This week Bruce Norris is joined by Rick Sharga. Rick is the executive vice-president at Carrington Mortgage Holdings, LLC. He is one of the nation’s most frequently quoted sources on foreclosure, mortgage, and real estate trends. He has appeared on NBC Nightly News, CNN, CBS, NBC, and just about every possible outlook. Rick is also a member of the board of directors of REO Max and president of the Technology Counsel of Southern California.
Bruce said Rick has changed hats since he last spoke with him and has begun work with Carrington. As the vice president, Rick said there is plenty to do. It is a 2,000+ person company that in a lot of ways is still in growth mode. The oldest part of the company there that is still part of the family really was only founded in 2003. There is no shortage of things to do, but candidly he is doing a lot of similar work he used to do when he was over at Realty Trac. He tries to make the Carrington brand name a little better known in the various markets in which they serve. Bruce wondered what they do at Carrington and what they would be putting themselves in front of that would be different from Realty Trac. Rick said it is a very different company.
The company was started through a hedge fund back in 2003. It was started by Bruce Rose, a gentleman who came out of Saloman Smith Barney, who started investing in mortgage-backed securities. A lot of mortgage-backed securities at the company were built on sub-prime loans. When the market started to go sideways, Bruce decided they really needed to do something to be able to take over servicing of the loans that were in those pools in order to manage their disposition. They bought the mortgage servicing business from New Centuries’ bankruptcy in 2007, and since then they have started ancillary business units to support the investment and servicing operations. They created Carrington Property Services to manage the assets, and they created White Van Real Estate Services to do property preservation field services. They also have a real estate brokerage called Atlantic and Pacific Real Estate that manages the sales transactions of properties. They also created a mortgage lending business called Carrington Home Loans that actually originates mortgages as well as a title and escrow company. They are really involved in virtually every aspect of the single-family real estate business, ranging from investing in pools of loans all the way through writing title on an individual property.
In regards to purchasing loans in bulk, Bruce wondered if this is still a main stay. Rick said this is the case and that the market is finally starting to open up a little. Bruce knew there was a dry spell, but he did not know how extensive it was. Both Rick and Bruce anticipated they would see larger pools of loans being sold off earlier in this downturn than they actually have. Rick said they have purchased two pools of loans from large lenders, somewhere in the $150-$250 million range in the last few months. These are all nonperforming loans that they then tried to modify using their servicing organization. They had a pretty good track record of loan modifications, so it is an absolute important part of their business.
Bruce wondered what the concentration of the location would be for the loans, whether it would be the East Coast or the West Coast. Rick said they are still looking at the hardest hit states and will probably skew more towards the Southwest and the Southeast. Occasionally they will see some business in Texas or Illinois, but mostly it will be in the Southwest and Southeast.
Foreclosure laws are different everywhere, so Bruce wondered if this really makes a challenge trying to get ownership of the property. In California, the rules change almost every quarter, so Bruce wondered if this is going on everywhere. Rick said unfortunately yes. He was talking with someone in the servicing business earlier, and he did not realize there are 45 separate state programs that are only oriented towards working with distressed borrowers that as a servicer you have to be aware of and potentially plugged into in order to help the borrowers avail themselves of state funds to get out of trouble. Florida is still a huge mess; it is a judicial foreclosure state that takes over 750 days to do a foreclosure. New York still has the distinction of having the longest foreclosure cycle at 1100+ days from the time the borrower receives the notice of default through the date the short sale takes place. It does vary greatly for obvious reasons. If you are a company like Rick’s, you try to avoid states like Florida, New York, and New Jersey, which are just backlogged and very difficult to get through the process. The reality is they are trying to modify more loans than they foreclose on, but even doing that becomes problematic in those states. Forget about the law changes and the regulatory changes. Borrowers really don’t have a lot of motivation to modify their loans in those states because they have not paid anything in a while. They do get used to this, and it is probably easy to get used to.
Bruce wondered when they are buying pools, are they in a competitive bid situation or a relationship-oriented offer. Typically there are competitive bidders involved; and very often when they do not secure pools, it is because someone overvalued it and is overbidding for those assets. The number of bidders is typically fairly limited. One of the aspects that is relationship oriented is the more intelligent lenders will take a look at what will happen to their borrowers if they release the assets to an investor. To a certain extent they would much prefer to work with a company like Rick’s since they will take good care of their borrowers and come up with better resolutions.
There are other investors Rick categorizes as churn and burn guys who really are trying to rapidly move into foreclosure, evict the borrowers, and flip the properties for some short-term profit. This not only is not good for the borrowers, but it is not good for the local housing market either. It is because you are selling these properties at a pretty significant discount at a time when the market really does not need much more of that. Bruce said he wishes they were selling at a significant discount. There is a lot of new money that has shown up that seems bent on paying full price and still writing a check for it with all cash. Rick said they raised $450 million at the company with their partner, Oak Tree, to go out and buy vacant REO properties and convert them into rentals.
Rick said Bruce really sets the bar for how to handle things like this in a local market, so to a certain extent there is institutional money coming into the market to compete with individual investors like himself. The reality is we are walking away from most opportunities to purchase right now because the numbers have gotten silly. They see people coming in and paying full value or over value on a property just so they can get into this part of the market, and this is not a terribly intelligent strategy and focused more on short-term than on long term opportunities.
It seems to be they have had the same dream that the best avenue for wealth is to own real estate in Riverside. Rick laughingly said it is not just in Riverside, but they saw Bruce get rich so fast they figured that was the best place to go. Bruce said they think there is nothing else to do with their money, and he wondered if this will change and their attention will be withdrawn from residential real estate just as fast as it showed up. Rick said they are concerned about the nature of the investors getting involved for the reason Bruce is suggesting. They are also concerned that they are seeing some people getting in and already trying to use leverage to buy, which suggests they might be under-capitalized. As a landlord, you need some underlying capital to be able to support the infrastructure and properly maintain the property. They are a little concerned about under-capitalized companies coming in. They have actually heard investors say things like they will buy the properties now and figure out how to manage them later, which is scary.
The cities are really willing to find them on their way to education. This is a lesson that some of these folks are going to learn the hard way, but there is still significant interest in finding ways to invest in the residential real estate market. There are precious few ways to do that from an institutional perspective. There is an opportunity to participate this way in a way that also fills the market need since Rick believes we will see significantly more rental activity over the next few years. It can be a win-win if it is done properly, and Rick tends to believe there is enough inventory for everybody that institutional investment is only going to take up a certain percentage of the market, individual investors like Bruce, and homebuyers will still be able to find the inventory they are looking for once the spigots are opened up a little bit by the people holding the assets.
With all the infrastructure of REO agents all over the place, Bruce wonders why a lender would choose to sell in bulk if they could just list them with people who used to have 500 listings and now have 50. Bruce wondered why they would choose the bulk route, to which Rick said this is a question the realtors raised regularly. If we were really dealing with limited inventory, and if all of the inventory saleable that way, then they would probably not be having a conversation about it. There are a couple macro trends that suggest this is an interesting way to go. Rick believes we are going to see homeownership rates continue to plummet for the next two or three years. We would not be surprised if they drop as low as 60% nationally. Bruce said it is a mathematical certainty since you have 8% of the people not making their payments for a long time. If that is the case, and in some cases the projections are even lower, you are going to have more inventory than you have buyers.
There is also a situation where 96% of rental units nationally are occupied, so rental rates are escalating and there is simply not a lot of available places for people to live. Extensive research suggests that most people still prefer to live indoors. That suggests that renting out some of these properties would seem to make a lot of sense. There is also a backlog of seriously delinquent properties that have not yet gone through foreclosure and have been delayed by things such as the robo-signing schedule, the attorney generals settlement, which ironically has now slowed things down yet again. However, when all that inventory hits and the regulators start pushing the banks to get some of that inventory off their books, they are going to have to do something with the inventory. With the most conservative number he has seen recently, there are still about 600 REO assets out there that simply are off the market and not being marketed. If they were all off the market, they would have a terrible effect on home prices. This is maintaining inventory levels and supply and demand control as well as trying to maximize value. Most investors Rick has talked to are willing to pay between $.80-$.90 on the BPO for these assets because they are looking at the return on the rental income over a certain period of time. They really don’t need to buy these things at typical bulk sale prices.
Bruce wondered if there is a mandatory date or date in mind when tenants have to exit the properties. Rick said that unlike the regulations that the lender has, like for example they have to typically get rid of a property within three years after taking it back; in his case they are instead looking at a minimum hold time of about 3 years to as long as 7 years depending on the given market. However, it does have some flexibility since investors have to have not only a long-term view, but also flexibility. If the programs works like it should, Rick said they are considering creating a REIT that makes it an ongoing investment opportunity. Here, you would basically buy and sell properties out of the REIT as market conditions dictate. If Rick’s prediction is correct that ownership declines for the next three years, then there is no way you are going to have price increases in any of those years. In some markets, this is going to be a recovery that is extraordinarily localized. We are seeing evidence of this even today. The reality is we are probably looking at a bumpy ride along the bottom of the market for the next several years on a national basis until we work through this lot of distressed inventory and until we get unemployment rates down to where people can start buying.
One of the things Rick has noticed is most of relationships or data points that would have causality or correlation have fallen apart over the last couple of years. Rick asked when we ever saw a period of time when prices, interest rates, and sales volume fell. The answer is never. Interestingly enough, the one that has not broken is the relationship between employment rates and home sales. Historically, there seems to be an inflection point somewhere in the neighborhood of 6-6 ½% unemployment where home sales either spike up or spike down depending on which way the unemployment is going. The most optimistic projection he has seen is we will not get below 7% unemployment for another 2-3 years. What is interesting about that is, for example, in Riverside we have about 45% of people upside down. This means the current owners are incapable of buying anything because of debt levels, and 60% of sales in Riverside are either short sales or REOs. This means 60% of the people who have un-owned their real estate are incapable of buying as well. You start putting together the numbers of unemployment, and you ask yourself who is expected to buy all of this inventory. It is not going to be the owner occupant in the next two or three years because they are going to be credit incapable.
Rick said they are flying in a credit ensemble from Switzerland; and they are coming in with Swiss francs and will buy Riverside entirely. This is one of the reasons a lot of the inventory is going to be purchased by investors, whether they individual investors, small groups, or institutions. There really is not a choice, and in the short run it is not necessarily a bad thing since it is better than having them be vacant. Rick said he has used this argument quite regularly when people started talking about how bad renters are in the neighborhood. Rick said he tends to think renters are a much better option than a vacant house that becomes a crack lab. It is an unfair thing to say about a renter who happens to be renting instead of buying in general, but a much better solution in a market that doesn’t need any more vacant homes.
Bruce thinks the finger pointing is to the investor. They are probably looking at the investor as unwilling to maintain the property at a level that is acceptable, even if the renter might want it to be. Bruce is in a group in Riverside where they are pretty well liked by the city, so they go to meetings and have made some headway in how they view investor participation in owning something. However, not all investors are created equally, so they are pretty cautious about thinking that another 10% of Riverside is going the rental route. Historically, you cannot blame them for this. There have been a lot of abuses over the years, and Rick thinks there is so much scrutiny on what is going on in the real estate market right now, and there is so much local enforcement of new regulations that some of it is going to be clipped out. However, the other point Rick said he would make is to not discount motivated self-interest. If we are an investor coming in to buy a property, rent it out for a number of years, and then try to sell it at a profit, you would think they would try to maintain the property at a level where we would be able to maximize the profit and keep somebody decent at the end of the process. This is one of the concerns Rick said he has about seeing people using leverage or looking for financing to buy these properties since they are not sure they are going to have the capital it takes to maintain these things adequately, which could be a problem.
When someone buys a bulk package of loans, it is interesting how the rules must have changed during the process of one owning several thousands of these loans at a time when MERS came into existence when we did not know what those four letters meant, then all of a sudden everyone in the country new within 90 days what it meant. This must have had a pretty profound effect on the cost level when dealing with a bulk of loans that you now have to look at and see if there are problems. Rick said they have either been extraordinarily lucky or extraordinarily good at their diligence. They made some decisions several years ago to not be a MERS shop at the time when everyone was running that way. They have applied this principal to loan purchasing as well. They have been known over the years as a difficult investor because they rejected a lot of loans that other investors were willing to buy for any number of reasons. He cannot say the portfolios they have purchased have been error-free and pristine, but they are probably better than what has been out there on average, and they have been able to avoid a lot of those problems.
Bruce said if he was an occupant owner and found out that Rick was the one who bought his loan, he would probably have a smile on his face because he would have more options than the original lender would have and would therefore have a lower cost basis. Rick said there are two separate initiatives being discussed. When they buy a pool of performing loans, it is not with the intent of creating rental properties from that pool. What they are looking for there are REO properties that are already vacant since they think that has the best impact on the market and the highest long-term return opportunity for their investors. When they purchase a pool of non-performing loans, typically those loans are priced at more of a bulk rate, which means the discount could be anywhere from 40-60% of the unpaid principal balance. This would make it market value in Riverside, although what you are shooting for is slightly better than market value. What you do then is try to work with the individual borrowers to modify their loans. It is a lot easier for somebody who has purchased a loan at a discount to pass along a discount to that borrower.
Bruce wondered what the most common outcome is for the owner occupant who is going to receive a loan mod with terms either changed, principal reduction, or opportunity to do a short sale. Rick said you almost always get the opportunity to modify your loan with. They have modified over 60% of the loans they have had in their portfolio, and typically the monthly payment has dropped by over 20%. In some cases, if they see a loan that has a good opportunity to continue to perform, they will consider principal reduction as well. Short sales are always their preference prior to a foreclosure since they think it is better for everyone involved. The ironic part of today’s market is sometimes the hardest person to convince to do a short sale is the borrower.
To find out more about Rick Sharga’s company, Carrington Mortgage Holdings, LLC, you can visit their website at www.carringtonhc.com.
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