Hedge funds try to turn a profit, one home at a time

With other distressed markets played out, big-ticket investors start snapping up homes in Northeast

May.May 01, 2013 07:00 AM

Over the past year, much ink has been spilled on the phenomenon of institutional investors snapping up distressed single-family homes across the country, a trend that took off last year after famed investor Warren Buffett famously said he’d buy up “a couple hundred thousand” single-family homes if it were practical.

Since then, REITs, hedge funds and private equity players have competed to buy thousands of foreclosed houses in states like California, Nevada and Arizona — where the downturn left thousands of homes available for pennies on the dollar — renting them out to yield handsome returns.

The buying frenzy has been so intense that distressed homes in these areas have grown scarce, driving up prices and forcing investors to expand to other markets. As a result, some institutional investors are now looking at homes and commercial properties in the New York City area. And industry insiders said they expect that interest to grow as more foreclosed properties become available here.

The single-family home-buying trend is “moving east,” said Daren Blomquist, vice president at RealtyTrac, which monitors foreclosures. “We’ll start to see this shift to other markets as these investors run out of good inventory to buy in the Western market.”

He noted that there have been fewer foreclosures in New York than in harder-hit regions, and the foreclosures here have been slower to appear because the state takes longer to process them. But the supply of foreclosures here has increased over the past 10 months, he said, providing more opportunities for investors.

A first-quarter market report from RealtyTrac showed that foreclosure starts in New York State increased some 200 percent from the same quarter of last year — the highest annual increase in the nation.

Of course, investors will need a different strategy in New York, where homes have retained much of their boom-time value, than in hard-hit markets. Rather than focusing primarily on short-term yields, institutional investors buying properties here are more often interested in long-term price appreciation. That can mean distressed single-family homes or other types of real estate; sources said they’ve already seen hedge funds buying commercial properties in the Hamptons.

“There are institutional buyers that are buying in New York, and even are buying in [Upper] Manhattan, because they think there is a supply constraint there and that the market is going to go up,” said Ryan Hinricher, a portfolio manager at the residential real estate investment firm Investor Nation, which has worked with institutional buyers purchasing single-family homes.

It’s unlikely that the New York area will ever see hundreds of homes being snapped up at once by investors, experts said. Still, “there’s high demand and a lot of money behind these folks, so they’ll be looking for every opportunity they can get to buy properties,” Blomquist said.

An institutional shift
Investing in single-family homes is, of course, nothing new. For decades, investors have purchased houses or apartments on the cheap, fixed them up and sold or rented them for a profit.

But that market has traditionally been the province of mom-and-pop investors and smaller companies; until recently, deep-pocketed Wall Street players have largely stayed away.

“The institutional buyers have always purchased shopping centers, major apartment communities — they’ve never really been in housing,” Hinricher said.

But that’s changed in the past two years, Blomquist said, with hedge funds and institutional investors acquiring thousands of distressed single-family houses and leasing them out. Typically, these investments yield annual cash-on-cash returns of 5 to 8 percent, Hinricher said.

“I would say 2012 was the year it really took off,” Blomquist said. “In 2011 you had some of the really early players getting in, but the hedge fund–type, Wall Street–backed money didn’t really jump in until 2012.”

The strategy has exploded since then, with private equity giant the Blackstone Group reportedly spending $3.5 billion on 20,000 single-family houses and Thomas Barrack’s Colony Capital raising $2.2 billion. While most of the groups buying individual houses are private entities, some have now announced plans to go public, creating single-family REITs.

Due to interest from these investors, vast amounts of inventory have been absorbed in markets like Orlando, where investors over the last 12 months “bought up all the cheap stuff,” said Hinricher.

Jon Grabowski, president of Precise Associates Inc., a Detroit-based investor that purchases houses and rents them out, said he and other investors have begun considering acquisitions in the Northeast, including Baltimore and Philadelphia.

Home prices are still too high in New York, he said, but that could change.

“The model makes sense in the Northeast, and it’s a completely untapped market, which is attractive to us,” he said.

Some investors have already dipped their toes in the water, purchasing distressed single-family homes in the New York area.

RealtyTrac identified at least 12 investor entities that included single-family homes in New York State among the large numbers of foreclosed properties they purchased in 2012. For example, a California-based entity called Lvs Title Trust I last year purchased seven foreclosed single-family homes in New York, including one in Brooklyn, one in Staten Island and one in Suffolk County. That was alongside some 120 other homes it bought nationwide. So far in 2013, the entity has purchased three single-family homes in New York State, including one in Brooklyn. Meanwhile, an entity called Gecko Realty bought five foreclosed single-family homes in New York State — including one in the Bronx, two on Long Island and two in the Hamptons — in addition to around 20 other properties it purchased across the country.

Of course, not all of these are institutional investors — some are likely smaller companies or property flippers. For example, as The Real Deal has reported, Retained Realty is a company affiliated with Howard Milstein’s Midtown-based Emigrant Savings Bank that specializes in buying distressed properties and quickly selling them for a profit. According to RealtyTrac, Retained and associated entities purchased 29 foreclosed single-family homes in New York in 2012, including four in Queens and 12 in the Hamptons.

And Blomquist said huge players like Blackstone don’t seem to be purchasing large numbers of single-family homes in New York — at least not yet. That’s partly because there simply aren’t enough distressed properties available to make it worth their while.

Still, some large players want to diversify and provide investors with a “blended return” by buying a few single-family homes in the New York area, Hinricher said.

And experts said interest in New York is growing, especially as more foreclosures are coming down the pike.

New York, like Florida, “has a very lengthy foreclosure process,” Blomquist said. “It’s just taking longer for some of the foreclosures to come through the pipeline. So we believe there’s going to be more opportunity to buy at the foreclosure auction in New York than last year.”

A market like Queens, which has seen more foreclosures than other areas of New York City but where rents remain high, would make sense for institutional investors who want to buy up single-family homes, he said.

Some investor groups are even buying individual apartments in areas of Upper Manhattan, Hinricher added, where new big-box stores and major infrastructure investments like Columbia’s expansion are attracting institutional money.

Hedge funds + Hamptons

Now that hedge funds and other players have gotten a taste of the single-family market, sources say they expect them to expand into other sectors of real estate.

Already, “hedge funds are adding Hamptons properties and commercial properties to their portfolios,” said Ernie Cervi, executive managing director in Bridgehampton for the Corcoran Group.

He declined to give more details due to client confidentiality, but said funds are investing in a range of East End properties, from those that “can be developed and resold” to longer-term investments, “from raw land to commercial properties.”

One reason for the interest, he said, is that commercial spaces in the wealthy Hamptons are few and far between. “Given the limited amount of commercial space in each hamlet, one might think that a commercial building in an exclusive resort town can only become a trophy property and increase in value over time,” he said.

Michael Rossi, who managed a trading desk for a boutique hedge fund before cofounding the Manhattan-based residential brokerage Elegran Real Estate, agreed.

“Whenever there’s some type of weakness in any market, hedge funds will move into that marketplace,” said Rossi.

Whether it’s commercial properties or single-family homes, real estate brokers may not realize that their buyer is a hedge fund.

Tony Cerio, a Brown Harris Stevens broker who has several commercial properties for sale in the Hamptons, said buyers rarely give details about the identity of the investors in a deal.

“We have groups that look at them, whether hedge funds or not — we don’t know,” said Cerio, who is listing Inlet Seafood in Montauk for $21 million. “But they don’t come right up to you and say, ‘We’re a hedge fund buying.’ They never let you know that.”

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