Big Builders Scoop Up Big Bucks With Foreclosures

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Homebuilder Beazer Homes (NYSE: BZH  ) is starting to look up recently, after experiencing a rather disappointing year. Its revenue stream has certainly opened up, increasing 73% and 52% for Q1 and Q2. Now it's exploring a new endeavor to bolster profits even more: buying foreclosures that it fixes up and then rents.

Beazer has recently teamed up with Kohlberg Kravis Roberts (NYSE: KKR  ) to create a new real estate investment trust called Beazer Pre-Owned Rental Homes. Currently, the trust features 200 single-family houses that Beazer has been accumulating in the Phoenix and Las Vegas areas for the past year or so. According to The Wall Street Journal, about 10% of these homes had originally been built by Beazer and were purchased cheaply as either foreclosures or short sales.

Large homebuilders are prime candidates for this sort of investment, since they have lots of cash on hand and can do the renovation work themselves. Lennar (NYSE: LEN  ) , one of the nation's biggest homebuilders, has purchased approximately 300 houses through its financing arm, Rialto Capital Management, and Toll Brothers (NYSE: TOL  ) has been in the foreclosed-property game for nearly two years, after creating its Gibraltar Capital and Asset Management division. The subsidiary has been busy acquiring properties since then, although, unlike Lennar's Rialto unit, Gibraltar also invests in commercial property and other assets.

Homebuilders aren't the only players in this lucrative game. Other big investors have also been scarfing up distressed properties for a deep discount and then renovating and putting them on the rental market. New York hedge fund Och-Ziff Capital Management Group (NYSE: OZM  ) , has partnered with McKinley Capital Partners to purchase hundreds of homes in California over the past few years. The houses are being rented, but the partners expect to sell the homes eventually, once the market rebounds.

Participation in this investment scheme may have just have gotten a bit easier. Fannie Mae's recent decision to package and sell foreclosed properties in bulk to well-financed investors is attracting some of these big names, such as Rialto. Though interested, Lennar's CEO noted that caution was the order of the day, since determining costs would be problematic with such large pools of properties. Fannie offered 2,500 renter-occupied homes in the April round, with strict requirements for participation and rigid parameters, such as the provision that the entire bundle must be purchased and then rented for a specific number of years.

Fool's take
The results of the government's property auction won't be known for some time, but chances are good that at least some of the foregoing companies threw their hats in the auction ring. Big investors, particularly homebuilders, see the profit not only from renting these formerly distressed homes but also from eventually selling them when the market improves. I can certainly see these investments making money over the next several years.

Will these types of investments help the housing market to recover more quickly? I believe they will. Though some critics think it's unfair for Fannie to sell these properties to big money, small investors simply wouldn't be able to market these homes quickly enough to make it worthwhile. Cleaning up the foreclosure mess is central to healing the housing market, and here's an example, for once, where throwing money at a problem really does help.

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Fool contributor Amanda Alix owns no shares in the companies mentioned above. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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  • Report this Comment On June 01, 2012, at 10:06 PM, MHedgeFundTrader wrote:

    The March Case Shiller Home Price Index is out, showing that the fall in home prices continues unabated, paring -2.6% on a YOY basis. Detroit delivered the biggest drop, down a shocking -4.4%, followed by Chicago (-2.5%), and Atlanta (-0.9%). But 14 out of 20 markets managed increases in prices. The national index is still declining, but at a slower rate. Given that this indicator lags real time by about three months, is there something going on in housing that we should be anticipating?

    Don’t get your hopes up and rush out and place a deposit on a new home. I think that the strength that we are seeing may be only a short term anomaly of the marketplace. So much hedge fund and private equity money poured into the foreclosure market recently that we suddenly ran out of inventory. Up to 60% of recent home sales have been in the foreclosure area. This explains the sudden pop in the average cost of homes sold.

    These funds have set up local management companies to rent out properties and are soaking up 1,000 homes at a throw, looking to sit on them for a decade until the demographic headwind turns to a tailwind. They are encouraged by negative real interest rates, the 30 year mortgage now plumbing an unbelievable 60 year low of 3.75% that made this investment a no brainer for the patient and deep pocketed. The goal is to eventually securitize these holdings and sell them for a premium.

    We are not by any means out of the woods. Pending home sales plunged by 5.5% in April, and March was revised down sharply. The west showed the steepest decline, down 12%. The banks also have a seemingly limitless ability to produce new foreclose inventory.

    The demographic headwind is still at gale force strength, as 80 million baby boomers try to sell houses to 65 million Gen Xer’s who earn half as much money. Don’t plan on selling your home to your kids, especially if they are still living rent free in the basement. There are six million homes currently late on their payments, in default, or in foreclosure, and an additional shadow inventory of 15 million units. Access to credit is still severely impaired to everyone, except, you guessed it, the 1%. Many deals fall out of escrow at the last minute over appraisal issues which fail to meet the banks’ new, more demanding requirements.

    I think the best case that can be made for housing here is that we may finally be coming into an uneasy balance that sets up a bottom for prices which we will bounce along for five to ten more years. This has been made possible by the arrival of an entire new class of buyers, the opportunistic hedge funds.

    The Mad Hedge Fund Trader

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