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Bruce Norris is joined again this week by Rick Sharga. Rick is the vice-president of Carrington Mortgage Holdings and one of the country’s most frequently quoted sources on foreclosure, mortgage, and real estate trends. Rick has appeared on every major network and news show in the country, and he has even briefed government organizations such as the Federal Reserve and Senate Banking committee on foreclosure trends. Prior to being with Carrington, Rick was senior vice president of Realty Trac, with is responsible for marketing and business development.
Bruce asked about what kind of experience it was to speak in front of the Federal Reserve and Senate Banking Committee. Rick said it was an eye-opener, particularly when you realize how broad a range of subject matter on which these people have to become instant experts. This was especially true in talking about some of the more arcane aspects of foreclosures, how the processes work, and how there are 51 different jurisdictions across the country that all operate a little differently. This gave Rick an appreciation for the magnitude of the job they try to do because there is so very much that they need to try to absorb.
Speaking in front of the Fed was a little humbling for Rick. He was talking to the chief micro economist and the chief macro economist, and they were asking for Rick’s opinions on the market. He said it should be the other way. It was very gratifying for him and humbling to have enough of a reputation within a certain subject matter to be able to share it with other people who can put it to use.
It is a daunting task for the committees when you think about all the subjects on which they have to get up to speed. They most likely invite experts in and tell them to get them up to speed. This explains why well-intended and seemingly logical legislation that gets passed goes so horribly wrong. There really isn’t the expertise that comes with the business aspect of being involved in the everyday aspects of the operations like a lot of people like Rick are. The other part is you have agendas that really step up to play, so you really have to consider if you are hearing facts or if you are hearing wishful agendas. Rick jokingly said he was shocked that Bruce thought there were agendas playing in Washington.
Bruce asked where Carrington Mortgage Holdings is located. Rick said their headquarters is in Orange County in Alisa Viejo. They have an investment group that is headquartered in Connecticut as well as servicing operations with facilities in Santa Ana, California and Fishers, Indiana. Bruce also asked how many people all together are employed by the company. They have a little over 2500 employees and are continuing to grow. They are seeing growth in a number of their businesses, including the servicing business, loan origination, and real estate brokerage. Rick said it has been an interesting transition coming over to Carrington and seeing all these various aspects of mortgage and real estate related businesses we never had.
Bruce asked if this was the very definition of vertically integrated. Rick said they stopped talking about vertical integration because nobody really understood it. Rick said the CEO does like to say that they do just about everything involved in residential real estate transactions outside of cutting down the trees. It is an integrated operation in the regard that they have business units that invest in pools of loans, that write loans, service loans, buy and sell properties for consumers or investors, write title insurance, do property preservation and construction. It is really does run across the board; and the flip side of that is, depending on the customer, they do not have to work with all those entities.
Bruce said it would sound like Rick and the employees have been in the business for fifty years, but that is really not the case. It is like an accidental success story that the company really started as an investment management business. They began in 2003 investing in pools of subprime loans and managing the credit risk on the loans. When the market went sideways, the company bought the loan servicing business from New Century when they filed bankruptcy. They did this primarily because the loans that had been purchased were sitting in that servicing platform, so it was a defensive move. Bruce Rose, their CEO, likes to say that he had visions of running a hedge fund in Connecticut and suddenly found himself with a 600 person servicing operation. All the other businesses really have grown since then to support some of the other businesses.
It’s funny how things work out sometimes. Rick said Bruce Rose never had a master plan to be involved in all the various aspects of mortgage and real estate operations, but he has certainly been flexible enough in that he had a vision once he got started to put together a good business model.
Rick’s company also has a new loan origination business. Bruce wondered if this was originating loans only for owner-occupants or for investors as well. Rick said it is primarily for owner-occupants. It is aimed at this market, and they do a lot of FHA loans. They also do refis and retail lending. They have branches in about 22 states, and they have a wholesale channel, so they are also working with mortgage brokers and helping them to get consumers funded.
One of the services Rick mentioned was he buys existing note pools. Bruce wondered if this is usually a national note pool. Rick said a lot of the pools are regional, although they are buying nationally. Very often the pools have some regional influence to them. What they are really buying mostly are pools of non-performing loans since their servicing group is very good at getting those loans to re-perform. This is a win-win since it is best for the borrower and ultimately best for the investor as well.
Bruce wondered who the seller typically is, whether they are FHA or Fannie. Rick said they have participated in both government agency pools as well as pools sold off by large lenders or other financial institutions. Typically they work these loans through their servicing group and ultimately wind up foreclosing on less than 20% of the loans they purchase. The guys are very good at finding a way to come up with alternative disposition strategies other than foreclosures. It is a big deal when 8 out of 10+ families get to stay there and retain ownership. Bruce wondered if this is typical, or if they turn to lease or sometimes renters. Rick said no but that this is an interesting phenomenon. They really expected to see more of an interest in people handing over the deed and taking a lease. What they found was that the people who want to stay in the homes really want to stay in as the borrower and just do a loan modification. Since they are buying the loans at a discount, they can usually pass on some of the savings in terms of lower payment prices on a mortgage.
A lot of the people don’t really want to stay anymore, so they become very good candidates for short sales or even sometimes deeds in lieu. In other cases, people are really just ready to move on and get on with the rest of their lives and are happy for the opportunity to do a short sale so they don’t have debt hanging over their head.
Bruce asked Rick if a high percentage of the time the occupant owner is cooperating with a short sale or if they are getting the loan recast and stay to make the payment. These two categories make up the 80% that he talked about with Bruce. A lot of it depends on the pool and what part of the country you are in, whether the Northeast or elsewhere. If you are in the northeast and in a state like New York where you have 1100 day foreclosure cycles, it is sometimes harder to get a borrower to agree to a short sale since they know they do not have to do anything for a couple years. It takes 1100 days for a foreclosure in New York and 1,000 in New Jersey. It will ultimately wind up having a negative effect on the real estate recovery since the distressed inventory will be around for so long.
Bruce asked if Rick thinks we will ever see a national foreclosure law. Rick said probably not, at least not in our lifetime. The CFPB recently put out national loan servicing standards, and those were mostly aimed at servicing of delinquent loans. After they issued their national standards, they issued an addendum saying that state laws trump these national laws. From the perspective of a company that does loan servicing in many states, it would be great to have one set of foreclosure rules and one set of servicing standards, but it really does get into the whole state rights versus federal rights issue. Right now foreclosure laws are all managed by the states.
Carrington is also buying properties, although very selectively. They think the market is very frothy right now. Rick and Bruce have talked about how well some of the business models hold up or don’t hold up as home prices appreciate very rapidly. Right now there are better opportunities in things like non-performing loans and mortgage servicing right now. They are just not willing to pay 125% list price for a property they are going to hold onto and try to get a rental return. At the same time, there seems to be a new player willing to do that almost every day. Everybody has a different business model. There was an announcement recently about one of the companies having an IPO. If you are overpaying a little bit but put some leverage into your purchase by getting other people’s money, sometimes the returns look better. Rick said he does not know what the implications are for the people that are doing the follow-up investing on properties that were intrinsically over-valued. There is a lot of money coming into the return rates, so it will be really interesting to see if they are able to deliver what their perspectives indicated they would.
Rick is probably a lot more familiar with the different business models that are out there. For Carrington’s purpose, Bruce wondered if whenever they bought a property it was always the intent for them to have it occupied by a renter for some period of time and then resell it for a profit. Rick said typically when they buy a property this is the model. It is almost always with the notion of having somebody rent the property out for a period of 3-5 years and then sell it as home prices appreciate. Their model was and is a hybrid model. There are rental returns built into it as well as home price appreciation. When a market overheats, it really makes both parts of the model difficult to achieve because the underlying collateral is potentially over-priced.
Bruce wondered what surprised Rick as he went through the buying effort. He wondered if there was something more difficult than he thought it would be originally. Rick said there were a couple things, and the two biggest really come down to inventory. The properties of REOS and lender-owned properties really dried up much more quickly than they or anybody had anticipated. As part of that, there had been speculation that they would see a lot of bulk sales and fairly large pools of properties sold. This has really not been the case as there has been a couple exceptions over the last few years, although really not that much. The other surprise was how much interest developed in the particular asset class so quickly. It seemed there was a new company announcing a new $100 million fund every day. It went from an interesting idea to the investment topic de jeur.
Bruce said when they are bidding at the trustee sale they can always tell that somebody has gotten their first $100 million since it is usually spent in a 3-day period. Along these lines, Rick heard an anecdotal piece from an auction in Atlanta where one of the institutional people ran out of checks. What is sad is that because they are doing so much business, the auctioneer actually waits for them to come back. From the auctioneer’s perspective, it makes sense to wait for the person who is coming back with the fresh set of checks.
Since people worry a lot about home price inflation rather than appreciation, the encouraging thing Rick has seen is that as the investors have come and gone from some of the markets, the prices have held. They may have accelerated the price appreciation and driven prices up a little faster than they would have gone on their own. However, once they have hit that new level they have generally held. This suggests that the value is still right for the properties that are being purchased. Rick brings up a really important point and something that is really a concern of people that are investors. Bruce does not think the homeowners really thought things out because this is a new experience. Bruce does not recall ever having this money invested in single-family homes. To Bruce, this is an unprecedented group of people. Collectively, all of these companies together have become market-makers.
Rick thinks the aforementioned is over-stated in the press right now. On a localized basis you could sometimes make an argument that they could become market makers. If you look at Phoenix last year and Atlanta, you see it happening. Collectively, there was $10 billion of funding announced last year, which was not all spent. $10 billion as a percentage of the overall housing market where there were about 5 million units sold is really a rounding error. Bruce has been studying foreign buying, which is about $800 billion. Rick does not think the institutional investors are really market makers in a broad sense. It has been interesting press conversation since it is not a new phenomenon. In terms of actual impact on the overall market, this affect has been overstated.
Bruce wondered if he also feels the same way about rent values. He wondered if they would not have so much inventory that they would sway. Rick said not yet since rental units are still occupied somewhere north of 95% across the country. What they have seen on a short-term basis is you take a neighborhood in Phoenix, and suddenly there are a lot of homes on the market for rent. You might have a temporary over supply because you cannot break their lease and move into something new. There could be some softening of rental rates, but he does not think it is because the entire inventory is hit at once.
FHA just announced that they were selling 40,000 notes this year, which is in a competitive bid situation. Bruce wondered if the FHA retains part ownership of this. Rick said he is not aware of any of those types of arrangements where the seller retains partial ownership. Rick believes they are all at right sales. The government pools, specifically FHA pools, tend to come with more specific requirements and language about what the buyer may or may not do with the pools. In the FHA pool that was sold earlier this year, there was some language that restricted buyers from being able to foreclose on properties for a certain period of time. It required a certain percentage of loan modifications. There were more restrictions and requirements with the government pools than with the private pools, and Rick believes they are all outright sales.
Bruce wondered if these are all auction type settings to where it is just the highest bidder who receives it. Rick said he is sure highest bid is one of the factors, but there are also performance and disposition considerations. He is not sure it is necessarily 100% based on the highest bid, but they do at least have to be competitive.
Carrington has a model where they are going to buy and sell a property. Bruce wondered if there are other models he is aware of that are going to have the single-family homes with a different disposition where they may be putting the homes into a scattered apartment type REIT. Bruce said they would not come back on the market; although Rick said they will at some point, and this is one of the differences between a traditional apartment REIT and a real estate investment trust. It would make sense to build flexibility into a REIT like this where you can move certain properties out and replenish with other properties as they come to market. Rick is not aware of anybody’s plans that call for a permanent hold of the rental properties. The big variances tend to be the length of the potential hold and how much of the return for your investors you are planning to get for rental rates as opposed to home price appreciation.
Rick talked to a group in Indiana, and they were looking at 18-20% annual yields on the rentals, but they were really ultra holds. They did not see prices appreciating in a suburb in Indianapolis any time soon. Rick said they saw another big investor get out of Northern California since they were buying three $400,000 homes. You cannot simply have rental yields since you cannot charge $3-$4,000 a month rent for too many tenants. What they saw was home prices appreciating more rapidly than they thought, so they got out and made their profit. The REITs would be long holds. What you are basically counting on is the cash flow from the rental units being what you are investing in. Those building units would stay in the REIT longer than a typical buy and short-term hold. There could be some transactions that move properties in and out of that REIT.
Bruce asked Rick what a long-term hold would be. Rick said it would probably be anywhere from 5-10 years, which is a long-term hold. The average for most people going in was they were looking at a 3-5 year old. If you are looking at a REIT, you are probably looking at something a little longer than that. Bruce said it would seem to him that most of the product they would have in the REIT would have to be bought in the next 6-12 months. One of the largest investment groups looking into this was Blackstone, and they really believed there was about a two-year buying window, and we are in the second year of this right now. As prices go up, it gets harder to get the returns you are trying to find.
Bruce wondered if they keep switching locations, or if they do them all simultaneously. Rick said you are actually seeing a movement right now away from some of the more popular states. Typically everyone started where the foreclosure numbers were the highest, so you go for states such as Arizona, California, Nevada, Florida. What we are seeing now is a movement into second tier states, or states that did not have as terrible a fall from peak to trough in terms of home prices. In this case, you can buy reasonably priced homes and get a reasonable rental yield for the next few years. It is really not a buy/flip business so much as it is something that already cash flows and you might as well keep it.
Bruce asked Rick if he thinks this model is going to be gone at some point and they will find something more traditional to do with their billions of dollars. Rick said as there are other opportunities to deliver good returns, you will see less interest in this. However, he thinks you will see a more permanent group of large investors in the single-family rental space when we come out of this cycle than when we started.
For more information about The Norris Group’s California hard money loans or our California Trust Deed investments, visit the website or call our office at 951-780-5856 for more information. For upcoming California real estate investor training and events, visit The Norris Group website and our California investor calendar. You’ll also find our award-winning real estate radio show on KTIE 590am at 6pm on Saturdays or you can listen to over 170 podcasts in our free investor radio archive.
