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"There is a lot more capital investment needed to bring properties up to rental condition as opposed to REO [resale condition]. It's a huge, huge learning curve." —Cheryl Lang, Integrated Mortgage Solutions In addition, the housing recovery has gained a stronger foothold in the past year, making discounted REOs harder to find as evidenced by market indicators such as steady home price increases and declining foreclosure inventory. In fact, as of May, Lender Processing Services reported a year-over-year jump in home prices of 8.1 percent and a year-over-year drop in foreclosure inventory of 27 percent. What was once declared to be the next big play in housing now seems to be shrinking into the background with declining interest from investors, an absence of funding, and a lack of distressed inventory for bargain buys, without even the promise of properties to come considering the industry's shadow inventory assessments have contracted to fewer than 2 million properties. There is still potential for big returns, however, particularly for those who got in early betting big on home price appreciation. While investors can learn from traditional rental models, the REO rental market requires professionals dedicated to the unique challenges surrounding REO to truly thrive. "One of the biggest problems with REO-torent today [is] the gap between knowledge and actual execution power," according to Ron D'Vari, CEO and co-founder of NewOak Capital, a financial advisory and investment banking firm. "The operational challenge has been that REO-torent was not considered an asset class until recently." Investors will find that in order to fully protect their assets and maximize returns, the straightest line from REO to cash-flowing rental involves strong industry partners with experience in both the rental space and in tackling issues unique to REO, from financial advisory firms that use technology to flesh out portfolio models to property managers who can dually handle rehab and tenant issues. With the right components in place, investors of any size or affiliation can shrewdly capitalize on the swelling—and long-term—consumer demand for single-family rental properties. In D'Vari's words: "This is an asset class. You need to buy it right. You need to have a 52 revenue model for it and an operational model for it. It needs to be purchased, refurbished, and it needs to be, of course, rented." Addressing Portfolio Challenges When it comes to working in the REO rental market, "the biggest challenge is how you do due diligence on a portfolio," D'Vari cautioned. David Hicks, co-president of HomeVestors of America, agrees. "Many REO brokers are having challenges because they are buying properties, some at pool, and not knowing what they are really buying," he said. Hicks often coaches franchise owners on managing rental properties and has found that many who are new to the REO rental market may not have a very clear and concise picture of the status of assets in their portfolio. "When buying REOs, [investors] tend to buy properties that are scattered in terms of location, so they don't have as much control in terms of the areas as they [could] have," Hicks said. Among the most important requisites he has for people who deal with REOs are market knowledge and familiarity. "[Make] sure that you know the market well enough so that you know how much you have to put a property through rehab-wise to make it rent-ready. If you go into a market with a rental budget without knowing the market, you can be in trouble," according to Hicks. Renee Deane, EVP of operations for Carrington Property Services, says some of the key markets for REO rental are Phoenix, Atlanta, Chicago, Las Vegas, Southern California, and parts of Tennessee—not surprisingly some of the areas that saw the greatest depreciation in the subprime meltdown. In order to do business in these markets, it is crucial that professionals understand local codes and market standards. As D'Vari and Hicks point out, managing and modeling rental costs—from initial acquisition of the property to maintenance costs to setting rental rates for tenants—can saddle investors with unexpected challenges and expenses. When handling REO properties, D'Vari advises having a clear picture of the properties. He says one critical need for anyone wanting to play in the REO-to-rent space is "the ability to remotely manage every asset and connect all the available information." The key to this is having a strategy in place for the property, from its acquisition to an eventual resale—"cradle-to-grave" as D'Vari calls it. "What portion of the asset do you want to do due diligence on? What do you want to bring back from the field? How much do you want to spend on that acquisition pre-closing? These are all important questions," D'Vari said. "You have decisions from initial portfolio review filtering, to narrowing down properties to what you want to buy, to pricing it and putting it under contract, to deciding how you want to close and operate." Tackling Tenant Challenges Perhaps the biggest difference between traditional REO sales and REO rental is, of course, the tenant. As in traditional REO sales, the types of renters taking advantage of available REOs run the gamut. Many have been homeowners in the past or are looking for a stepping stone between apartment rental and home purchase. "Single-family rental as the new asset class in the commercial division has a lot of potential," said Christopher J. Crippen, fund manager for US Residential Asset Fund, LLC. "It fills a missing gap in the multifamily-rate portfolios … usually a customer graduates out of their [multifamily apartment] property once they have a family." Recognizing the close link between singlefamily renters and future homeowners, many investors with rental properties incorporate a rent-to-own feature into their offerings. Crippen says this allows investors "to give potential renters or current tenants a financial workshop or snapshot to help them get into homeownership." One model that Crippen has found works well involves the renter putting a little more down for the deposit, depending on what they can afford, and then they pay a little more each month, which adds up to a good-size down payment down the road if they choose to purchase the property.