What Happens Behind the Scenes During a Housing Market Correction?

First, the housing market isn’t going to crash with no one knowing what to do this time.

You aren’t going to see your neighbor’s home boarded up with a foreclosure sign in the window.  The reason you’re not going to see this is because the banking industry and our government are prepared for this upcoming cycle.  In fact, the Federal Reserve is attempting to bring the current boom cycle to an end, but we’ll talk more about that in a minute.

It’s not good for anyone to have a vacant foreclosure on their street.  It lowers everyone’s property value and it also invites crime. 

Therefore, in response to the mortgage crisis, over the last 10 years a network of downline services and institutional investors have emerged to quickly dispatch non-performing loans provided by the Federal Housing Administration (FHA), banks, and private sellers.  In this new market, both non-performing and performing loans are actively traded and discounted from the institutional investor down to the individual investor.

This network allows foreclosures, or the shadow inventory, to be managed behind the scenes.  The government and big banks don’t want to be a landlord or to have anything to do with fixing and flipping properties.  However, smaller companies and individuals are more flexible because they have the local grass roots knowledge and, most importantly, the time to do it right.

In my opinion, you will not see the opportunities you saw last time.  Before the process was slow and involved – having the bank secure the property and foreclose on individuals, which takes time and money.  It wasn’t uncommon to see a homeowner go two to three years without making a home payment.  Then the property would sit vacant while the bank figured out how to market it for sale on the MLS.

Banks have figured out that it’s easier to sell their distressed loans early, sometimes only after three to six missed payments.  They sell these loans for several reasons, however, the two most important reasons are time and money.  The longer a borrower remains delinquent with their missed payments, the less the loan is worth to an investor. 

It takes time and money to service a non-performing mortgage.  They need to hire outside consultants to value the property and help with outreach effort.  All of this costs money.  Meanwhile, the borrower isn’t making any payments so there is no cash flow.  The bank capital is wrapped up in the mortgage and the only fast way to get some of the capital back is to sell the loan at a discount.  They sell the loan at a discount because in most cases, no savvy investor would want to pay to be in the exact same position as the bank without an incentive.  

The size of the discount you want to offer is where it becomes an art form.  It depends on how quickly you can regain control of the property.  States like New York can take three to four years in some cases.  It depends on the condition of the property and the financial condition of the borrower.  It also depends on the type of loan.

Long story short, there are several factors and if you don’t have the experience you will be taught an expensive lesson. 

One lesson I will not repeat is only purchasing one loan at a time.  The issue is that many opportunities that are available in the one-off purchase are from hedge funds.  The hedge fund buys a large pool of loans.  Since they are purchased in bulk, they receive a significant discount.  They then cherry pick the best deals out of the pool and then sell the rest they don’t want to rookies. 

I had one hedge fund out of New York tell me I wasn’t his target market after I grilled him on his evaluation of a property.  It wasn’t because I was under-qualified – it was because I was overqualified.  We ended the conversation with him saying he prefers to work with newbies since he likes teaching others.  I guess the tuition costs were baked into the sales price.

There’s safety in numbers.  If I buy one loan and it goes bad, I’m out of luck.  If I buy five loans and one under-performs, I’m OK.  The more loans I buy at once, the bigger the discount.  But, there’s not only safety in numbers, there’s efficiency.  I must work with my team of lawyers, title companies, and loan servicing companies whether it’s one deal or one hundred.  If the loans are purchased in the same area, then I can receive a larger discount on the rehab costs, etc.

Our group has created a stable platform to invest in this new market.  We have been steadily purchasing performing mortgages and land contracts at a significant discount to create a foundation for this fund.  These foundation investments are secured by a 1st position lien on properties that have substantial equity and serve to provide an immediate return to our investors.  Additionally, we purchase pre-foreclosures (non-performing loans) from banks directly.   

Our strategy is to continue to create this reliable mix of real estate loans.  The performing loans create instant cash flow, while the non-performing loans create a pipeline of future high returns.  After re-positioning non-performing loans into either performing loans or selling them, we can capture the equity that was created. 

You can’t control Wall Street but you can control Main Street. It’s time to get back to simple investments secured by brick and mortar real estate. 

Interested in hearing more? Set up a time to talk click here.

Kind regards,
Kyle Zimpleman, Managing Member