Wednesday, May 19, 2010

The economics of buying an REO for cash

Over at Calculated Risk, we find that mortgage delinquencies are at an all-time high. Yet people looking for low end homes to buy (like me, until recently) complain that nothing is available -- the short sales are stuck in short-sale hell because half of the people who have listed their homes as a short sale have no intention or ability to go through with it (because seconds won't release their liens) and are just using it as a delaying tactic, and the foreclosures are going to cash buyers for roughly 20% less than what the banks could sell them for if the banks would accept offers with financing contingencies. This is continuing to place appraisals into downward spirals that make it hard to have homes appraise at what the market value would be if we had an actual functioning housing market, thus makes it hard to get financing since it's hard to make the home appraise. Thus the banks prefer the cash investors despite the fact that their own best interests would be better served by issuing new mortgages to people who can actually afford these homes, but division A (distressed properties) doesn't talk to division B (originations) so it's like they're shooting themselves in the feet -- again.

So... who are these cash investors? How can they come in and buy a home for $390,000, then rent it out for $1700 per month, when my mortgage payments would end up at around $2900/month on that very same home? Wouldn't they lose $1200/month on that deal? Well, *NO*. Because they're not paying interest on the money they used to buy the home, these are wealthy dentists and lawyers and executives who have that much petty cash to spend. So let's do the math. $1700/month is a 5% return on investment if you have $390K to invest. Now, granted, the *actual* return is going to be less, because of management costs and taxes (which are around 1.2% per year here, so lop 1.2% off that 5% ROI). But Treasuries are going for roughly 0% ROI right now. People need a place to live, so it's going to take a *lot* to drive the cash ROI on homes down to 0%.

So that's the deal. It sure must be nice to be rich, because you win when the economy is up (you get to sell your investment properties bought during the troughs for ridiculous prices), and you win when the economy is down (you get to buy investment properties for 20% less than the "little people", then make a ridiculous ROI on them during deflationary times where everything else is at effectively 0%). The rich aren't like us. They don't have to work for a living unless they want to (remember, management companies are taking care of maintaining and renting these homes, for a percentage of the take). Their money does it for them. As an ordinary working stiff, isn't that, like, the coolest thing you ever heard of?

-- Badtux the Money Penguin

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