone years without maintenance as the owners struggled to pay their debts, adding to renovation costs for investors who take them over. Loans on homes subject to foreclosure filings in December were an average 920 days delinquent, up from 255 days late in January 2008, according to data provider Black Knight Financial Services. That makes them too much trouble for investors like Jon Daurio, a co-founder of Kondaur Capital, which started buying delinquent loans in 2007. "The longer the borrower is in a house that's nonperforming, the amount of deferred maintenance just grows and grows and grows," says Daurio, who left Kondaur in 2011. "For me, it's too risky."