These states had the most new foreclosures in February 2009, according to RealtyTrac.
Moody's projects as many as 5 million foreclosures over the next few years, with John Burns Real Estate Consulting forecasting 2.9 million foreclosures this year, 3.3 million next year, and as many as 10 million additional foreclosures through 2014. Whichever is correct, foreclosures will continue to dominate a number of the largest markets, putting pressure on new-home pricing and sales.
Tim Sullivan, president of Sullivan Group Real Estate Advisors, says there is a window of opportunity beginning to open. “Prices have eroded in certain markets to offer deals significantly below replacement cost. The key is to find assets within the markets with the best opportunity for ‘reboundability.'”
Sullivan is working with a number of private equity firms and builders looking at the space, particularly in California, and sees this as a significant play for investors. “On a risk-adjusted basis, if investors can acquire REO homes and generate current cash flow and a 15 percent-plus unlevered internal rate of return over a four- to five-year hold, that's a compelling opportunity.”
While the REO market has traditionally been dominated by individual investors and smaller operators, builders are uniquely positioned to accomplish the one thing that has eluded these investors and that the bigger private equity players want to see before committing significant capital to this space—scalability.
Signature Properties, a private builder in the San Francisco Bay Area, is focusing its strategy on the 70 communities it has built over the past 25 years. Said Signature president Mike Ghielmetti, “With every community we've built, we still have many of the original project managers, sales managers, and crews that were involved, which gives us a significant competitive advantage in identifying the best opportunities, managing the rental of those homes for a period of time, and selling once the market recovers.”
Signature has begun buying homes and intends to partner with a larger capital source as it begins to achieve scale. “We look forward to building again when the market returns, but over the next two to three years, we see this as a solid investment opportunity.”
Paul Staley of Staley & MacArthur, who acquired and remodeled distressed homes in the late 1990s with Fortress and the Bay Area Smart Growth Fund and has recently re-entered the business, agrees that home builders are well positioned to pursue the strategy.
“Whether it's the initial repairs to the home, the marketing and lease-up, or the ongoing customer care, you need to have the right infrastructure and systems in place to manage REOs effectively. The builders have these systems in place and have a significant competitive advantage over the individual investors and even syndicates who acquire these in bulk.” Staley and his partner, Ron MacArthur, have raised capital to acquire 30 to 40 homes in the Bay Area and are looking to build out the infrastructure to buy throughout California once the broader market begins to stabilize.
While builders and investors will proceed cautiously as they pursue the REO opportunity given continuing market volatility, this strategy may shape up to be one of the most interesting in 2009.
Laurence Pelosi is managing member of McKinley Partners, a real estate investment and advisory firm. He may be reached via e-mail at firstname.lastname@example.org.
Learn more about markets featured in this article: San Francisco, CA.