Updated from 10:48 a.m. with statement from FHFA spokesperson and corrected to more accurately reflect pilot program transactions.NEW YORK ( TheStreet) -- At a time when institutional investors are pouring billions of dollars into the foreclosed homes with the purpose of converting them into rentals, Fannie Mae ( FNMA) and Freddie Mac ( FMCC) seem to be missing out on all the action. The bailed-out housing giants, also known as government sponsored enterprises or GSEs, together own over 150,000 foreclosed homes that should be ripe for the picking for investors scouting for bulk deals. But the agencies do not seem to be capitalizing on the opportunity to dispose these assets and it is unclear why. It was Fannie Mae that ushered in the "institutionalization" of the single- family rental business last year when it announced amid great fanfare a pilot "REO-to-rental" program.
The initiative was meant to test whether a bulk sale of REOs -- properties that go back to the mortgage owner after a foreclosure sale -- could attract private capital to the dispersed single-family asset class. The strategy was seen as a complement its existing strategy of one-off sales, with the added benefit of stabilizing housing markets that were weighed down by a glut of foreclosed homes. Through the pilot program, Fannie Mae managed to successfully offload over 1,700 foreclosed homes in three bulk-sale transactions to Colony Financial ( CLNY), Pacifica and Cogsville Group in joint-venture structured transactions. A portfolio of over 500 foreclosed homes in Atlanta was not awarded. The FHFA said the bids that it received did not present Fannie Mae with an economically viable transaction. It said the properties may be available for inclusion in a potential future structured transaction or through its retail sales platform.
The Federal Housing Finance Agency, regulator of Fannie Mae and Freddie Mac, said in late 2012 that it was "encouraged" by the results of the pilot program and was committed to pursuing the initiative. But it has since then been silent on plans to expand the REO-to-rental program. " "FHFA is still evaluating the results of the pilot REO-to Rental program and the evolving market dynamics," an FHFA spokesperson said. Meanwhile, Wall Street has stormed the single-family rental scene, traditionally dominated by mom-and-pop real estate investors. Institutional investors led by Blackstone ( BX) are pouring billions of dollars into foreclosed homes with the express purpose of converting them into rentals. Maybe Fannie Mae's pilot program was not an unqualified success after all. Perhaps it did not get as high a price as it wanted for the properties. Or maybe it could not attract enough buyers given its more restrictive terms. Fannie Mae required bidders to demonstrate experience in property management and to also show a commitment to stabilizing communities. For instance, the new owners had to pay for tenants to receive credit counseling to repair their credit. Or maybe the agency is still not sure that the business model will work. There is clearly plenty of interest in the single-family rentals, but it is not yet certain that investors would be able to replicate the success they have had in the multi-family rental business. Property management poses a big challenge. While the foreclosed homes sold are located in proximity to each other, ongoing maintenance is still costly when homes are dispersed, unlike multi-family units where they are all clustered into a single building.
Perhaps it is the politics of selling foreclosed homes to wealthy institutional investors. Many real estate brokers and mom-and-pop investors believe that such bulk sales give Wall Street investors an unfair advantage. Smaller investors are often outbid by the bigger guys. Many times, they do not even get a chance to bid, as properties are sold in bulk before they hit the market. Supply of existing homes is the lowest it has been in a decade. Given that the market is improving, the agencies may believe that it is easier to execute sales on the retail level. In any case, it would be useful if the FHFA were to provide an update on its evaluation of the program, given the rush of money that is now flowing into the single-family rental business. Meanwhile, investors who participated in the pilot program appear to be profiting from the deal. Colony Financial CEO Richard Saltzman said at a mortgage conference Tuesday that the company's purchase of a portfolio of foreclosed homes from Fannie Mae last year is working out "fabulously".
Colony Financial has an equity stake in Colony American Homes, which was one of three winning bidders in Fannie Mae's pilot program. Colony was awarded a portfolio of 970 Fannie- Mae foreclosed homes in Phoenix, Arizona, Riverside, California and Las Vegas, Nevada according to a transaction summary filed by the FHFA. Colony paid $35 million for a 10% equity stake in the portfolio. Under the deal, the firm receives 20% of the gross rental income as a management fee and 10% of revenues until Fannie Mae gets $136 million. Thereafter, Colony and Fannie Mae split the distributions from the business equally. Of course, the real boost for Colony likely comes from the enormous home price appreciation these cities have experienced in the past year. Home prices in Phoenix, Arizona were up 19% year-over-year in April, while prices in Riverside, California were up 16%, according to data from CoreLogic. Saltzman did not elaborate on the performance of the real estate portfolio. But he said he does not expect Fannie Mae or Freddie Mac to aggressively dispose of their REOs in bulk sales now that they were once again a source of revenue for the government. "Just given what a hot potato - candidly -- the whole GSE situation is and given that GSEs are profitable and a source of revenue for the government as opposed to a source of distress and given that things are looking better for housing in general, I think the pressure is off for the GSEs to continue to do these divestitures," he said. "Time will tell. Depending upon who really is in a managerial position the kind of focus on these initiatives and these efforts will also have a big influence. But it does not appear there is going to be a big pipeline of this stuff from where we sit today. " Fannie Mae and Freddie Mac held about 150,000 foreclosed properties on their balance sheet as on March 31, 2013. Both reported improving recoveries on the sale of foreclosed homes on the back of rising home prices. At Fannie Mae, net proceeds from the sale of foreclosed homes improved to 65% of unpaid principal balance in the first quarter of 2013 from 56% a year earlier. But the companies still face significant challenges in selling their inventory of homes. A significant portion of the REOs the agencies own are simply not marketable. Fannie Mae said in its latest 10-Q filing it is unable to market 42% of the more than 100,000 foreclosed homes on its books because many homes are in redemption status, where the borrower gets a chance to win back a home lost to foreclosure. Other homes are occupied by borrowers who are yet to be evicted or by tenants under its deed-to-lease program. Still others are in need of repair.
Freddie Mac, similarly, says it is unable to market 35% of its REO inventory. This might be another impediment to doing large bulk sales. A recent report by the Office of the Inspector General of the FHFA highlighted the GSEs management of foreclosed properties as a critical concern, especially in light of the agencies' significant "shadow inventory." As of Sept. 2012, the agencies had nearly 1 million mortgages that are over 90-days delinquent, but had not yet completed the foreclosure process and were yet to hit the real estate market, the report noted. The OIG said it will implement a proactive audit of the FHFA's and GSEs' efforts to dispose of the assets. The audit would include any expanded REO-to-rental program, it said. If the FHFA does decide to go ahead with the program, it might not make much difference to the single-family rental market. Investors have found plenty of supply without the GSEs participation. But if the FHFA's analysis shows that it benefits the taxpayer and communities, it would be a shame to miss the boat. -- Written by Shanthi Bharatwaj in New York. >Contact by Email. Follow @shavenk