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» VISIT US ONLINE @ DSNEWS.COM COVER STORY clearing out inventory before properties reach REO status. Dashed Expectations MARKET PULSE Rental Vacancies Future 4-1-1 POINT— COUNTERPOINT Andrew Jakabovics, senior director of policy development and research at the nonprofit housing organization Enterprise Community Partners, says he's been seeing bulk sales of nonperforming loans (NPLs) instead of bulk sales of REOs or other distressed properties. Investors are going in with the idea that they can either restructure the debt or end up with a property portfolio, he explains. "There's always been a market for notes, so I think it's been easier for servicers to justify bulk note sales, which have always traded, rather than moving into the REO sector," Jakabovics said. "I think you're starting to see some of the players who are involved both on the servicing side and on the REO side—who have the capacity to handle both sides of that transaction—making a heavy play back into the NPL space, simply because it gets them higher-performing assets or it gets them the properties" if their REO strategy is to build out a portfolio, he said. The REO market has also been affected by other areas of housing inventory, Sharga says. The number of existing homes for sale has been lower than anticipated because 20 percent of borrowers are upside down on their loans and unable to sell, and new home construction is at a virtual standstill. "All three areas of housing stock that would be available for sale are lower than normal, and at precisely that point in time is when large investors entered the market to try to buy properties to convert to rentals," Sharga said. Another factor affecting overall inventory is the fact that no potential seller wants to sell at the bottom of the market, according to Trulia's Kolko. "Prices bottomed about a year ago, which means that lots of homeowners are holding off putting their homes on the market," he said. The rising acquisition costs don't work in favor of investors in single-family home rentals who have a business model predicated on buying low and selling when the market recovers, Sharga says. Investors with a model based more on generating reasonable returns from rental rates, with value appreciation a secondary consideration, can weather the rising price environment more readily. LEGISLATIVE REVIEW the foreclosure process … [and] in a lot of cases, have just made REO vanish or not materialize," he said. Institutional investors—including big funds that expected to buy up large quantities of REO properties—never saw the bulk sales they had anticipated, Sharga says. These investors also encountered unexpected competition from individual investors and traditional homebuyers for an increasingly limited supply of REOs, so prices went up. Higher prices for REOs made it more palatable for investors to buy more traditional housing stock because there wasn't much of a difference between the asking price for an REO and the asking price for a comparable non-REO property. "We saw investors move upstream from REOs into short sales, into foreclosure auctions, even into traditional listings," Sharga said. TECH FOCUS Investors expected a lot more REOs to hit the market, and REO volumes haven't met with those expectations for a couple of years, Sharga says. Bulk sales of REOs never took off as expected either, largely because lenders were generally successful selling single properties. "I think that's part of the frustration among a lot of REO specialists in the real estate industry in special service firms who staffed up expecting to handle a pretty dramatic wave of REO properties," Sharga said. "I think what happened is that the industry staffed up for an anticipated flood and basically got a steady stream instead, and there simply isn't enough business volume to support all of the infrastructure that was put in place." Sharga continued, "If it had all hit at once, I think the industry would have been ready for it. But spread out over a longer period of time, it seems like there hasn't been enough business to go around, and eliminating some of the stock— properties that never made it to market—just exacerbated the situation for those businesses that were counting on it." The expected REO pipeline was substantially affected by government intervention—1.1 million loans have been modified through the Home Affordable Modification Program (HAMP), which spurred another 5.5 million loan mods through various lenders' propriety programs, and another 2 million underwater loans have been refinanced through the government's Home Affordable Refinance Program (HARP). Another factor affecting the REO pipeline is local and state legislation and regulatory changes that have delayed the foreclosure process in states like Florida and Illinois. The delays stretched foreclosures in New York and New Jersey to three years, for example, Sharga says. "There's shadow inventory there, but the anticipated REO activity never took place," he said. The National Mortgage Settlement of 2012 is another mitigating factor. To satisfy the requirements of the settlement, namely that lenders forgive about $20 billion in principal balances, it makes sense for lenders to reduce principal on high-dollar properties in states like California and Arizona that had significant price depreciation and to carry out those writedowns with significantly delinquent homeowners, such as through short sales, Sharga explains. "There are countless federal and state government activities that have slowed down REO inventory is still high relative to what would be considered normal—three to four times higher than normal—but down significantly from its peak, which was six times the normal level, Sharga notes. He says he's expecting inventory to continue declining. "I see about another three years of unusually high numbers, but declining numbers, and then we're going to get back to normal numbers at that point, assuming we don't have any economic disasters between now and then," Sharga said. "The [REO] pipeline has been pretty much shut off at the front end. We continue to see numbers drop, at least in terms of new delinquencies, so there's nothing replenishing what's in the pipeline," Sharga said. Quite simply, it all comes down to the basic, conventional dynamics of supply and demand—a semblance of "normal" market movement in what's been an erratic, abnormal cycle. 51

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