In January 2012, Carrington Holding Co. was so bullish on buying and renting out foreclosed single-family homes that it obtained $450 million in financing to fund a buying spree of vacant real-estate owned (REO) properties from banks and mortgage servicers.

But less than 18 months later, the Santa Ana, Calif.-based firm — one of the nation's largest players in single-family property management, lending and servicing — decided it was time to throw in the towel. The market had lost its lucrative yields and had become oversaturated with hundreds of institutional investors. After witnessing the fast rise in home prices this year and the disappearance of REO discounts from banks in the reheated housing markets of California, Nevada and Florida, Carrington called it quits this past May.

"REO properties used to trade at a 20- to 30-cent [on the dollar] discount three years ago," says Christopher Whalen, Carrington's managing director and executive vice president. (He also is one of banking's more vocal risk analysts.) "Today, investors in REO properties for rent are basically paying retail, multiple-listing prices for residential assets."

It's a turnaround few anticipated after the housing slump reached a trough in 2009, when discounted distressed properties accounted for about a third of total home sales, according to CoreLogic.

As recently as December 2011, Fitch Ratings gloomily forecast that the bank-owned property glut was "staggering." But a flood of investors stepped up in early 2012 after the Federal Housing Finance Agency started allowing white-shoe investors to purchase pools of Freddie Mac- and Fannie Mae-owned properties in certain distressed markets to relieve the glut of foreclosures on the books.

Today, the REO headache many thought would be amassed in banks' portfolios for years to come has all but dissipated in those former trouble spots.

"REO inventory is down significantly," says Paul Leonard, senior vice president of government affairs for the Financial Services Roundtable's Housing Policy Council. "I've heard that it's down more than 30 percent since 2011—some have said more—mainly driven by fewer delinquencies and foreclosures."

"For a bank," says Whalen, "you've probably sold most of your REOs in California and Nevada by now. It's gone, or it should be."

Mortgage giants Bank of America and Wells Fargo would not discuss the status of their REO properties and secondary market sales for this story. A spokesman for BofA said it does not share data on its REO inventory or its return on REO sales. Wells did not return calls seeking a comment.

Carrington is leaving the market at a time when other investors remain active in amassing bulk purchases of REO properties. Many of these investor groups have failed to turn a profit on the properties, but like private equity giant Blackstone Group, which owns $4.5 billion worth of single-family rental properties, carry on in hopes of either riding the crest of higher rents in a rebounding housing market, or someday securitizing portfolios of "REO to rentals."

If the securitized market for REO-to-rental were to take off, then it might be worth the low-single-digit margins that investors currently are tolerating on their REO purchases, after accounting for taxes and maintenance costs.

In May, the National Association of Realtors reported that April sales of previously owned homes were up 0.6 percent from March, and the median sales price ($192,800) was up 11 percent from a year ago, all on a shrinking base of supply, as listings were down 13.6 percent from a year ago.

The comeback has been strongest in some of the states hardest hit by the housing downturn. For March, CoreLogic's Home Price Index registered the strongest year-over-year gains in Nevada, where prices jumped 22.2 percent, followed by California (17.2 percent) and Arizona (16.8 percent).

One of the factors in the improving housing situation (and the dwindling REO count) has been the rise in the number of short sales, which banks are increasingly favoring as a way to avoid lengthy and more costly foreclosure procedures. Legal hindrances, such as the homeowners' bill of rights in California that restricts dual tracking and imposes stiff fines on improper documentation, also have been a prod for banks and servicers to steer clear of foreclosing on delinquent owners.

Matthew Heidenreiter, senior director of outsourcing services at CoreLogic, says that short sales are accounting for a higher percentage of distressed sales these days. In January, short sales represented close to 10 percent of total home purchases, versus 5 percent five years earlier, while the share of total home sales that could be categorized as distressed sales has remained steady at nearly 25 percent.

"In some states, [short sales] have taken the lion's share of distressed sales," Heidenreiter said at an April mortgage servicing conference in Dallas sponsored by National Mortgage News (which like American Banker Magazine is a SourceMedia publication).

Distressed sales are, of course, more pronounced in certain markets. In Nevada and Michigan, problem properties make up nearly half of all home sales. In California and Florida, it's between 30 percent and 35 percent.

Heidenreiter sees several other trends contributing to the declining threat of REO exposure for banks, including a seven-year low in the default rate in California. But he warned of an overhang of "shadow inventory" foreclosures that have yet to hit the marketplace.

Though CoreLogic estimates the number of delinquent homes that banks have failed to act on is down to 2.2 million (versus 3 million in 2010), Heidenreiter tallies up 26 U.S. states that carry 90-plus day delinquency rates above 5 percent. In nine states, the percentage is above 7 percent.

"Unless they all win the lottery, those aren't going to shore up overnight," Heidenreiter says.

"There are still underlying issues there. There's still delinquency. There are still borrowers whose homes are at risk, which is going to equal more foreclosures and more distressed homes sales in the future."

Bankers are aware of the delinquencies issue, which is why they have been picking up the pace of loan modifications and short sales, says Eric Selk, executive director of the industry-backed HOPE NOW Alliance, which is trying to resolve issues of REO distribution and foreclosure prevention.

"In the first quarter of 2013, 84,000 short sales were performed by the industry," says Selk. "That's a lot of work that was done in three months."

But so far, all signs point to a nearly endless stream of buyers, be they home dwellers or investors, who are relieving banks of the REO properties at near base-price offerings. Leonard says that informal surveys of the Financial Services Roundtable's members indicate that "once a property is repaired and listed, it's typically on market for 45 to 60 days." At one member firm, it was taking an average of just 177 days from foreclosure sale to cash received, he adds.

Many institutions, through the guidelines established by the Home Affordable Modification Program, are able to keep troubled homeowners in their residences by helping them stay below a 31 percent debt-to-income ratio on modified payment plans. And some, such as Wells Fargo, are partnering with community development nonprofits through the National Community Stabilization Trust to revitalize abandoned or foreclosed homes and repurpose them as affordable housing units or rentals in underserved neighborhoods.

Carrington's Whalen says that though the firm is turning its back on REO rental acquisitions, it is attempting to help bring relief to distressed markets.

But rather than seizing and managing REO rentals for little to no return, Carrington instead will focus on acquiring nonperforming loan portfolios, and will put a priority on working with delinquent borrowers to keep them in their homes—which Whalen says is the best possible outcome for the investor, the borrower and the neighborhood.

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